Morris Goldstein and Nicholas Lardy’s solution to Chinese currency problem

Morris Goldstein and Nicholas Lardy’s solution to the Yuan problem:

“...we propose the following compromise. First, China should implement in the next few months a 10 to 15 percent appreciation of the renminbi relative to the current value of the basket. This could be done either by a revaluation or by allowing market forces to push up the currency’s value. Such a “downpayment” would help to persuade external critics that China is serious about controlling its growing external imbalance. Second, China should widen substantially either the band around the central rate or the daily fluctuation limit. That would provide increased independence for monetary policy, allow scope for further renminbi appreciation and give China experience in managing increased flexibility. Third, to offset some of the contractionary effect of the renminbi appreciation, China should simultaneously implement fiscal expansion. Fourth, China should maintain most capital controls until its banks are further strengthened.

This would still require sizeable real appreciation of the renminbi later, with all the problems that such a phased adjustment entails. If speculative inflows resurge, the authorities would need to choose between an acceleration of renminbi appreciation and a temporary recourse to tighter controls on capital inflows. In the final stage of currency reform—when China’s banking system is more stable—China would float the currency and remove the remaining capital controls. Admittedly, this is not an elegant plan. But if it would break the existing logjam in addressing global payments imbalances, it merits consideration.”

see Goldstein and Lardy's full article in the Finanicla Times