VII. CHINA SPILLOVERS: GIMF SIMULATIONS OF REBALANCING AND APPRECIATION1
This chapter applies the Global Integrated Monetary and Fiscal (GIMF) model to study the spillovers from China rebalancing. The GIMF model permits an assessment of changes to fiscal, exchange rate, and structural policies in both the near and longer terms. The model’s simulations point to significant spillovers from rebalancing. Benefits are larger if rebalancing comes through a comprehensive package of structural, fiscal, and exchange rate reforms rather than exchange rate appreciation alone.
1. Policies. The set of policies considered for rebalancing demand and reallocating resources across sectors include a real appreciation of the exchange rate by about 20 percent over five years, financial sector reform comprising among others interest rate liberalization and increased access to financial services by households and SMEs, higher public social spending, and a stronger social safety net. All these policies support rebalancing demand toward private consumption. They are broadly consistent with the medium-term reform plans already being implemented or envisaged by the Chinese authorities. The real effective exchange rate appreciation of 20 percent over 5 years serves purely as an illustration so as to model a “substantial” change in the exchange rate over the medium term.
2. Model. To analyze the spillover effects of these policies, the multi-country dynamic general equilibrium GIMF model is used. The model allows for dynamic interaction across a broad range of countries and sectors, and permits an analysis of fiscal as well as exchange rate and structural policies (see Kumhof and Laxton, 2010). The GIMF model used for this chapter comprises 8 regions: 5 Asian blocks, namely, China (CN), Emerging Asia (AS—which includes Hong Kong SAR, Indonesia, Malaysia, Philippines, Singapore, and Thailand), Japan (JA), South Korea (KO), and Australia and New Zealand (AZ); the U.S. (US), Euro Area (EU), and the rest of the world. Financial sector variables operate mainly through a financial accelerator mechanism. There are several layers of production, with distinctions between manufacturing of intermediate goods, distribution of intermediate goods to domestic and foreign assemblers, and final production of consumption and investment goods. The model thus captures the direct and indirect transmission channels of shocks as well as spillover effects from rebalancing.
3. Scenarios. Two scenarios are considered: (i) a comprehensive rebalancing scenario that assumes (a) structural reforms to raise productivity in the services sector, which would be accompanied by a shift in households’ preferences toward non-tradable goods; (b) fiscal reforms aimed at reducing individual uncertainties and precautionary savings; (c) financial sector reforms to liberalize interest rates and develop further the domestic capital market; and (d) a gradual appreciation of the RMB—20 percent over 5 years; and (ii) a real effective exchange rate (REER) appreciation scenario only—20 percent over 5 years.
Figure 1.Fully Fledged Rebalancing Scenario:Output
Figure 2.Fully Fledged Rebalancing Scenario:Trade
Figure 3.Full Fledged Rebalancing: REER
Output rises in all regions, including China, with the largest gains among partners being in the Asian economies.
Investment rises throughout Asia (ex Japan), but falls in U.S. and Euro Area.
In China, investment rises primarily in the non tradable sector because structural reforms raise productivity and profits. This increase is offset in the short term by lower investment in tradables, given the rising cost of capital and appreciating exchange rate. The overall impact on total investment depends on how quickly capacity rises in the non tradable sector and on the payoffs from reforms.
In Korea, emerging Asia, and to a lesser extent Australia and New Zealand, investment rises in relation to GDP in the short run as these economies benefit from stronger demand from China. But as China’s demand for imported goods moves away from intermediate inputs and toward final goods and as production shifts toward catering to the domestic market, the benefits for intermediate goods exporters is reduced.
In the U.S. and the Euro Area, total investment falls in relation to GDP as the non-tradable sector shrinks with the real depreciation of the dollar and the euro. However, the depreciation supports the manufacturing sector.
Private consumption rises in relation to GDP in China and Korea, but falls in the other partner economies.
In China, the higher share reflects the impact of fiscal and financial sector reforms that provide better access to finance for households and small private firms, reduce the need for precautionary savings, and raise labor income.
In Korea, the rise in consumption stems from higher income as firms hire more labor to satisfy the demand from China, as well as wealth effects from lower payments (through both lower interest rates and an appreciating currency) on foreign liabilities (the valuation effects from currency changes would be somewhat overstated to the extent that most foreign liabilities are hedged, as would be the case for Australia and New Zealand.).
Consumption falls in relation to GDP in Japan, emerging Asia, the United States, Euro Area, and Australia and New Zealand, as the real depreciation of their currencies limits spending and results in a rise in saving. This increase in saving mirrors the decline in China’s saving rate.
Current account balances are lower in China (reflecting stronger domestic demand and an appreciating currency) and in emerging Asia. Balances are higher in the U.S., Euro Area, and Australia and New Zealand owing to stronger import demand from China.
5. REER appreciation. A 20 percent appreciation of China’s REER would lower output in China and shift its composition toward domestic demand (Figures 4–6). Such a shift would be accompanied by a rise in import demand from the rest of the world, which would generate positive spillovers. At the same time, the appreciation reduces China’s exports, lowering the current account surplus. Current account balances rise modestly in most regions because of stronger exports to China, but fall in emerging Asia owing to a reduction in China’s demand for intermediate goods.
Figure 4.Appreciation Scenario:Output
Figure 5.Appreciation Scenario:Trade
Figure 6.Appreciation: REER
6. Conclusion. Rebalancing through the exchange rate alone would be less beneficial to other countries and more costly to China compared to the case where rebalancing is brought about by a comprehensive package of polices. A lack of rebalancing owing to a non-appreciation, or a real effective depreciation, benefits China at the expense of the world. But a comprehensive rebalancing would bring mutually beneficial outcomes.
Prepared by Papa N’Diaye (APD) and Nathan Porter (SPR).