Reappraisal of exchange rate regimes

Comments on He Fan “China must push ahead with exchange rate reforms”, 30/04/2013, http://www.eastasiaforum.org/2013/04/29/china-must-push-ahead-with-exchange-rate-reforms/

The real appreciation of the RMB is much more than the 30 per cent since the exchange rate reforms of 2005 as mentioned in the post, given that inflation in China has been far greater than that in the US.

Having an annual limit on the total movement of the exchange rate has merits, although the exact figure can be hard to determine and it is not necessarily asymmetry between the upper and lower bounds. It should ideally be linked to some measure of equilibrium level of exchange rate, based on relative inflation rates and trade situations.

In that sense, the 7.5% limits appear to be arbitrary, as the author seems to have acknowledged.

In terms of sequence of reforms, removing trade distortions, such as export subsidies and imports restrictions should probably take a higher priority than exchange rate reforms.

Further, it is not necessarily certain that free exchange rate regime is better than a fixed exchange rate regime if the effects of exchange rate bubbles on the real economy are taken into account.

The advantages of monetary policy freedom must be balanced with the distortionary effects on resource allocation in the real economy and potentially damaging adjustments.

So far, people take the easy way, that is, monetary policy freedom, but leave the blames of real damage to the markets to avoid accountability.

That is not necessarily optimal for the world economy or indeed any individual economies.

In my view there is a need for a reappraisal of exchange rate regimes with a new framework in which both the effects of both monetary policy and the effects of exchange rate on the real economy are taken into account, and consider whether there are any new policy design for the international system to work better.

There should be a system that has a set of well-designed rules to allow countries to choose a fixed or flexible exchange rate regime and should a fixed regime is selected how the system will adjust under a set of agreed rules.

Such a system can and should include provisions that will allow monetary flexibility for every country supported by a set of agreed international rules.