China's exchange rate policy and fiscal expansion
| DOI | https://doi.org/10.1108/17544400910966059 |
| Date | 19 June 2009 |
| Published date | 19 June 2009 |
| Pages | 81-85 |
| Author | Ronald I. McKinnon |
| Subject Matter | Economics |
China exchange
rate policy
81
Journal of Chinese Economic and
Foreign Trade Studies
Vol. 2 No. 2, 2009
pp. 81-85
#Emerald Group Publishing Limited
1754-4408
DOI 10.1108/17544400910966059
Revised 15 February 2009
PERSPECTIVE
China’s exchange rate policy
and fiscal expansion
Ronald I. McKinnon
Stanford University, Stanford, California, USA
Abstract
Purpose – The purpose of this paper is to present an overview of China’s exchange rate policy and
fiscal expansion.
Design/methodology/approach – This paper is a reprint of a Financial Times online forum
contribution dated 10 February 2009.
Findings – The paper finds that there is a good economic rationale for China’s wanting to keep the
yuan/dollar rate stable.
Originality/value – This ‘‘perspective’’ piece written by a Professor of Economics is brought to a
wider readership via its inclusion in Journal of Chinese Economic and Foreign Trade Studies.
Keywords China, Government policy, Exchange rates, Fiscal policy
Paper type General review
Tensions between the USA and China escalated recently when the new US Secretary of
the Treasury, Timothy Geithner, suggested in mid January that China might be
designated as a ‘‘currency manipulator’’. This prompted Premier Wen Jiabao on
January 29 to mount a vigorous defense of China’s existing exchange rate policy at a
high-level meeting of world leaders at Davos, Switzerland. Mr Wen pledged to keep the
renminbi at a ‘‘reasonableand balanced level’’.
There is a good economic rationale for China’s wanting to keep the yuan/dollar rate
stable. First, as long as the fixed rate is credible – as it was between 1995 and 2004 at
8.28 yuan per dollar – it served as an effective monetary anchor for China’s internal
price level. After inflation had exploded to more than 20 percent per year in 1993-1995,
the fixed rate anchor helped China regain price-level stability. Second, the big fiscal
stimulus, which Premier Wen is now contemplating, would be most effective if China’s
exchange rate were kept stable – as it has been since last July.
Monetary control: lost and then regained
However, China bashing, i.e. mainly US pressure to appreciate the RMB, had become
intense by 2004. To deflect American protectionist threats, the Chinese authorities
began, as of July 21, 2005, to allow the renminbi to appreciate slowly – about 6 percent
per year against the dollar (Figure 1). But the resulting one-way bet that the renminbi
always rises prevented private capital outflows from financing China’s huge trade
surplus. Chinese banks and other financial institutions refused to acquire predictably
depreciating dollar assets. Compounding the situation, inflows of international ‘‘hot’’
money to buy everhigher renminbi assets led to enormous balance of payments
surpluses.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1754-4408.htm
This is a revised version of content which appeared in the Financial Times online forum, 10
February 2009.
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