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Conventional static economic theories and practical policies

Comments on Peter Drysdale “China’s economic policy strategies – Weekly editorial”, 19/04/2010, http://www.eastasiaforum.org/2010/04/19/chinas-economic-policy-strategies-weekly-editorial/

The argument that "contraction engineered by higher interest rates alone, without the benefit of the deflationary effect of an appreciation of the currency would need sharper contraction and would cut imports more drastically, also worsening the current account surplus", can be well understood, because it is what one would expect from economics textbooks.

However, if one look at what is beyond the theories for a static expansion and contraction case and work in the real dynamic world where a "contraction" may mean a fairly soft or moderate landing as opposed to an absolute reduction in output, the above argument may look a bit shaky.

What does a contraction in China mean by all intent and purpose? It should ideally be a growth from 12 to 10%. Nevertheless it is still a 10% growth, and as a result, China still will increase imports much more.

At the same time, the external demand is not necessarily growth in pace of the 10% economic growth in China, means external demand for China's exports may actually grow much slower than its imports, even in that scenario of a contraction.

The upshot is that it is not convincing to use the simple and conventional static thinking on current account to the exchange rate policy indiscreetly. One has to consider the specific case at hand here.

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