Abstract

The US labeled China a Currency Manipulator in August 2019 because of the massive trade balance surplus of China. The correlation between RMB’s exchange rate and China’s trade balance has been discussed worldwide. The Traditional Marshal-Lerner Condition states if the sum of the absolute value of export and import price elasticity of demand is more than 1, the trade balance will be adjusted through the fluctuation of the exchange rate. However, Traditional Marshal-Lerner Condition requires trade balance is 0 at the beginning, while China benefits the huge surplus of the trade balance for decades. Therefore, the Traditional Marshal-Lerner Condition may not be appropriate to explain why RMB’s exchange rate failed to shrink the surplus of China’s trade balance. The author reconsiders the derivation of Marshall-Lerner condition and presents another Marshall-Lerner condition which illustrates the conditions the export and import price elasticity of demand need to meet when the trade balance is uneven at the beginning so that the fluctuation of exchange rate can play a role in regulating trade balance. Then the industry-level data from January 2008 to June 2018 were used to calculate the export and import price elasticities of demand by using ARDL model. The empirical results show the validity of Traditional Marshal-Lerner Condition in China was investigated, while the Generalized Marshal-Lerner Condition cannot be satisfied during the sample period. Taking the huge amount of surplus, and the movements of RMB’s exchange rate recent years into consideration, the results of Generalized Marshal-Lerner Condition, that the variation of RMB’s exchange rate will not succeed in adjusting the trade balance in the Chinese economy, maybe more persuasive than the traditional one.

Key words: China, Marshall-Lerner condition, trade balance, ARDL model.