An Empirical Time Series Econometric Study of the J-curve Effect of Exchange Rate in Trade Balance between China and the US

Abstract

Background and Aims: With the tensed relationship between China and the US, investigating the trade relationship between the two big countries has received more attention than before. This paper is just towards that direction to empirically examine the relationship between China’s real effective exchange rate (REER) and trade balance with the US in both the long-run and short-run, which may exhibit the J-curve effect – currency depreciation deteriorates trade balance in the short-run but promotes trade balance in the long-run – in China’s international trade with the US. Data and Methodology: Quarterly data on China’s REER, trade balance and gross domestic product (GDP, for income) and the US GDP from 2001 to 2017 are retrieved from relevant official websites for the current study. Unit-root test is first conducted on each modeling variable and its first difference to examine the stationarity of the variables. Autoregressive distributed lag (ARDL) approach with error-correction modeling (ECM) cointegration is then adopted to test the popular hypothesis of J-curve effect using the available quarterly data. Results and Conclusion: The modeling results reject the J-curve effect in the short-run but show a long-lasting positive effect of Chinese yuan’s depreciation in China’s trade balance with the US. Also, the US GDP has a positive and much stronger effect than Chinese GDP on China’s trade balance. As such, it is suggested that China should maintain a good relationship with the US and a stable exchange rate for long-run trade balance and economic growth at an appropriate level or rate.