China's New Exchange Rate Policy: Will China Follow Japan into a Liquidity Trap?

Ronald McKinnon

No 05-002, Discussion Papers from Stanford Institute for Economic Policy Research

Abstract: On July 21, 2005, China gave in to concerted foreign pressure—some of it no doubt well meant—to give up the fixed exchange rate it had held and grown into over the course of a decade. The U.S. Congress had threatened, and still threatens, to pass a bill that would impose an import tariff of 27.5 percent on Chinese imports unless the renminbi was appreciated, and pressured the U.S. Administration to retain China’s legal status as a “centrally planned” economy (despite its wide open character) so that other trade sanctions—such as anti-dumping duties—could be more easily imposed. True, the actual appreciation since July 21 of the still tightly controlled renminbi has been trivial—less than 3 percent. And it is much less than the 20 to 25 percent appreciation called for by vociferous American critics of China’s foreign exchange policy.2 But the move signaled that further appreciations had become more likely in the guise of achieving greater exchange rate flexibility. American pressure on China today to appreciate the renminbi is eerily similar to American pressure on Japan that began almost 30 years ago to appreciate the yen against the dollar. There are some differences between the two cases, but downward pressure on interest rates from foreign exchange risk could lead China into a zero-interest liquidity trap much like the one Japan has suffered since the mid-1990s.

Date: 2005-09
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Journal Article: China's New Exchange Rate Policy: Will China Follow Japan into a Liquidity Trap? (2006)
Journal Article: CHINA'S NEW EXCHANGE RATE POLICY: WILL CHINA FOLLOW JAPAN INTO A LIQUIDITY TRAP? (2005)
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