In a recent interview, Tyler Cowen asked me why China doesn’t end its deflation by devaluing the yuan. I suggested that it might be due to pressure from the US. A recent Bloomberg article provides support for that claim:
In fact, the PBOC has been fending off depreciation pressure on the yuan since Trump won the US elections in November. It has capped the yuan’s drop at around 7.3 per dollar by setting the daily reference rate, which limits moves in the onshore yuan by 2% on either side, since late January.
It has also delayed interest-rate cuts, paused bond purchases so far this year and tolerated a funding squeeze among banks to prevent further yuan declines and capital outflows.
“Despite the upcoming extra 10% tariff hike, the PBOC will probably refrain from tweaking its steady yuan fixing policy, considering Trump’s warning on yuan depreciation,” said Ken Cheung, chief Asia FX strategist at Mizuho Bank in Hong Kong. “The PBOC may also be inclined to preserve currency stability during the National People Congress.”
The US government did the same thing to Japan back in the 1990s and 2000s, pushing them into deflation. It never ceases to amaze me how much harm can be done by policymakers that lack a basic understanding of economics.
In the long run, the deflation in China will restore equilibrium, as the real exchange rate will depreciate even as the nominal rate is fixed. But recall what John Maynard Keynes said about the long run.
China does not need a weaker yuan in real terms, but it does need a weaker yuan in nominal terms in order to boost its NGDP growth rate. Monetary stimulus would be unlikely to boost China’s current account surplus, as the faster economic growth would probably suck in imports at a faster rate that the weaker yuan would boost exports. In other words, the income effect would likely dominate the terms of trade (substitution) effect.
READER COMMENTS
bill
Mar 8 2025 at 9:20pm
Do you think the CCP could engineer a 1 day drop in all prices and wages of X%? Effectively devalue the yuan without changing its nominal exchange rate? Would that help?
Scott Sumner
Mar 8 2025 at 11:32pm
That would be extremely difficult, even for the CCP. The cost might exceed the benefit.
Warren Platts
Mar 8 2025 at 11:43pm
Why in the world would China need a bigger trade surplus than it already has? Or maybe I’m totally misreading what you’re trying to say?
Scott Sumner
Mar 9 2025 at 7:51am
It does not need a bigger trade surplus, it needs a more expansionary monetary policy. Read what I wrote after the part you quote.
Warren Platts
Mar 9 2025 at 3:29pm
Scott, respectfully, hold on a sec: you wrote, “China … does need a weaker yuan in nominal terms in order to boost its NGDP growth rate.” I’ve always been told that devaluing a currency is what countries do to boost exports, whether they are chronic surplus countries or chronic deficit countries (cf. the Plaza Accords you referenced above.) Probably, China would be better off trying to boost consumer consumption rather than ever more exports.. Yes, that would juice imports.
Scott Sumner
Mar 9 2025 at 10:59pm
“I’ve always been told that devaluing a currency is what countries do to boost exports,”
Never reason from a price change. That’s true if the devaluation is caused by more saving, but not if the devaluation is caused by an expansionary monetary policy.
Todd Ramsey
Mar 9 2025 at 9:42am
Off topic: in a prolonged period of bad micro policies (large tariffs, for example) that led to negative real GDP growth (negative 2% annually, for example), would NGDPLT lead to 6% to 7% annual inflation?
If so, is NGDPLT still a good idea, or would an inflation targeting regime work better? Do you think it possible to have negative real growth over a prolonged period because of poorly considered tariffs? Or would NGDPLT prevent this from happening?
Scott Sumner
Mar 9 2025 at 11:00pm
It’s very unlikely that the effect of tariffs would be that large, but you do want to have steady NGDP growth even if RGDP falls. In that case, inflation is a feature, not a bug.