China's Exchange Rate Policy: The Case Against Abandoning the Dollar PEG

This paper critically evaluates the policy literature surrounding China's exchange rate regime.It first discusses several popularly raised contentions in relation to the dollar peg employed by China, which in fact are poorly grounded in evidence.These include notions that the RMB is clearly undervalued and that its value is a prominent cause of the U.S trade deficit.The paper then describes a consensus position that has emerged which argues that China should abandon the peg in favour of a flexible exchange rate regime.We see numerous weaknesses in this position but a few stand out.Moving to a flexible regime is far from the most proximate policy response to the problems that the consensus literature itself identifies in China's economy.Institutional realities that make moving to a flexible regime difficult also appear to have been seriously overlooked.The paper concludes by noting that in the longer term moving to a managed float may be in China's best interests - but for now the focus needs to be firmly in the area of domestic financial reform.