Best strategy for China's monetary policies now

Comments on Yiping Huang “China needs to adjust its monetary policy now”, 18/04/2010, http://www.eastasiaforum.org/2010/04/18/china-needs-to-adjust-its-monetary-policy-now/comment-page-1/#comment-111907

While it is conceivable to move both monetary policy in terms of rate hikes and the exchange rate in terms of moving back to linking to a basket of currencies simultaneously, it would be much more prudent to move monetary policy first and observe what the current account will move before considering a move in the exchange rate policy.

This is largely due to the following:

1. China's housing market is worryingly highly priced. Together with inflation pressure, it is warranted to require higher interest rate to have a serious effect on housing demand and speculations.

2. The current account is showing a quite different picture and we have already seen a deficit in recent report. The question is: is that deficit an abnormality or a trend formation? Obviously, current account situation is a key factor in terms of exchange rate movement by policy makers, including external pressures. If current deficits continues or even gets big, what is the point to revalue the RMB?

3. Thirdly, there is no resolution to China's official $US assets yet. It would be highly imprudent to revalue the RMB without a convincing resolution to those assets, both from public policy point of view or from social stability point of view.

4. The question of what exchange regime is good for China, or for different economic circumstances, especially when taking into account policy instruments available to authorities. It is doubtful that a flexible exchange rate regime will be good for China, and for the rest of the world as far as China's currency is concerned. Excessive fluctuations in exchange rate are most likely to completely outweigh the benefits of monetary autonomy. Just imagine that a 50% or more move in the exchange rate, often seen in the real world exchange rate movement. What does that means to businesses? That is a 50% price hike, up or down. Is that a good thing?

5. Even from the most recent international experience, most leading industrialised economies have been under flexible exchange rates. Did that help them avoid or dampen the GFC?

So it is time to revisit the issue of exchange rate regimes.