The trade balance and the real exchange rate

Globalisation has affected the relationship between the trade balance and the real exchange rate in two ways. On the one hand, the growth of trade taking place within industries makes the trade balance more sensitive to real exchange movements. On the other hand, a higher degree of vertical specialisation and more global supply chains act to reduce this sensitivity. The relative importance of these two effects varies across countries. According to the estimates presented in this article, changes in the real exchange rate could play a larger role in curbing the US trade deficit than in reducing the Chinese trade surplus. This confirms that real exchange rate adjustment is only part of the solution for global rebalancing, and needs to be accompanied by other policy actions.