research - Associated Student Government, Northwestern University

RESEARCHconfidence. I chose to use one cointegrating equation due to the limited size of the dataset and the very limitedbenefit of using more than one.Johansen’s Test for the Number of Cointegrating VectorsHypothesized Trace 5 Percent 1 PercentNo. of CE(s) Eigenvalue Statistic Critical Value Critical ValueNone * 0.752404 30.71109 27.07 32.24At most 1 0.268847 6.888924 20.97 25.52At most 2 0.219545 5.453325 14.07 18.63At most 3 0.038913 0.873178 3.76 6.65* denotes rejection of the hypothesis at the 5% levelEffect of Renminbi Appreciation on US Real GDPIn order to look at the long-run effects of the different endogenous variables on the real GDP of the US, Iestimated the following equation using a vector error correction model. The fitted equation is:lnUSRGDP = .5071 lnRMBUSD + -1.0303 lnRPUSC + .7087 lnUSORER + .9970 lnCRGDP + -3.0067lnORGDP + 32.4234(.0190) (.0292) (.0160) (.0462) (.0555)This analysis suggests that a 10% appreciation of the RMB would lead to a 5% increase in long run US real GDP.The impulse response analysis indicates that this effect would occur primarily over the first four years. Similarly, a10% increase in Chinese prices relative to US prices is expected to increase US real GDP by 10.3%. Due to the effectof the increase in Chinese prices, Chinese consumers would purchase more goods from the US, and US consumerswould purchase more goods domestically in place of the relatively more expensive Chinese goods. The fact that theeffect of a relative price increase is larger than an equal nominal appreciation may be accounted for in the interactionbetween the two variables. For example, a nominal appreciation could lead prices to decrease and diminish theeffects of the appreciation, whereas the RMB-USD exchange rate being fixed means that the nominal exchange ratecould not adjust to diminish the effects of a relative price increase of Chinese goods.On one hand, I expected a nominal appreciation to be associated with a relative decrease in Chinese prices asimports become cheaper because Chinese exporters have been found to sacrifice profit margins (i.e., prices) in theface of a nominal appreciation. On the other hand, it is possible that this may be more of a short-term effect, andin the medium term the decreased price of foreign inputs that are used for domestic production will make Chinesegoods cheaper domestically. This would create an increase in domestic demand that would lead domestic prices toincrease. The impulse response analysis reveals that the relative price of US goods to Chinese goods would initiallyincrease slightly, but by year four the effect would be significantly negative until it levels out around the ninth yearfollowing the nominal appreciation. This would support the logic that initially Chinese domestic prices do decreasedue to the decrease in prices of imports as a result of the stronger currency. US prices would increase, though at alesser magnitude due to the fact that trade with China represents a much smaller portion of the US economy thanthe portion of China’s economy that trade with the US represents. Then, as discussed above, in the medium termChinese demand for domestic goods would increase and cause prices to increase.The appreciation will also have a positive effect on the real GDP of other OECD countries as consumers in theUS and the OECDX (and the rest of the world) substitute goods from OECD countries in place of the relatively moreexpensive Chinese goods. Again, this effect will level out after four years, but there is an underlying assumption thatthere is a sufficiently high degree of substitution between goods from OECDX countries and those from China aspreviously discussed.VOLUME 7, 2011-2012NORTHWESTERN UNDERGRADUATE RESEARCH JOURNAL23