“Impacts of China’s Exchange rate Policy”
By Jeff R. Oyo
Tuesday, March 11, 2014
Presenter:
Jeff R. Oyo
Discussants:
•Kylene Holmes
•Deshawn King
Senior Seminar – ECO 490
Introduction
In policy circles, the questions include whether China
should allow its currency to appreciate to encourage
global rebalancing – that is, to shift the composition of
activity away from exports and facilitate the efforts of
deficit countries like the United States to export more.
Source: Eichengreen, Barry, and Hui Tong. "The External Impact of China's Exchange Rate Policy:
Evidence from Firm Level Data." (2011).
Introduction 2/3
• The currency of the People's Republic of China
consisting of yuan is referred to as Renminbi.
Source: http://www.xe.com/currency/cny-chinese-yuanrenminbi
Introduction3/3
• China is an important factor in manufacturing parts
and components to manufacture in other countries.
– Firms relying on these inputs will therefore be
adversely affected by renminbi appreciation that
makes those inputs more expensive.
• Finally, China is an important purchaser of foreign
assets and an influence on foreign financial
conditions.
Source: Eichengreen, Barry, and Hui Tong. "The External Impact of China's Exchange Rate Policy:
Evidence from Firm Level Data." (2011).
Background
China’s emergence as a global power raises concerns
about its economic policies. Monetary policy commands
attention, since maintaining low inflation is crucial for
social and economic stability. High inflation could erode
the value of Chinese households’ large savings in
domestic banks – broad money M2 amounted to over
150% of GDP in 2008.
Mehrotra, Aaron, and José R. Sánchez-Fung. "China's monetary policy
rate." Comparative Economic Studies 52, no. 4 (2010): 497-514.
and the exchange
Problems
• Why is this important?
– According to Eichengreen and Tong’s working paper on
The External Impact of China’s Exchange Rate,
willingness to allow the renminbi to rise might imply
fewer Chinese purchases and, in turn, higher foreign
yields.
– Their paper outlines test that portrays change in
Chinese exchange rate policy potentially impacts firms
in other countries.
Problems Continued
• Why has China not revalued its currency?
– The classic case of not revaluing in the face of a large
external surplus is when there is a conflict with
domestic macroeconomic objectives.
• Misguided Monetary Policy
• People’s Bank of China
Modeling Monetary Policy in China
• In Aaron Mehrotra and Jose Sanchez-Fung “China’s
monetary policy and the exchange rate” they model
monetary policy in China using the type of hybrid
McCallum-Taylor reaction functioned studied in a
previous paper.
Source: Mehrotra, Aaron, and José R. Sánchez-Fung. "China's monetary policy and the
exchange rate." Comparative Economic Studies 52, no. 4 (2010): 497-514.
Recent Headlines
• China Inflation Decelerates in February
• China Posts Trade Deficit in February
• People’s Bank of China Drains Funds to Curb Lending
Surge
• China Annual Inflation Rate Rises 2.5% in January
• China's Trade Surplus Widens in January
• China’s GDP Expands 1.8% QoQ in Q4 2013
• Chinese Economy Slows in Q4 of 2013
Recap
• China’s exchange rate is being controlled by
government authorities: the People’s Bank of China
(PBoC: China’s central bank) manages the value of
the renminbi. They do so by fixing the USD/CNY-rate
on each trading day. This is the exchange rate that
applies to trade flows into and out of China only.
• A prime reason for China to keep the value of its
currency low versus its trade partners, is that it
makes China’s exports cheaper, and thus more
attractive.