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China's Exchange Rate and International Adjustment in Wages, Prices and Interest Rates: Japan Déjà Vu?

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  • Ronald McKinnon
  • Gunther Schnabl

Abstract

China's fixed its exchange rate at 8.28 yuan to the dollar from 1994 to July 2005, and has only allowed for a small appreciation since then. China's productivity growth has been very high relative to most other countries: its trade surplus has been rising and it continues to accumulate large dollar exchange reserves. Many observers, including high officials in the US government, take this as per se evidence that the renminbi is undervalued. To balance China's international competitiveness and reduce its trade surplus, they want the renminbi to appreciate much more. This common presumption of renminbi undervaluation is wrong, and its appreciation need not reduce China's trade surplus but would cause serious deflation in China. To show this, we consider international adjustment between China and the US from both an asset market and a labor market perspective, and compare this to Japan's unsuccessful appreciation of the yen from 1971 to 1995. During a time of economic catch-up and rapid financial transformation, fixing the exchange rate is the preferred way of anchoring the domestic price level. (JEL codes: F15, F31, F33) Copyright 2006, Oxford University Press.

Suggested Citation

  • Ronald McKinnon & Gunther Schnabl, 2006. "China's Exchange Rate and International Adjustment in Wages, Prices and Interest Rates: Japan Déjà Vu?," CESifo Economic Studies, CESifo Group, vol. 52(2), pages 276-303, June.
    • Handle: RePEc:oup:cesifo:v:52:y:2006:i:2:p:276-303
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    References listed on IDEAS

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    1. Gunther Schnabl & Christian Danne, 2005. "The Changing Role of the Yen/Dollar Exchange Rate for Japanese Monetary Policy," International Finance 0503001, University Library of Munich, Germany.
    2. Ronald McKinnon & Gunther Schnabl, 2006. "The East Asian Dollar Standard, Fear of Floating, and Original Sin," Chapters, in: Volbert Alexander & Hans-Helmut Kotz (ed.), Global Divergence in Trade, Money and Policy, chapter 3, pages 45-71, Edward Elgar Publishing.
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    6. Rishi Goyal & Ronald McKinnon, 2003. "Japan's Negative Risk Premium in Interest Rates: The Liquidity Trap and the Fall in Bank Lending," The World Economy, Wiley Blackwell, vol. 26(3), pages 339-363, March.
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    9. McKinnon, Ronald & Schnabl, Gunther, 2006. "Devaluing the dollar: A critical analysis of William Cline's case for a New Plaza Agreement," Journal of Policy Modeling, Elsevier, vol. 28(6), pages 683-694, September.
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    More about this item

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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