Question

Critically analyzing China’s monetary policy between 1995 and 2005. Provide any websites, textbooks, etc. if used to obtain information.

Background

With capital controls, think of China as a closed economy; without capital controls, think of China as a small open economy. Remember the relation between net exports and net capital flows. Try to reason as a business person and answer to the best of your abilities.

Briefly research China’s exchange rate regime between 1995 and 2005. (Please note that after 2005, China’s exchange regime has changed, and became more flexible, with an abrupt acceleration in the degree of flexibility in 2015, even though there continues to be debate about its rigidity and fairness to foreign economies, so stay focused on this period that is simpler to analyze.

1. Describe how China’s exchange rate regime operated over this period and locate China’s exchange rate regime on the “Impossible Trinity Triangle”.
2. For each of the following objectives, evaluate whether the regime was effective or not, and why:

• Maintaining low inflation.
• Providing monetary policy independence (as measured by …).
• Promoting competitiveness of Chinese exports.

Answer 1

The currency of china i.e. yuan, doesn’t follow the floating exchange rate which depends upon the market forces. Till 2005 it followed fixed rate of exchange. The old foreign exchange regime has a overvalued exchange system.
In 1995, yuan was converted into current account
In 1998- keep the currency stabilised.
2001- China joined WTO and decided to adjust its currency regime.
2004-China decided to moved towards flexible currency regime.
2005- china revalued their currency and has shifted to flexible currency with demand and supply effects of other currencies.
The impossible trinity triangle which means the combination of free capital flow, fixed exchange range and sovereign monetary policy. The china tried to implement these and implementation of these three at the same time may lead to problem in the economy.
The china policy aims at two targets (i) economic target for stability and (ii) political target for growth.