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The difficulties of the Chinese and Indian exchange rate regimes

  • Patnaik, Ila

    ()

    (National Institute of Public Finance and Policy)

  • Shah, Ajay

    ()

    (National Institute of Public Finance and Policy)

China and India have both attempted distorting the exchange rate in order to foster exports-led growth. This is described as the Bretton Woods II framework, where developing countries buy bonds in the US and keep undervalued exchange rates, in order to foster export-led growth. The costs and benefits of this approach need to factor in the extent to which monetary policy is distorted by the pursuit of exchange rate policy. In this paper, we start by identifying dates of structural change, and the characteristics of the de facto exchange rate regime, for both countries. These results utilise recent developments in the econometrics of structural change. We then examine business cycle conditions and the short-term rate (expressed in real terms) in both India and China. We find that through the great business cycle boom of the early 2000s, both countries followed expansionary monetary policy. This is consistent with the idea that de facto exchange rate pegging induces a loss of monetary policy autonomy. By following expansionary monetary policy at a time of buoyant business cycle conditions, in both countries, monetary policy contributed to exacerbating instability of GDP; it helped exacerbate both boom and bust. Capital flows and conditions on currency markets changed profoundly from late 2007 onwards. Hence, this paper is primarily focused on the period from 1998 till 2007, the period where both countries were trying to use monetary policy to obtain exchange rate undervaluation. These difficulties need to be brought into the assessment of the Bretton Woods II regime.

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File URL: http://www.nipfp.org.in/working_paper/wp_2009_62.pdf
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Paper provided by National Institute of Public Finance and Policy in its series Working Papers with number 09/62.

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Length: 20
Date of creation: Aug 2009
Date of revision:
Handle: RePEc:npf:wpaper:09/62
Note: Working Paper 62, 2009
Contact details of provider: Web page: http://www.nipfp.org.in

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  1. Prasad, Eswar S., 2009. "Is the Chinese growth miracle built to last?," China Economic Review, Elsevier, vol. 20(1), pages 103-123, March.
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  9. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  10. Frankel, Jeffrey, 2008. "New Estimation of China's Exchange Rate Regime," Working Paper Series rwp08-077, Harvard University, John F. Kennedy School of Government.
  11. Ajay Shah & Ila Patnaik & Rudrani Bhattacharya, 2008. "Early Warnings of Inflation in India," Working Papers id:1682, eSocialSciences.
  12. Takatoshi Ito & Anne O. Krueger, 1994. "Introduction to "Macroeconomic Linkage: Savings, Exchange Rates, and Capital Flows, NBER-EASE Volume 3"," NBER Chapters, in: Macroeconomic Linkage: Savings, Exchange Rates, and Capital Flows, NBER-EASE Volume 3, pages 1-5 National Bureau of Economic Research, Inc.
  13. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
  14. Zeileis, Achim & Shah, Ajay & Patnaik, Ila, 2010. "Testing, monitoring, and dating structural changes in exchange rate regimes," Computational Statistics & Data Analysis, Elsevier, vol. 54(6), pages 1696-1706, June.
  15. Takatoshi Ito & Anne O. Krueger, 1994. "Macroeconomic Linkage: Savings, Exchange Rates, and Capital Flows, NBER-EASE Volume 3," NBER Books, National Bureau of Economic Research, Inc, number ito_94-1, August.
  16. Ronald McKinnon & Gunther Schnabl, 2009. "China's financial conundrum and global imbalances," BIS Working Papers 277, Bank for International Settlements.
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