The Choice of Exchange Rate Regime: The Relevance of International Experience to China's Decision

Whether a country should choose a fixed or flexible exchange rate, or some intermediate regime, is one of the oldest policy questions in economics. It is also one of the most important. Many countries have encountered crises that interrupted their growth because they made a bad choice. Others have never got growth going because of misguided decisions. Obviously this is not to say that exchange rate policy is the only thing that matters, but it is to claim that a flawed exchange rate policy can bring the rest to naught.

How should one evaluate China’s current policy, of pegging its exchange rate in terms of the US dollar? This has not, at least as yet, led to a crisis that interrupted growth, and it certainly has not prevented an impressive growth performance. This does not mean that China’s current policies deserve to be perpetuated, but it does imply that any change needs to be evaluated carefully to make sure that it will not risk undermining China’s success.

I start by describing what I see as the two most important lessons of international experience with exchange rate regimes in the period since World War II. I then proceed to lay out the conditions that are necessary in order for a fixed exchange rate regime to make sense. Since some of those conditions are clearly not satisfied by China, I describe some intermediate regimes that might be desirable where a fixed rate is inappropriate. Finally I turn to discuss what the analysis implies as regards contemporary China.