Reforms in China’s Monetary Policy Reforms in China’s Monetary
Chapter 3 : Exchange Rate Policy
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| Chapter 3 : Exchange Rate Policy
The third chapter discusses the RMB exchange rate regime and international balance. I analyze the mid-to-long run trend of China’s current account sur- plus from the perspective of the saving-investment gap and draw the conclu- sion that the surplus to GDP ratio will be around 2–4 percent, as evidenced by the latest empirical tests. I estimate the RMB equilibrium exchange rate applying multiple methods, including the DSGE model, and find that the rate has been close to the equilibrium level. Since China has passed the Lewis Point, the Balassa-Samuelson effect has worked, and we cannot underesti- mate the positive role exchange rate plays in suppressing inflation. We need to watch closely the change of China’s tradable sector and its productivity rate. I propose that against the backdrop of economic globalization and more fre- quent flow of capital, the Impossible Trinity has evolved into the Impossible Duality, in which the significance of floating exchange rate has been reduced. A country can only choose between the free flow of capital and monetary pol- icy independence. There are three possible explanations. First, the real returns of developed and emerging market economies are different. Second, expec- tation has rendered the conventional law of demand and supply ineffective. The demand curve of the assets from the countries with appreciating cur- rencies is upward sloping. Third, the foreign money market is far larger than the home money market and the foreign exchange market, and therefore the 6 ● Reforms in China’s Monetary Policy foreign money market rate has turned to be the decisive variable in uncovered interest rate parity. I have learned from many scholars, and it would be futile to try to name them all. For this book, I am particularly grateful to Zhou Xiaochuan, Shang Fulin, Hu Xiaolian, Yi Gang, Wu Jinglian, Li Yang, Lawrence J. Lau, Ronald I. Mckinnon, and Zhang Xiaohui. I wish to thank Sun Bibo, who contributed to “On the Estimation of RMB Equilibrium Exchange Rate: An Empirical Research Based on DSGE Model” of chapter 3 , and Lu Dong, who contrib- uted to “Predictive Analysis on Mid-long Term Trend of Current Account Surplus in China—Based on a Perspective of Savings-investment Structural Change” of chapter 3 . For permission on using in this book, I would like to thank the Economic Research Journal and Finance & Trade Economics for parts of chapter 1 ; Caijing Magazine, Economics News, Caijing Times, China Money, and Journal of Financial Research for parts of chapter 2 ; and Comparative Studies (Bijiao), Journal of Financial Research, Financial Development Review, and Caijing Magazine for parts of chapter 3 . |