The Exchange Rate of RMB and the Trade Balance in China - Research Paper Example

The trade balance is defined as the gross inflow of export income minus gross outflow of financial resources for imports. Apparently, there exists a clear logic behind the economic theory. Exchange rate appreciation indicates a rise in the relative commodity prices in the domestic economy. Hence, there will be a natural inclination on part of the nationals to switch over to foreign goods consumption which seems more affordable, especially when there is no significant change in the average disposable income level.

Thus, it could be argued that outward-looking trade policy must be accompanied by a tendency to slash down the domestic rate of exchange. This could emerge as a possible option for nations who had lagged behind others in terms of their economic growth rate. Domestic monetary authorities may choose to lower their respective rates of exchange to trigger export demands and eventually escalate the margin of net exports. Many-a-times empirical facts are found to elude the theories since theories are defined on the basis of certain assumptions.

When these suppositions come loose in reality, there creeps in a strong possibility of contradiction with a preconceived hypothesis. The present paper tries to figure out whether there exists any such inverse relation in reality as well. The foremost task will be to design the layout for a suitable theory which relates the rate of exchange of a nation with that of the national trade balance. The theory being utilised in the present context, the Marshall-Learner Condition, is one of the most initial of all suppositions in this respect.

However, it was often treated as a stepping stone for most of the latter theorists who tried to establish their hypotheses by incorporating a few or some significant modifications.