Question

China pegged its currency at 8.28 yuan per US dollar from 1995 to 2005. At the same time, the People's Bank of China (the Chinese central bank) enjoyed an independent monetary policy. In order to maintain these two goals, China imposed capital control. What would have happened in the absence of capital control?

Answer 1

It can be seen that the China has pegged it's currency against the United State dollars and it is trying to maintain a fixed exchange rate with respect to the United State dollars and it is trying to protect itself against volatilities of the foreign market.

 

It has also allowed the central bank of China to enjoy independent monitory policy which will help the Chinese Central Bank to maintain adequate flow of funds in order to achieve the desired pegged exchange rate.

 

The capital control is generally helping the Chinese regulators to limit the flow of funds inside and outside the domestic economy and it will be helpful for them in order to have a control over the flow of funds through regular capital monitoring.

 

Absence of the capital control will be resulting into lack of control over the influence and outflows of foreign funds in the Chinese economy and it will be resulting into exchange rate exhibiting of very higher degree of volatility with respect to foreign fluctuations and the desired pegged exchange rate will not be achieved. 

 

It will also be resulting into lack of investors trust on the Chinese market and Chinese exchange rate will be exposed to sharp. It could also be resulting into rapid depreciation of Chinese currency.

 

It will negatively impact the Chinese exchange rate on the downside and it will also result into higher degree of fluctuation and disturbances in the economy.