The headline is mine. Don’t blame Dr. Prasad.
But that is the conclusion I took away from Eswar Prasad’s most recent paper. I usually write about how China’s exchange rate policy distorts the global flow of capital, and impedes effective balance of payments adjusmtent. Eswar Prasad – now at Cornell, but formerly one of the IMF’s leading China hands – focuses instead on how China’s peg has distorted China’s domestic economy.
Maintaining the peg, in Dr. Prasad’s view, impedes China’s ability to achieve many of the Chinese government’s stated goals – jobs, an efficient financial sector and a more balanced economy. Moreover, incremental reform no longer works – especially not when the de facto peg effectively constraints a host of other policies.
“There are inherent limits to the incremental reform strategy that has worked well in the past. At a certain level of development and complexity of an economy, the connections among different reforms become difficult to ignore. … Ignoring these linkages – for example, trying to push ahead with banking reforms while holding monetary policy hostage to an exchange rate objective – makes an already difficult reform process harder.”
The right answer is to do more, not less – and to so now, when strong growth makes reforms easier. Dropping the peg is key. Why? Because a host of other policies in China are now directed at reinforcing the peg, and those policies cannot easily be changed if the paramount goal of Chinese policy is a weak RMB.
“The … inflexible exchange rate, while not the root cause of imbalances in the economy, requires a large set of distortionary policies for its maintenance over long periods. It is these distortions that – though multiple channels – hurt economic welfare and could, over time, shift the balance of risks in the economy.”