Currency Pegs, Trade Deficits and Unemployment: A Reevaluation of the China Shock
48 Pages Posted: 10 Jan 2025
Abstract
We develop a dynamic quantitative model of trade and labor adjustment, incorporating nominal wage rigidity and consumption-savings, to study the interaction of China's currency peg and its spectacular growth, and how it affected US outcomes. Calibrating the model to trade and labor data, we show that China's currency peg accelerated the US manufacturing decline, amplified the US trade deficit, and increased unemployment, but the welfare impact of the China shock remains positive. Our counterfactuals suggest that a floating Chinese exchange rate would have mitigated these effects. We also find that China's broader savings glut contributes negligibly to US manufacturing losses, underscoring the central role of China's currency regime in shaping these outcomes.
Keywords: international trade, Labor market dynamics, Wage rigidity, exchange rate, Currency pegs, Trade imbalance, Current account, China's trade, General equilibrium
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