Putting the Cart Before the Horse? Capital Account Liberalisation and Exchange Rate Flexibility in China

The Renminbi Rises

“…If the capital account is opened in the absence of interest rate liberalisation, a deep capital market and a flexible exchange-rate mechanism, it runs the risk of threatening monetary policy efficacy (Prasad, Rumbaugh andWang 2005, McCauley 2011). With free capital movement, it will be impossible for the PBoC to continue to control the exchange rate and at the same time have monetary autonomy (i.e.…”

The external and domestic side of macroeconomic adjustment in China

“…Parts of the literature are assessing the external implications of a more significant exchange rate change, focusing on trade flows (Sun and Ma, 2005;Ji and Wang, 2006;Devereux and Genberg, 2007) or focusing on the linkages with capital account liberalisation (Prasad et al, 2005;Goodfriend and Prasad, 2006;Ma and McCauley, 2007;Capiello and Ferrucci, 2008 in particular the questions on growth and inflation (McKinnon and Schnabl, 2006;Shi, 2006;Yu, 2007).…”

“…In particular, for assessing the macroeconomic implications of the fixed exchange rate regime, it is crucial to go beyond its potential implication for international relative prices, and try to introduce features that are able to approximate its potential implication for the internal macroeconomic adjustment process. Prasad et al (2005) have pointed out that China's fixed exchange rate regime has generated specific costs; in particular that it has required domestic financial repression that entails large distortions and efficiency losses. Aziz and Dunaway (2007) point out that liquidity injections from massive foreign exchange interventions have contributed to real costs of investment of only about 1-2 percent and have implied that the cost of capital has not only been low but also fallen relative to wages.…”

The External and Domestic Side of Macroeconomic Adjustment in China

“…For the same reasons, also the assessment of the implications of a further change in China's exchange rate policy, in particular a more significant appreciation, is difficult. Parts of the literature are assessing the external implications of a more significant exchange rate change, focusing on trade flows (Sun and Ma, 2005;Ji and Wang, 2006;Devereux and Genberg, 2007) or focusing on the linkages with capital account liberalisation (Prasad et al, 2005;Goodfriend and Prasad, 2006;Ma and McCauley, 2007;Capiello and Ferrucci, 2008). Other strands of the literature are considering the domestic implications, discussing in particular the questions on growth and inflation (McKinnon and Schnabl, 2006;Shi, 2006;Yu, 2007).…”