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Exchange Rate Pass-through in China: A Cost-Push Input-Output Price Model

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Abstract

Relying on a cost-push input-output model for China, we estimate the exchange rate pass-through to both domestic prices and export prices at the industry level. Our empirical results indicate that the decline of the RMB price in the processing exports sector in response to an RMB appreciation is larger than that in the non-processing exports sector, which, in turn, is larger than the decline of the consumer price indexes. Our cross-sector analysis also suggests that exchange rate changes have the lowest impact on prices in capital- and technology-insensitive industries.

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Notes

  1. Processing exports include: 1) Processing with Imported Materials (PIM): the business enterprise in China makes a foreign exchange payment for imported raw and auxiliary materials, parts and components, accessories, and then exports the finished products after processing or assembly. 2) Processing & Assembling (P&A): the business enterprise does not have to make a foreign exchange payment for the imports, but just charges the foreign party a processing fee.

  2. Pei et al. (2012) observe that the contribution of the change in exports to the change in value added in China (from 2002 to 2007) was 32% higher when ordinary IO tables are used than when the tables capturing processing trade are used. On a similar note, Craighead (2020) argues that intermediate goods trade reduces the “exchange rate disconnect” by increasing the volatility of the real exchange rate relative to output and weakening the link between the real exchange rate and output.

  3. A few previous studies have shown the importance of imported intermediate inputs for ERPT. For example, Shi and Xu (2010) find that the degree of ERPT to intermediate import prices affects the economy more than the ERPT to final import prices. However, most previous studies ignored the price transmission through imported intermediate goods and production chains at the industry level. Furthermore, previous studies neglected processing trade, which accounts for about two thirds of total Chinese trade (Johnson and Noguera 2012).

  4. Some previous studies used IO models to analyze price formation (Folloni and Miglierina 1994). Some studies research the impact of changes in energy prices (Berüment and Taşçı 2002; Bazzazan and Batey 2003; Wu et al. 2013), while others focus on the effect of implicit subsidies on sectoral prices (e.g. Sharify 2013).

  5. See Carvalho (2014) for a literature review.

  6. The data are available at http://www.oecd.org.

  7. It is worth stressing that except for the production network, an exchange rate appreciation can also influence domestic and export prices through other channels, such as firms’ markups or product quality. However, these other channels are not focused upon in our analysis.

  8. More specifically, the processing exports of each industry are used as weights to calculate the ERPT for total processing exports, while the non-processing exports are used for that of non-processing exports, and the outputs for domestic demand are used for that of domestic demand.

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Acknowledgements

We like to thank two anonymous reviewers for their very helpful comments on a previous version of the paper.

Funding

This research is supported by the National Social Science Foundation of China (Grant Number: 17CJL039, 15ZDA009), the National Science Foundation (Grant number: 71704195, 71873091), and the Social Science Foundation of Qingdao (Grant Number: QDSKL1901008).

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Authors and Affiliations

  1. School of International Trade and Economics, Central University of Finance and Economics, Beijing, China

    Yuwan Duan

  2. School of Economics, Ocean University of China, Shandong, China

    Yanping Zhao

  3. Institue of Marine Economy of Ocean University of China, Shandong, China

    Yanping Zhao

  4. De Nederlandsche Bank, Amsterdam, The Netherlands

    Jakob de Haan

  5. University of Groningen, Groningen, The Netherlands

    Jakob de Haan

  6. CESifo, Munich, Germany

    Jakob de Haan

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  1. Yuwan Duan
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  2. Yanping Zhao
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Correspondence to Yanping Zhao.

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Duan, Y., Zhao, Y. & de Haan, J. Exchange Rate Pass-through in China: A Cost-Push Input-Output Price Model. Open Econ Rev 31, 513–528 (2020). https://doi.org/10.1007/s11079-020-09590-7

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