If oil prices continue to rise and the RMB continues to appreciate, the U.S. inflation rate may increase at a faster pace in the near future. And this would have an unwelcome impact on consumers’ wallets.Inflation (Finance) ; Foreign exchange rates - China

Mingyu Chen

Yi Wen

English

Research Papers in Economics

Economic SYNOPSES
short essays and reports on the economic issues of the day
2011 ■ Number 17
T
he value of the Chinese renminbi (RMB) has
increased more than 21 percent against the U.S.
dollar since 2005 (see the chart). This would be
good news for the United States if increased costs of Chinese
imports (as a result of the appreciated RMB) made U.S.
consumers purchase fewer Chinese goods and reduced its
trade deficit with China. However, U.S. imports from China
have been increasing. Between 1999 and 2010, the share
of Chinese goods among total U.S. imports has increased
from 6.9 percent to 16.1 percent, and the share of Chinese
imports among total U.S. consumer expenditures has
increased from 1.3 percent to 3.6 percent. Furthermore,
the U.S. trade deficit with China increased from $67 billion
to $263 billion between 1999 and 2010, a fourfold increase.
Some critics believe that the rising trade deficit has hurt
the U.S. labor market and economic growth (i.e., by export-
ing U.S. manufacturing jobs to China) and was caused pri-
marily by an undervalued RMB relative to the dollar. In
response, some politicians and economists have recom-
mended a 25 to 40 percent tariff on Chinese imports to
correct the trade imbalance.1 China has allowed the RMB
to appreciate gradually since 2005 because of international
pressures. Nevertheless, since then U.S.
trade deficits with China have still con-
tinued to increase. As of 2010, China is the
second-largest trading partner (country)
of the United States, next to Canada. What
does RMB appreciation imply for the U.S.
economy?
Because it is so much cheaper to pro-
duce goods in China than in the United
States, Chinese-made goods cannot be
easily substituted with American-made
goods over the medium term. Hence, RMB
appreciation would increase import prices
without bringing many job opportunities
back to the United States.
Fair (2010) estimates the macroeco-
nomic effects of RMB appreciation on the
U.S economy using a multi-country model.
His estimates suggest that in 2008 a 25 percent appreciation
of the RMB would increase the U.S. domestic price level
by 0.5 to 1.5 percent. Similarly, Auer (2011) argues that
the increasing importance of cheap imports from China
was a major contributing factor to the low-inflation envi-
ronment in the United States over the past decade. Given
that nearly a sixth of all manufactured goods sold in the
United States are actually made in China, Auer estimates
that a 25 percent appreciation of the RMB spread over 10
months is equivalent to a temporary 5-percentage-point
shock to producer prices.
We can also do a back-of-the-envelope calculation on
the impact of RMB appreciation on the U.S. consumer
RMB Appreciation and U.S. Inflation Risk
Mingyu Chen, Research Analyst
Yi Wen, Assistant Vice President and Economist
If oil prices continue to rise and 
the RMB continues to appreciate, 
the U.S. inflation rate may increase 
at a faster pace in the near future. 
And this would have an unwelcome
impact on consumers’ wallets.
6.0
6.5
7.0
7.5
8.0
8.5
Exchange Rate of the RMB (¥) against the U.S. Dollar ($)
3-Jan-05
3-Apr-05
3-Jul-05
3-Oct-05
3-Jan-06
3-Apr-06
3-Jul-06
3-Oct-06
3-Jan-07
3-Apr-07
3-Jul-07
3-Oct-07
3-Jan-08
3-Apr-08
3-Jul-08
3-Oct-08
3-Jan-09
3-Apr-09
3-Jul-09
3-Oct-09
3-Jan-10
3-Apr-10
3-Jul-10
3-Oct-10
3-Jan-11
3-Apr-11
¥/$
SOURCE: Federal Reserve Board/Haver Analytics.price index (CPI). Suppose (i) all imports from China are
final consumption goods, (ii) the quantity of imports from
China does not decrease (or increase) after the appreciation
of the RMB, (iii) the basket of consumption goods for com-
puting the CPI also does not change, and (iv) any changes
in the value of the RMB will have a one-to-one pass-through
effect on prices of imported Chinese goods. Given these
assumptions, a 25 percent increase in the value of the RMB
would increase the CPI by 0.9 percent because Chinese
goods account for 3.6 percent of U.S. consumption expen-
diture and the prices of this portion of the consumer basket
increase by 25 percent (3.6 × 0.25 = 0.9 percent). That is,
the CPI would be nearly 1 percentage point higher. As for
the core CPI, the figure is likely to be much larger.2
So, how does this calculation relate to the average U.S.
consumer? If oil prices continue to rise and the RMB con-
tinues to appreciate, the U.S. inflation rate may increase at
a faster pace in the near future. And this would have an
unwelcome impact on consumers’ wallets. ■
Auer, Raphael A. “What the Yuan Means for American Inflation.” Economist,
February 3, 2011;
www.economist.com/blogs/freeexchange/2011/02/exchange_rates.
Fair, Ray C. “Estimated Macroeconomic Effects of a Chinese Yuan Appreciation.”
Business Economics, October 2010, 45(4), pp. 233-43.
Krugman, Paul. “Taking on China.” New York Times, March 14, 2010;
www.nytimes.com/2010/03/15/opinion/15krugman.html.
Wen, Yi. “Making Sense of China’s Excessive Foreign Reserves.” Federal Reserve
Bank of St. Louis Working Paper No. 2011-006A, February 2011,
http://research.stlouisfed.org/wp/2011/2011-006.pdf.
1 See Krugman (2010). For counterarguments, see Wen (2011).
2 The core CPI equals CPI less food and energy. China does not export food or
energy to the United States, so most Chinese goods are contained in the core
CPI basket. 
Economic SYNOPSES Federal Reserve Bank of St. Louis      2
research.stlouisfed.org
Posted on June 23, 2011
Views expressed do not necessarily reflect official positions of the Federal Reserve System.

RMB appreciation and U.S. inflation risk

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RMB appreciation and U.S. inflation risk

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