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China's New Exchange Rate Policy: Will China Follow Japan into a Liquidity Trap?

Author

Listed:
  • Ronald I. McKinnon

    (Stanford University)

Abstract
On July 21, 2005, China gave in to concerted foreign pressure—some of it no doubt well meant—to give up the fixed exchange rate it had held and grown into over the course of a decade. The U.S. Congress had threatened, and still threatens, to pass a bill that would impose an import tariff of 27.5 percent on Chinese imports unless the renminbi was appreciated, and pressured the U.S. Administration to retain China’s legal status as a “centrally planned” economy (despite its wide open character) so that other trade sanctions—such as anti-dumping duties—could be more easily imposed. True, the actual appreciation since July 21 of the still tightly controlled renminbi has been trivial—less than 3 percent. And it is much less than the 20 to 25 percent appreciation called for by vociferous American critics of China’s foreign exchange policy.2 But the move signaled that further appreciations had become more likely in the guise of achieving greater exchange rate flexibility. American pressure on China today to appreciate the renminbi is eerily similar to American pressure on Japan that began almost 30 years ago to appreciate the yen against the dollar. There are some differences between the two cases, but downward pressure on interest rates from foreign exchange risk could lead China into a zero-interest liquidity trap much like the one Japan has suffered since the mid-1990s.

Suggested Citation

  • Ronald I. McKinnon, 2005. "China's New Exchange Rate Policy: Will China Follow Japan into a Liquidity Trap?," Discussion Papers 05-002, Stanford Institute for Economic Policy Research.
    • Handle: RePEc:sip:dpaper:05-002
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    References listed on IDEAS

    as
    1. Ronald McKinnon & Gunther Schnabl, 2004. "The Return to Soft Dollar Pegging in East Asia: Mitigating Conflicted Virtue," International Finance, Wiley Blackwell, vol. 7(2), pages 169-201, July.
    2. Michael Funke, 2005. "Inflation in Mainland China - Modelling a Roller Coaster Ride," Quantitative Macroeconomics Working Papers 20507, Hamburg University, Department of Economics.
    3. 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.
    4. Ronald I. McKinnon & Kenichi Ohno, 1997. "Dollar and Yen: Resolving Economic Conflict between the United States and Japan," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262133350, April.
    5. repec:zbw:bofitp:2005_006 is not listed on IDEAS
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    Cited by:

    1. Yin-Wong Cheung & Dickson C. Tam & Matthew S. Yiu, 2008. "Does the Chinese interest rate follow the US interest rate?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(1), pages 53-67.
    2. repec:dau:papers:123456789/5487 is not listed on IDEAS
    3. Lijian Sun & Shengxing Zhang, 2008. "External Dependent Economy and Structural Real Estate Bubbles in China," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 16(1), pages 34-50, January.
    4. Antoine Bouveret & Sana Mestiri & Henri Sterdyniak, 2006. "The renminbi equilibrium exchange rate: an agnostic view," Documents de Travail de l'OFCE 2006-13, Observatoire Francais des Conjonctures Economiques (OFCE).
    5. repec:hal:spmain:info:hdl:2441/5282 is not listed on IDEAS
    6. Paul S. L. Yip, 2016. "China’S Exchange Rate System Reform: Two Potential Mistakes And The Recommended Long-Term System," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(02), pages 1-40, June.
    7. Philip R. Lane & Sergio L. Schmukler, 2006. "The international financial integration of China and India," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    8. Wu, Ying, 2009. "Measuring China's monetary sterilization and autonomy in the era of globalization: 1995-2005," Journal of Asian Economics, Elsevier, vol. 20(3), pages 336-347, May.
    9. Kwack, Sung Yeung & Ahn, Choong Y. & Lee, Young S. & Yang, Doo Y., 2007. "Consistent estimates of world trade elasticities and an application to the effects of Chinese Yuan (RMB) appreciation," Journal of Asian Economics, Elsevier, vol. 18(2), pages 314-330, April.
    10. Antoine Bouveret & Sana Mestiri & Henri Sterdyniak, 2006. "La valeur du yuan. Les paradoxes du taux de change d'équilibre," Revue de l'OFCE, Presses de Sciences-Po, vol. 98(3), pages 77-127.
    11. Paul S. L. Yip & Yiu-Kuen Tse & Yingjie Dong, 2017. "The Exchange Rate System Reform in China: US Pressure, Implicit Gradual Appreciation and Explicit Exchange Rate Bands," Economic Growth Centre Working Paper Series 1710, Nanyang Technological University, School of Social Sciences, Economic Growth Centre.
    12. Cappiello, Lorenzo & Mehl, Arnaud, 2007. "Uncovered interest parity at distant horizons: evidence on emerging economies & nonlinearities," Working Paper Series 801, European Central Bank.
    13. repec:hal:spmain:info:hdl:2441/5121 is not listed on IDEAS
    14. repec:spo:wpmain:info:hdl:2441/5121 is not listed on IDEAS
    15. Cao Emily Yixuan & Cao Yong & Prasad Rashmi & Shen Zhengping, 2011. "U.S.-China Exchange Rate Negotiation: Stakeholders' Participation and Strategy Deployment," Business and Politics, De Gruyter, vol. 13(3), pages 1-25, October.
    16. repec:hal:wpspec:info:hdl:2441/5121 is not listed on IDEAS
    17. repec:spo:wpmain:info:hdl:2441/5282 is not listed on IDEAS
    18. Niklas Potrafke, 2007. "Social Security in Germany: A Prey of Political Opportunism?," Discussion Papers of DIW Berlin 677, DIW Berlin, German Institute for Economic Research.
    19. repec:dau:papers:123456789/5512 is not listed on IDEAS
    20. repec:spo:wpecon:info:hdl:2441/5121 is not listed on IDEAS

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