Concluding Remarks

The yuan cumulatively appreciated against the dollar about 20% since July 2005. The yuan's further appreciation is expected to be an effective solution for reducing bilateral trade imbalances between the PRC and the US. To what extent the yuan's appreciation would be able to lower the PRC's huge trade surplus depends on the pass-through effects of the yuan's appreciation. With the available information, this paper conducted a comprehensive empirical analysis on pass-through effects of the yuan's appreciation on prices of the US and Japanese imports from PRC. In the case of Japan, not only was pass-through estimated for all imports from PRC, but also for five major commodity groups food, raw materials, apparel, manufacturing, and machinery. Empirical results indicate that the pass-through effects of the yuan's appreciations on prices of US imports and that of Japan differ substantially. While pass-through effects on US import prices are relatively weak, about 23% in the short run and less than 47% in the long run, I did not find any evidence that the yuan's appreciation from July 2005 to 2008 was passed into prices of Japanese import from the PRC.

The initial empirical analysis shows that, Japanese import prices were relatively more responsive to changes of the bilateral exchange rates between the yuan and the yen. For a 1% nominal appreciation of the yuan against the yen, Japanese import prices would be expected to rise 0.55% in the short run and 0.99%, a complete pass-through, in the long run. The high degree of pass-through effects were also found at the disaggregated sectoral level: food, raw materials, apparel, manufacturing, and machinery. However, the near complete pass-through effects were not due to the appreciation of the yuan, but due to the PRC's peg to the dollar policy and the fact that the dollar has been used as a dominant invoicing currency for PRC exports to Japan.

After controlling the currency invoicing factor, I found no evidence that the yuan's cumulative appreciation since July 2005 was passed on to prices of Japanese imports at both the aggregate and disaggregated levels. In other words, PRC exporters were not able to transmit the rising cost associated with the yuan's appreciation to Japanese importers. My empirical findings have very important policy implications for current debates on whether the yuan's further appreciation would be effective in mitigating the US trade deficit with the PRC and reducing the PRC's overall trade surplus. The low pass-through on the US import prices and the insignificant contribution of the yuan's appreciation on the complete pass-through phenomenon on Japanese import prices suggest that a moderate appreciation of the yuan would have very limited impact on PRC exports and would not bring substantial changes to the PRC's trade surplus with either the US or the rest of the world. In addition, the experience of Japan since the Plaza Accord shows that productivity growth plays a critical role in maintaining price stability and reducing pass-through effects. The PRC's labor productivity expanded five times from 1987 to 2007 (APO [2010]). The impressive high productivity growth partially explained why little pass-through was found after the yuan's 20% appreciation.

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