Asymmetric long-run effect of exchange rate on bilateral trade balance between USA and China

Purpose - This paper aims to investigate asymmetric long-run effects of bilateral exchange rate on US trade imbalances with China and to examine if the effects are the same under China’s fixed and managed floating exchange rate systems. Design/methodology/approach - The authors estimate both linear autoregressive distributed lag (ARDL) model assuming symmetric effect and nonlinear ARDL model assuming asymmetric effect of exchange rate on US trade deficit with China. The authors use data from 1994Q1 to 2005Q2 (under Chinese fixed exchange rate system), from 2005Q3 to 2021Q3 (under Chinese managed floating exchange rate regime), and from 1994Q1 to 2021Q3 (overall data). Findings - The Chow test indicates 2005Q3 is a structure break point. Further, the results suggest the effects of bilateral exchange rate on US trade deficit with China are not the same under different exchange rate systems. The asymmetric long-run effect of bilateral exchange rate does exist. The results also demonstrate the depreciation of Chinese currency will not significantly affect US trade imbalances with China. Research limitations/implications - Based on the results, the Chinese Government should embrace a more transparent and flexible exchange rate system. It will not significantly hurt Chinese trade balance, but it will help to reduce the tension between the USA and China. Originality/value - All previous literature (except two papers) related to the effect of Chinese exchange rate on US trade deficit with China assume the effect is symmetric, and all (except one) use data under different Chinese exchange rate systems. To the best of the authors’ knowledge, this is the first paper that studies the possible asymmetric long-run effect of bilateral exchange rate under different Chinese exchange rate regimes.