The CEA on Exchange Rates
By Arnold Kling
From the 2007 Economic Report:
the Chinese intervention does not systematically change the relative real prices between the United States and China. Had the Chinese government not intervened, Chinese domestic prices would have remained the same in terms of yuan and become more expensive in terms of dollars through a change in the exchange rate. With the intervention, Chinese domestic prices rose in terms of yuan and became more expensive in terms of dollars even though the value of the nominal exchange rate was unchanged. This outcome occurs any time a country takes actions to fix its exchange rate: fixing the nominal exchange rate does not necessarily have any impact on the relative prices between two countries. In other words, fixing the nominal exchange rate does not tend to move countries away from purchasing power parity. The only effect is that domestic goods prices have to do all of the adjustment since the exchange rate is fixed.
I think that what they are saying is that exchange rate policy is neutral because you only control the nominal exchange rate, not the real exchange rate, because the latter depends on prices. By the same token, you could say that monetary policy is neutral because you only control the nominal money supply, not the real money supply.
The traditional macro view is that prices adjust slowly, so that in the short run you do control both the real money supply and the real exchange rate. I would think that would make this chapter controversial. But I may be the one who has failed to keep up with professional thinking on the subject.
UPDATE: Menzie Chinn is up to date on professional thinking.