The main points I hope to convey from these two graphs are:
- The nominal and real exchange rates can diverge substantially in theory and in practice. Recently, the US-China real bilateral exchange rate has diverged from the nominal due to faster inflation in China.
- The bilateral exchange rate can diverge from the trade weighted exchange rate. In open economy macroeconomics, we usually concern ourselves more with the effective (in this case trade-weighted) exchange rate.
Figure 1: Log nominal bilateral USD/CNY exchange rate, monthly average of daily values (blue), and daily noon value for 9/24 (blue box), and log real bilateral USD/CNY, deflated using CPI (red). Both series defined as “up” denotes appreciation of CNY, both normalized to 2005M06=0. Dashed line at de-pegging in July 2005. Source: St. Louis Fed FREDII, CEIC, IMF, ADB Asia Regional Integration Center, and author’s calculations.
Figure 2: Log real bilateral USD/CNY, deflated using CPI (red), log real trade-weighted value of CNY from BIS (purple), and log real trade-weighted value of CNY from IMF (green). All series defined as “up” denotes appreciation. Dashed line at de-pegging in July 2005. Source: BIS, IMF International Financial Statistics, CEIC, St. Louis Fed FREDII, ADB Asia Regional Integration Center, and author’s calculations.
Since the graphs are expressed in log terms, normalized to 2005M06 (the month before China moved away from its peg), the the numerical value on the left axis can be read as the percentage appreciation in the yuan that has taken place since mid-2005 (in log terms, of course). The yuan is now therefore about 21% (24%) stronger against the dollar in nominal terms, and 20% stronger in trade weighted real terms as of August, as compared to June 2005.