China’s Exchange Rate Policy: The Case For Greater Flexibility

Abstract

Since the Asian crisis, the merit of the Chinese government’s de facto peg to the US dollar has been the subject of widening debate. This paper reviews the issues surrounding China’s currency regime choice and assesses the case for greater flexibility. Reform era exchange rate policies are examined along with the performance of the economy during and since the Asian crisis. In the Chinese context the arguments for and against fixed exchange rates are then explained and assessed. Finally, an elemental comparative static macroeconomic model is used to examine the implications of domestic and external shocks under different exchange rate regimes and with differing degrees of capital mobility. The results support the view that more flexibility would be beneficial to China and that this benefit can be expected to increase as capital mobility increases.