IDEAS home Printed from
   My bibliography  Save this paper

The Travails of Current Macroeconomic and Exchange Rate Management in China: The Complications of Switching to a New Growth Engine


  • Wing Thye Woo

    (University of California, Davis)


Just when China’s leaders receive conflicting signals of “overheating” and “below-potential growth”, they encounter tremendous external pressure to revalue the Renminbi (RMB) substantially. Our conclusion is that the major macroeconomic challenges have their roots in China’s inadequate marketization and continued discrimination against the domestic private sector. The monopoly state banks intermediate the large volume of savings not only inefficiently but also inadequately. The latter results in aggregate demand expanding slower than supply-side growth, imparting a deflationary tendency to the economy. The present remedy of increased public-directed investments can be a satisfactory solution in the short run, but they are a disaster in the long run because they would follow an increasingly rent-seeking path that is wasteful as in Japan (e.g. wasteful projects that benefit politically- connected companies), and the increased state enterprise investments would convert themselves into nonperforming loans. In partially-reformed China, public-directed investments via the state enterprises tend to veer out of control frequently and overheat the economy. China’s persistent trade surplus is fundamentally linked to the deflation phenomenon because a chronic trade surplus means that national savings is larger than domestic investments, the result of inadequate financial intermediation. China should now expand its investment program to incorporate large import-intensive infrastructure projects as the alternative to the appreciation the RMB, or as an important complement to limited RMB appreciation. The additional construction would create jobs, relieve production bottlenecks, and preserve employment in China's export-oriented sectors. The long-run solution to eradicating the deflation bias and the tendency toward current account surplus lies in establishing an efficient financial intermediation mechanism. Frequent bank recapitalization is the biggest threat to China’s fiscal solvency and macroeconomic stability. Our calculations conclude that the forthcoming second recapitalization since 1997 is the last one that China can afford. Even then, fiscal solvency and macroeconomic management requires that the state continues keeping interest rates artificially low in order to avoid reducing the present fiscal stimulus to accommodate the servicing of the bonds issued for the bank bailout. In short, China faces a difficult tradeoff between the maintenance of fiscal stimulus to keep growth on track and the promotion of financial market development via recapitalizing the state banks, splitting them up and privatising some of them, liberalising the establishment of private financial institutions, improving prudential monitoring and enforcement, and deregulating interest rates. The entry of Western banks into China’s financial markets is not the same thing as the opening of the capital account. China would not be well served by a rapid opening of the capital account because foreign banks could suddenly become conduits for large-scale capital flight, or for rapid swings in short-term lending and repayments, or facilitators of bank runs (in which depositors do not merely switch banks, or switch from domestic banks to domestic currency, but actually switch from domestic deposits to foreign assets). Just as in financial market liberalization, capital account opening should also proceed in stages, because it must be accompanied by sophisticated financial market regulation, something that is clearly not in place at this time. The state-owned sector and state-controlled companies are still a serious threat to sustained high growth, banking sector solvency, and price stability. Worse, yet, the corruption within state enterprises undermine social stability. The transformation to a private market economy should be accelerated by faster privatization of state enterprises, and the reduction in legal discrimination against private sector activities.

Suggested Citation

  • Wing Thye Woo, 2003. "The Travails of Current Macroeconomic and Exchange Rate Management in China: The Complications of Switching to a New Growth Engine," Development and Comp Systems 0310001, EconWPA.
  • Handle: RePEc:wpa:wuwpdc:0310001
    Note: Type of Document - PDF; prepared on IBM PC ; to print on HP/PostScript/Franciscan monk; pages: 45; figures: included/request from author/draw your own. Macroeconomic and exchange rate management in China

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Woo, Wing Thye, 2001. "Recent claims of China's economic exceptionalism: Reflections inspired by WTO accession," China Economic Review, Elsevier, vol. 12(2-3), pages 107-136.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. PierreL. Siklos & Yang Zhang, 2010. "Identifying The Shocks Driving Inflation In China," Pacific Economic Review, Wiley Blackwell, vol. 15(2), pages 204-223, May.
    2. repec:rim:rimwps:34-07 is not listed on IDEAS
    3. GERLACH, Stefan & Peng, Wensheng, 2006. "Output gaps and inflation in Mainland China," China Economic Review, Elsevier, vol. 17(2), pages 210-225.

    More about this item


    China; deflation; exchange rate; banking system; financial intermediation; state enterprise;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O53 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - Asia including Middle East
    • P21 - Economic Systems - - Socialist Systems and Transition Economies - - - Planning, Coordination, and Reform
    • P23 - Economic Systems - - Socialist Systems and Transition Economies - - - Factor and Product Markets; Industry Studies; Population

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpdc:0310001. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.