A FEER Model for the Equilibrium Chinese Yuan/US Dollar Real Exchange Rate

This paper provides an application of the FEER model to the real exchange rate of the Chinese Yuan against the US Dollar. An important contribution is that we incorporate into the sustainable current account fundamentals that reflect the unique features of the Chinese economy but have not been employed by previous studies. Another contribution is the construction of a unique data set of consistent time series for economic fundamentals and trade-related variables, which allow us to carry out an econometric investigation of trend and sustainable current accounts and compute the FEER for both pre- and post-reform periods. The empirical results show that both the sustainable and trend current account surpluses have been steadily rising since the early 1990s. Chinese exports appear to be more price elastic, while imports are more income elastic. The misalignment rates suggest that the RMB was overvalued against the USD during the pre-reform period and has been undervalued for most of the postreform period, particularly since 2003. However the misalignment rates are not as large as suggested by previous studies