research - Associated Student Government, Northwestern University

RESEARCHUS-CHINA TRADE:A Vector Error Correction ModelBrandon ZaharoffMATHEMATICAL METHODS IN THE SOCIAL SCIENCES PROGRAMRobert CoenFACULTY ADVISORDEPARTMENT OF ECONOMICSThis paper uses vector error correction analysis in addition to standard regression analysis to study the long-runrelationship of the US-China trade balance as well as exchange rates, relative prices, and real gross domestic productof China, the US, and OECDX (OECD excluding the US). The results indicate that an RMB appreciation would have asignificant long-term effect on the real GDPs of the US, OECDX, and China as well as the US-OECDX real exchangerate and the US-China trade balance. There is also clear evidence for the J-curve effect and that the Marshall-Lernercondition is met for the US-China trade relationship. This study also highlights the evolution of Chinese trade policy overthis time period and the implications of an appreciation on firms in both China and the US. Overall, the study suggeststhat a RMB appreciation would have a positive effect on the US-China trade balance and US and OECDX real GDP buta large negative effect on China’s real GDP. Still, an appreciation may be beneficial for China insofar as it increasesthe government’s ability to tackle inflation and asset price bubbles. The RMB appreciation would also have the effectof decreasing the cost of foreign goods and inputs in production to Chinese consumers and producers, respectively. Ifthis effect was large enough, it would cause the shift to an economy based more upon domestic demand and less onexports in China. This would make it less vulnerable to economic shocks in the rest of the world and sustain their growthregardless of the troubles of the United States.AcknowledgmentsI would like to thank Professor Robert Coen for all of his support as my faculty adviser. His guidance, throughweekly meetings and e-mails, was crucial in both the creating and interpreting of my models. Without his help Iwould not have learned as much about international trade and econometric modeling as I have. I would also like tothank Professor Joseph Ferrie and Sarah Muir Ferrer for their help in organizing thesis meetings and everything elsethat they have done to ensure that the MMSS thesis program continues to run smoothly. Additionally, I must thankall of my peers and professors, especially Professor Richard Walker, for challenging and inspiring me to learn as muchas I can in every subject. For their help in aiding my data collection, I must thank Jaime Marquez from the Divisionof International Finance at the Federal Reserve Board and Professor Tuck Cheong Tang at the Monash UniversitySchool of Business. Finally, I must thank my parents for their constant encouragement and support in my educationand listening to me talk about my thesis ad nauseam.Section I. IntroductionThe United States’ bilateral trade deficit with China has come under increased scrutiny from academics andpoliticians alike over the past few years as it has increased to $258 billion in 2007. 1 This has spurred much debateabout global imbalances and whether they were a cause of the 2008-2009 financial crisis. Also, many leaders across1 Source: Data from Census.gov20 NORTHWESTERN UNDERGRADUATE RESEARCH JOURNAL