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Trilemma Challenges for the People's Republic of China

Author

Listed:
  • Masahiro Kawai

    (Professor, Graduate School of Public Policy, University of Tokyo)

  • Li-Gang Liu

    (Chief Economist, Greater China, ANZ Research, Australia and New Zealand Banking Group Limited (ANZ))

Abstract

This paper first reviews recent developments in exchange rate regimes, capital account liberalization, interest rate liberalization, and monetary policymaking in the People's Republic of China (PRC). It then observes that the PRC's monetary policy autonomy may have been reduced with falling capital control effectiveness and a rigid exchange regime that is still tightly managed against the United States (US) dollar. This hypothesis is investigated empirically using both the Taylor rule and a McCallum-like rule to test whether the PRC's money market interest rate and/or quantity of money supply are being increasingly influenced by the US interest rate or reserve accumulation. The paper concludes that there is considerable evidence suggesting diminishing monetary policy autonomy in the PRC. To regain policy autonomy, the monetary authority needs to substantially increase exchange rate flexibility of the renminbi as long as it continues to pursue capital account opening.

Suggested Citation

  • Masahiro Kawai & Li-Gang Liu, 2015. "Trilemma Challenges for the People's Republic of China," Asian Development Review, MIT Press, vol. 32(1), pages 49-89, March.
    • Handle: RePEc:tpr:adbadr:v:31:y:2015:i:2:p:49-89
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    References listed on IDEAS

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    1. Bennett T. McCallum, 2000. "Alternative monetary policy rules : a comparison with historical settings for the United States, the United Kingdom, and Japan," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 49-79.
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    Cited by:

    1. Feng, Ling & Le, Duong Thuy & Yuan, Fan, 2023. "Inclusion of the RMB in SDRs and the impossible trinity in China," Economic Systems, Elsevier, vol. 47(2).
    2. Georgios Magkonis & Simon Rudkin, 2019. "Does Trilemma Speak Chinese?," Working Papers in Economics & Finance 2019-01, University of Portsmouth, Portsmouth Business School, Economics and Finance Subject Group.
    3. Han, Xuehui & Wei, Shang-Jin, 2018. "International transmissions of monetary shocks: Between a trilemma and a dilemma," Journal of International Economics, Elsevier, vol. 110(C), pages 205-219.
    4. Peng Zhang, 2018. "Exchange Rate and Asset Market: the Trilemma for China's Monetary Policy," Review of Economics & Finance, Better Advances Press, Canada, vol. 14, pages 1-16, November.
    5. Wei, Shang-Jin & Han, Xuehui, 2016. "International Transmissions of Monetary Shocks," CEPR Discussion Papers 11070, C.E.P.R. Discussion Papers.
    6. Shang-Jin Wei, 2018. "Managing Financial Globalization: Insights from the Recent Literature," NBER Working Papers 24330, National Bureau of Economic Research, Inc.
    7. Wei, Shang-Jin, 2018. "Managing Financial Globalization: A Guide for Developing Countries Based on the Recent Literature," ADBI Working Papers 804, Asian Development Bank Institute.

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    More about this item

    Keywords

    China; exchange rate; monetary policymaking; Taylor rule; policy autonomy; mccallum rule;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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