The New York Times reported on Saturday that China's central bank is adopting a more contractionary monetary policy in order to slow its economy and reduce inflation. If China's central bank is concerned that inflation is getting out of control, then it would be an ideal time for the country to begin to raise the value of its currency against the dollar. This would have two beneficial effects from the bank's standpoint. First, a more valuable Chinese currency will make Chinese exports more expensive. This will slow China's export growth, and thereby help to slow its economy. The other effect is that a higher valued currency will make imports cheaper. Lower priced imports will help to alleviate domestic inflation by making cheap goods available as inputs into production, and also by allowing workers to consume more without pay increases. A higher valued Chinese currency will be a mixed story for the United States. On the one hand, it will make U.S. goods more competitive, both in the United States and elsewhere in the world. (I will preempt an inevitable comment. If China goes this route, other countries will also raise the value of their currency against the dollar, as they have done in the past. So we will not just be shifting the place of origin of U.S. imports.) This will be a step towards a more sustainable trade deficit. The bad side of the story is that higher import prices will add more fuel to inflation. Higher prices goods from China and elsewhere will be yet another factor pushing the inflation rate higher in the months ahead, if China goes this route.
--Dean Baker
