The Effect of Exchange Rates on Chinese Trade: A Dual Margin Approach

Previous studies investigating the effect of exchange rate changes on a country's exports have found little evidence that exchange rates matter. This “Exchange Rate Disconnect Puzzle” may stem from the fact that studies have mostly focused on aggregate data. We analyze the effect of real exchange rate fluctuations of the RMB by decomposing Chinese trade into its “extensive” and “intensive” margins using product-level data. Contrary to recent empirical evidence on the insignificant effects of exchange rate changes on trade, we estimate that real appreciation of the RMB has a significantly negative impact on Chinese exports. We also find that the major channel of effect is via the extensive margin. There is only weak evidence to indicate that imports are affected by exchange rates. With respect to exchange rate volatility, we generally find that it is negatively associated with exports, with no significant effect on imports. There appear to be major differences across China's major and non-major trading partners. Most of the exchange rate effects that we estimate are with China’s non-major trading partners.