Reply to Economist.com: A theory of non-relativity

Author:

Scott Sumner

"The Economist, also known as known as Free Exchange, did a nice piece on my recent China post. They contrasted my views with those of Paul Krugman, and also asked a few questions. Here I’ll try to respond to those questions, but first I’ll clarify exactly where Krugman and I differ.

First some areas where we agree. Both Krugman and I see the biggest macro problem over the past 14 months as being the sharp fall in aggregate demand over most of the world. We are both strong supporters of additional stimulus; indeed we are both among the diminishing band of economists who still favor additional stimulus. We both strongly oppose monetary tightening by the Fed, ECB, and BOJ. But there are also some key differences, which may have indirectly contributed to our opposing views on the Chinese Rmb. In the US I favor additional monetary stimulus and oppose fiscal stimulus. Krugman is not opposed to additional monetary stimulus, but doubts the effectiveness of such actions when the policy rate is near the zero bound.

There is pretty general agreement that central banks have almost unlimited ability to depreciate their currency. And most major central banks (including the Fed and the People’s Bank of China) have the resources necessary to sharply increase their nominal exchange rates, if they so desire. So I agree that the Chinese government could appreciate the yuan in nominal terms. Let’s put off the issue of saving rates and current account deficits for the moment, and grant Krugman’s assumption that the PBOC could also appreciate the real Chinese exchange rate, at least for a considerable period of time. The question is whether it would be wise. I think it would be bad for China, and bad for the world.

However, my reasons are not what you might expect, as I look at the issue from a money/macro perspective, not a trade perspective. If the Fed were to adopt a much more aggressively expansionary monetary policy, and if this led to a higher value of the Chinese yuan, I’d be in favor. So why does it matter how the Chinese currency appreciates, as long as it appreciates? Because an exchange rate is merely the relative value of two currencies, it tells us nothing about the absolute value of those currencies in terms of goods and services, which is much more important. If the Fed adopted a much more expansionary monetary policy, and if the PBOC kept its policy stance the same, then world monetary policy would become more expansionary, and world aggregate demand would increase. That would help everyone..."

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Posted : Thursday 29 October 2009 22:43 | Managing Editor

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Friday 15 October 2010 | Su Su

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Friday 15 October 2010 | Su Su

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Wednesday 20 October 2010 | yan yan

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Wednesday 20 October 2010 | Blue China

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Tuesday 26 October 2010 | liking adese

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Thursday 28 October 2010 | Kelly Green

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