“With the exchange rate itself having little intrinsic value, fixing it would allow governments to use monetary and fiscal policy to target desired levels of unemployment and inflation”.
In the post second world war era, the exchange rate “…served as the anchor enabling western market economies and Japan to facilitate a greater role for the private sector domestically, and to pursue freer trade externally, reviving the global economy”. And even though the Eurozone is not perfect, the single currency did help encourage the free flow of goods.
The author argues that China would benefit from having a fixed exchange rate again, after dropping it in 2005. As learned in class a fixed exchange rate is easier for engaging in trade and exports. Such a system would be easier for a country like China, who extensively trades with the US. Fixed exchange rates in China would help support the competitiveness for their goods abroad. The article also states that in the countries of the US, Europe, Japan and China, “…they find that competitive monetary easing measures, and uncertainty about exchange rates, hold back rather than promote recovery”. The security of the fixed exchange rate will help the growth of the countries by increasing capital flows and encourage longer- term investment in projects.
As learned in class, if China pegs to the US dollar, they will give up sovereign monetary policy. This is a result of the Impossible Triangle also known as the unholy trinity, trilemma or the inconsistent trinity. A country can only pick two of the three options, a fixed exchange rate, free capital flows or sovereign monetary policy. If a fixed exchange rate falls, governments will buy its own currency, which increases demand, and if it appreciates governments will buy foreign reserves and sell its own currency.
This seems to parallel what we have talked about in class. When a government wants to stimulate economic growth, it decreases interest rates and gives up its flexible exchange rate in order to have the monetary policy autonomy to do so. However, between countries the best option may be to depreciate currencies. As mentioned above though, this could lead to a currency war. During the Great Depression, countries attempted this which ended up worsening the economic problem. Currency depreciation will only help a country who does it first before all others retaliate with the same action. I would not be surprised if China picks back up where it left off--pegging the Chinese ¥ to the US $ at an undervalued rate, as it seems the best option for recovering the losses that China has experienced due to the financial crisis.
ReplyDeleteThe way that these monetary and fiscal policies play out, to some degree, is calculable. As stated above, we've discussed the metrics for changes in monetary policy, and the consequential effects of the former on a countries economy. However, the real issue that China faces is not debating what good having a fixed exchange rate will do to their economy, but rather how the U.S. and much of the Western trading partners will react to such a change. Weather our politicians are bluffing or not, a fixed exchange rate would mean retaliation from the U.S. in form of trade barriers. If the goal is to create a completely free-trade system, China cannot create a fixed exchange rate, and expect to maintain free-trade as is.
ReplyDeleteThis post is so applicable to what we have been discussing in lecture. I didn't know that China dropped their fixed exchange rate in 2005. In fact, that is surprising to me, because they are a big trading country, as well as export oriented country. I do think that having fixed exchange for China would possibly help with competitiveness of goods abroad. I'm really glad you ended your post just explaining that if a fixed exchange rate falls, governments will buy its own currency which increases demand and if the exchange rate appreciates governments will buy foreign reserves and sell its own currency. I do wonder if fixed exchange rates are to increase soon, and if they will bring about capital flow across borders!
ReplyDeleteChina's growth has recently been slowing down from its past 30 year run. I wonder if this continued drop in economic growth with put more pressure on the government to return to the same fixed exchange rates it embraced earlier. If China did return to such an exchange rate, this could help increase exports and fuel additional growth.
ReplyDeleteI must say that with a strong capitalist idea, in the XXI century, I don't believe that countries should have fixed exchange rate. Yes it was very useful and needed in the time of development among the developed nations until the era of post WWII, but now economies must and should be strong enough that they can influence the exchange rate completely. A currency is the economical image of a nation and with that, governments should create incentives to companies to grow economically and create jobs.
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