With all the hullabaloo about the Fed's second round of quantitative easing or QE2 (which Bernanke argues is just monetary policy), recent actions by the People's Bank of China, that nation's central bank, offer some interesting insights into exchange rates and monetary policy.
The Times and the Journal both reported last week's 0.5 percentage point increase in the required reserve ratio for Chinese banks, from 17.5 to 18%, but the two reports offered different analytical perspectives. Both cited a domestic inflation rate of 4.4% in October over the previous year, above the Bank's target of 3%. But the Times report quoted arguments by banking analysts that raising reserve requirements was a way for the People's Bank to obtain more funds it could use to purchase foreign currencies. Tighter monetary policy would tend to appreciate the currency if interest rates rise, especially when the Fed is trying to lower long-term interest rates with its purchases of U.S. government bonds, but currency purchases could offset that.
For all the talk of an undervalued renminbi, it has been rising, at least prior to the crisis in 2008 and again since September.
