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China�s exchange rate policy: the case against abandoning the dollar peg

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This paper critically comments on the policy literature surrounding China�s exchange rate regime. It first seeks to expose as myths several popularly raised contentions regarding the dollar peg employed by China, including the belief that the RMB is clearly undervalued and that its value is a prominent cause of the U.S trade deficit. The paper then describes a consensus position that has emerged which argues that in the interests of better promoting its own macroeconomic stability, China should abandon the peg in favor of a more flexible exchange rate regime. We see numerous weaknesses in this position but a few stand out. Available data do not suggest that flexible regimes outperform fixed regimes in terms of inflationary outcomes. Moving to a flexible regime is also far from proximate policy response to the problems that are in evidence in China�s economy. Institutional realities that make moving to a flexible regime difficult also appear to have been seriously overlooked. The paper concludes by noting that in the longer term moving to a more flexible regime may be in China�s best interests. But for now, the focus needs to be firmly in the area of domestic financial reform.

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Paper provided by School of Economics, University of Queensland, Australia in its series EAERG Discussion Paper Series with number 0105.

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Handle: RePEc:qld:uqeaer:01

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  1. Ronald McKinnon & Gunther Schnabl, 2003. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Working Papers 03001, Stanford University, Department of Economics.
  2. Jeffrey Frankel, 2005. "On the Renminbi: The Choice between Adjustment under a Fixed Exchange Rate and Adjustment under a Flexible Rate," NBER Working Papers 11274, National Bureau of Economic Research, Inc.
  3. Ronald McKinnon & Gunther Schnabl, 2003. "Synchronized Business Cycles in East Asia and Fluctuations in the Yen/Dollar Exchange Rate," Working Papers 022003, Hong Kong Institute for Monetary Research.
  4. McKinnon, Ronald I., 2004. "The East Asian dollar standard," China Economic Review, Elsevier, vol. 15(3), pages 325-330.
  5. Mundell, Robert, 2003. "Prospects for an Asian currency area," Journal of Asian Economics, Elsevier, vol. 14(1), pages 1-10, February.
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Cited by:
  1. Xu, Hai Yan & Ward, Bert D. & Nartea, Gilbert V., 2007. "An Empirical Study of the Chinese Short-Term Interest Rate: A Comparison of the Predictive Power of Rival One-Factor Models," Review of Applied Economics, Review of Applied Economics, vol. 3(1-2).
  2. Zhang, Zhichao & Shi, Nan & Zhang, Xiaoli, 2011. "China’s new exchange rate regime, optimal basket currency and currency diversification," MPRA Paper 32642, University Library of Munich, Germany.

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