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Can a Rapidly-Growing Export-Oriented Economy Smoothly Exit an Exchange Rate Peg? Lessons for China from Japan's High-Growth Era

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  • Barry Eichengreen
  • Mariko Hatase

Abstract

We explore the parallels between Japanese currency policy after World War II and Chinese currency policy today. After two decades of pegging at 360 yen, Japan decoupled from the dollar on August 1971 and then repegged at a revalued rate of 308 yen. After stabilizing the exchange rate at this new level for about a year, greater flexibility was introduced. This phased adjustment - revaluation followed after a time by an increase in flexibility - bears more than a passing resemblance to recent Chinese policy initiatives. We analyze the impact of Japan's exit from its peg on exports and investment. The results point to sizeable effects of the yen's revaluation on both variables, especially investment. While our analysis suggests that a rapidly-growing, export-oriented economy can operate a heavily managed float despite the presence of capital controls and the absence of sophisticated foreign currency forward markets, it underscores the importance of managing the exchange rate with domestic conditions in mind and avoiding the kind of large real appreciation that would sharply compress profits and damage investment. For China this suggests starting with a modest band widening and a limited increase in flexibility, and not with a large step revaluation which could have a sharp negative impact on investment and growth. Our results thus provide support for the kind of measures taken at the end of July.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11625.

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Date of creation: Sep 2005
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Handle: RePEc:nbr:nberwo:11625

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  1. Michael Dooley & David Folkerts-Landau & Peter Garber, 2005. "An essay on the revived Bretton Woods system," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
  2. Takatoshi Ito, 1987. "Capital Controls and Covered Interest Parity," NBER Working Papers 1187, National Bureau of Economic Research, Inc.
  3. "Tachi, Ryuichiro" & "Komiya, Ryutaro", 1960. "Under-Liquidity and Monetary Policy in Japan," Economic Review, Hitotsubashi University, vol. 11(3), pages 288-295, July.
  4. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange rate pass-through into import prices: a macro or micro phenomenon?," Staff Reports 149, Federal Reserve Bank of New York.
  5. Eichengreen, Barry, 2004. "Chinese Currency Controversies," CEPR Discussion Papers 4375, C.E.P.R. Discussion Papers.
  6. Hutchison, Michael & Walsh, Carl E., 1992. "Empirical evidence on the insulation properties of fixed and flexible exchange rates : The Japanese experience," Journal of International Economics, Elsevier, vol. 32(3-4), pages 241-263, May.
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