In a recent interview, Tyler Cowen asked me why China doesn’t end its deflation by devaluing the yuan. I suggested that it might be due to pressure from the US. A recent Bloomberg article provides support for that claim:
In fact, the PBOC has been fending off depreciation pressure on the yuan since Trump won the US elections in November. It has capped the yuan’s drop at around 7.3 per dollar by setting the daily reference rate, which limits moves in the onshore yuan by 2% on either side, since late January.It has also delayed interest-rate cuts, paused bond purchases so far this year and tolerated a funding squeeze among banks to prevent further yuan declines and capital outflows.“Despite the upcoming extra 10% tariff hike, the PBOC will probably refrain from tweaking its steady yuan fixing policy, considering Trump’s warning on yuan depreciation,” said Ken Cheung, chief Asia FX strategist at Mizuho Bank in Hong Kong. “The PBOC may also be inclined to preserve currency stability during the National People Congress.”
The US government did the same thing to Japan back in the 1990s and 2000s, pushing them into deflation. It never ceases to amaze me how much harm can be done by policymakers that lack a basic understanding of economics.In the long run, the deflation in China will restore equilibrium, as the real exchange rate will depreciate even as the nominal rate is fixed. But recall what Keynes said about the long run.
China does not need a weaker yuan in real terms, but it does need a weaker yuan in nominal terms in order to boost its NGDP growth rate. Monetary stimulus would be unlikely to boost China’s current account surplus, as the faster economic growth would probably suck in imports at a faster rate that the weaker yuan would boost exports. In other words, the income effect would likely dominate the terms of trade (substitution) effect.
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