Friday, August 22, 2008

The Effect Of Chinese Currency Appreciation On Inflation

In the Financial Times, Adam Posen and Arvind Subramanian argues that China should end its mercantilist exchange rate policy and allow the yuan to rise faster to contain inflation. I agree that such a move would indeed lower inflation in China. However, it won't work in what they call a global fight against (price) inflation.

Indeed, a stronger yuan is likely to raise, not reduce, inflation outside China. The first reason for this is that it will raise Chinese export prices, and the second reason is that it will make commodities cheaper in yuan terms and so raise their price.
The beneficial effect on the global economy of a stronger yuan thus doesn't lie in that it would lower inflation generally, but in that it would reduce the excess current account surplus in China and by extension also reduce the excess deficits of some other countries.

1 Comments:

Blogger Rebecca Wilder said...

Thanks for the reference. I tend to think that it is too early for the People's Bank of China to let the currency float. Sure, as the WSJ points out (http://blogs.wsj.com/economics/2008/08/18/reading-tea-leaves-chinas-2q-monetary-report/), the PBoC has de-emphasized its policy of exchange rate intervention, but has enough "decoupling" really occurred between China and its major exporters (US and Europe) to insulate the Chinese growth engine from a surge in the Yuan? I don't think so.

4:41 PM  

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