Question

Write a 500-word report critically analyzing China’s monetary policy between 1995 and 2005.

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 from Chapter 6 of the textbook.

Apply the combined insights from Chapters 6, and 10–13 and come up with your best answers to the questions below by using some of the models we developed in the course. (Keep in mind that the answer to some of the questions below is not found in any model we studied, as we have not developed a model with capital controls. Still, 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 a debate about its rigidity and fairness to foreign economies, so stay focused on this period that is simpler to analyze.

Requirements:

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.

3. Given the large accumulation of foreign reserves over this period, describe what the macroeconomic equilibrium could have been in terms of domestic interest rates, exchange rate, and net exports had China not had effective capital controls in place but kept the fixed exchange rate regime.

4. Suppose that at the end of this period China suddenly lifted capital controls and moved to a fully flexible exchange rate regime. Discuss the implications for the Chinese interest rate, exchange rate, and net exports. (Please note that this is what China is currently doing, albeit gradually and not suddenly. So, you can use news stories to help your narrative, but be sure to give the most weight to your own critical observations and thinking.)

5. Create or include at least one table and one chart to illustrate the outcomes of China’s changed policies.

6. Discuss how China’s peculiar monetary regime affected your business or industry during the period from 1995–2005? And how it might have affected US consumers more generally.

Answer 1