Trilemma Challenges for the People's Republic of China

Masahiro Kawai () and Li-Gang Liu ()
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Li-Gang Liu: Chief Economist, Greater China, ANZ Research, Australia and New Zealand Banking Group Limited (ANZ)

Asian Development Review, 2015, vol. 32, issue 1, 49-89

Abstract: This paper first reviews recent developments in exchange rate regimes, capital account liberalization, interest rate liberalization, and monetary policymaking in the People's Republic of China (PRC). It then observes that the PRC's monetary policy autonomy may have been reduced with falling capital control effectiveness and a rigid exchange regime that is still tightly managed against the United States (US) dollar. This hypothesis is investigated empirically using both the Taylor rule and a McCallum-like rule to test whether the PRC's money market interest rate and/or quantity of money supply are being increasingly influenced by the US interest rate or reserve accumulation. The paper concludes that there is considerable evidence suggesting diminishing monetary policy autonomy in the PRC. To regain policy autonomy, the monetary authority needs to substantially increase exchange rate flexibility of the renminbi as long as it continues to pursue capital account opening.

Keywords: China; exchange rate; monetary policymaking; Taylor rule; policy autonomy; mccallum rule (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (9)

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