Friday, January 21, 2011

A nice overview of the renminbi/dollar exchange rate issues

Paul Krugman provides a nice overview of the Chinese renminbi and U.S. and Chinese monetary policies. But I'd say there are probably two reasons why inflation is running high in China: rapid growth irrespective of the exchange rate policy that is keeping the renminbi undervalued, and the exchange rate policy. Krugman focuses on the latter, but I'm not sure how that could drive broad-based inflation. Maybe he's absolutely right, but I would have imagined that an undervalued currency would drive inflation via the high prices of imports, which would allow domestic producers of substitutes to raise their prices as well. Unless the import is a widely demanded item like oil, I'm not sure why such a dynamic would have such a broad effect on inflation, such as in real estate.