China�s exchange rate policy: the case against abandoning the dollar peg

This paper critically comments on the policy literature surrounding China�s exchange rate regime. It first seeks to expose as myths several popularly raised contentions regarding the dollar peg employed by China, including the belief that the RMB is clearly undervalued and that its value is a prominent cause of the U.S trade deficit. The paper then describes a consensus position that has emerged which argues that in the interests of better promoting its own macroeconomic stability, China should abandon the peg in favor of a more flexible exchange rate regime. We see numerous weaknesses in this position but a few stand out. Available data do not suggest that flexible regimes outperform fixed regimes in terms of inflationary outcomes. Moving to a flexible regime is also far from proximate policy response to the problems that are in evidence in China�s economy. Institutional realities that make moving to a flexible regime difficult also appear to have been seriously overlooked. The paper concludes by noting that in the longer term moving to a more flexible regime may be in China�s best interests. But for now, the focus needs to be firmly in the area of domestic financial reform.