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Mr. Eswar S Prasad, Mr. Qing Wang, and Mr. Thomas Rumbaugh
This paper reviews the issues involved in moving towards greater exchange rate flexibility and capital account liberalization in China. A more flexible exchange rate regime would allow China to operate a more independent monetary policy, providing a useful buffer against domestic and external shocks. At the same time, weaknesses in China’s financial system suggest that capital account liberalization poses significant risks and should be a lower priority in the short term. This paper concludes that greater exchange rate flexibility is in China’s own interest and that, along with a more stable and robust financial system, it should be regarded as a prerequisite for undertaking a substantial liberalization of the capital account.
Aerdt G. F. J. Houben
This paper evaluates the Philippines’ experience with different exchange regimes since 1970. It argues that the shift to a flexible regime was crucial to restoring external viability and generating an export-led economic take-off, but that mixed performance in meeting money targets and asymmetric policy reactions to exchange rate pressures have resulted in an uneven inflation performance. Since adoption of a firm nominal anchor for monetary policy would contribute to a more effective control of inflation and thereby to better prospects for sustained growth, the merits of three monetary strategy options are reviewed: stricter adherence to a money supply rule, adoption of an exchange rate peg, and a switch to direct inflation targeting.
Mr. Eswar S Prasad and Raghuram Rajan
China has achieved tremendous economic progress in the last three decades, but there is much work to be done to make the economy resilient to large shocks, ensure the sustainability of its growth, and translate this growth into corresponding improvements in the economic welfare of its citizens. We discuss the complex challenges that Chinese policymakers face in striking the right balance in terms of speed and coordination of reforms. We argue that China's current stage of development, along with its rising market orientation and increasing integration with the world economy, may make the incremental and piecemeal approaches to reforms increasingly untenable and, in some cases, could even generate risks of their own. The present favorable domestic and external circumstances provide an excellent window of opportunity for bolder reforms and for tackling some deep-rooted problems without causing much economic disruption.
Mr. Esteban Jadresic
This paper assesses the eventual replacement of the currencies of the GCC countries with a common currency. It concludes that a properly implemented currency union may contribute to enhance economic efficiency in the region, deepen regional integration, and develop its non-oil economy. However, it cautions that a currency union should be seen as only one component of a much broader integration effort. This should include the removal of the distortions that inhibit intraregional trade and investment, agreements on policy frameworks to ensure macroeconomic stability, and further political integration. The paper also addresses the choice of exchange rate arrangement for the unified currency.
Mr. Peter Isard
This paper describes the basic structure, underlying philosophy, and key behavioral properties of MULTIMOD. It also focuses on several recent applications of macromodels in the IMF’s policy analysis, emphasizing that most questions put forward for analysis with models like MULTIMOD are initially posed in ways that cannot be addressed by simply pushing a computer key. Meaningful macromodel-based policy analysis requires a sensibly structured and parameterized macromodel, but it also generally requires considerable probing of the nature of the policy issues in order to reformulate policy questions in terms of well-defined exogenous shocks.
Mr. Vivek B. Arora and Mr. Olivier D Jeanne
The Canadian experience with a floating exchange rate regime can shed some light on the question of whether A question of current interest in many parts of the world is whether with growing economic integration among groups of countries makes a fixed exchange rate, or even a common currency, becomes more desirable. This paper looks at the lessons that one may draw from tThe Canadian experience, with a floating exchange rate regime, especially since the inception of the 1989 U.S.-Canada Free Trade Agreement, suggests. We find that exchange rate flexibility has not prevented economic integration between Canada and the United States from increasing substantially, during the 1990s, and has played a useful role in buffering the Canadian economy against asymmetric external shocks. A fixed exchange rate thus does not seem to be a prerequisite for economic integration. It may, however, yield substantial have benefits for some countries that lack monetary credibility or that may be tempted by self-destructive beggar-thy-neighbor policies.
Ms. Carmen Reinhart, Mr. Leonardo Leiderman, and Mr. Guillermo Calvo
Since 1990 capital has started to move from industrial countries to developing regions like Latin America, the Middle East and parts of Asia. Reentry into international capital markets is a welcome turn of events for most countries. However, capital inflows are often associated with inflationary pressures, a real exchange rate appreciation, a deterioration in the current account, and a boom in bank lending. This paper briefly examines how these inflows have altered the macroeconomic environment in a number of Asian and Latin American countries. The pros and cons of a menu of policy options are discussed.
Mr. Eswar S Prasad and Raghuram Rajan
In this paper, we develop a proposal for a controlled approach to capital account liberalization for economies experiencing large capital inflows. The proposal essentially involves securitizing a portion of capital inflows through closed-end mutual funds that issue shares in domestic currency, use the proceeds to purchase foreign exchange from the central bank and then invest the proceeds abroad. This would eliminate the fiscal costs of sterilizing those inflows, give domestic investors opportunities for international portfolio diversification and stimulate the development of domestic financial markets. More importantly, it would allow central banks to control both the timing and quantity of capital outflows. This proposal could be part of a broader toolkit of measures to liberalize the capital account cautiously when external circumstances are favorable. It is not a substitute for other necessary policies such as strengthening of the domestic financial sector or, in some cases, greater exchange rate flexibility. But it could in fact help create a supportive environment for these essential reforms.
Mr. Stephen S. Golub
This paper reviews the macroeconomic and microeconomic dimensions of the United States-Japan conflict over trade. From a macroeconomic perspective, there is nothing surprising about Japan’s surpluses, given global trends in saving and investment. The current accounts of the United States and Japan have both responded to exchange rate changes in a normal fashion with about a two-year lag. Although not the source of the Japanese current-account surplus, a key issue in the debate is the nature of Japanese trade policy and its possible effects on trade patterns. Empirical studies attempting to determine whether Japan’s trade prices and quantities are abnormal have arrived at conflicting conclusions. This is a Paper on Policy Analysis and Assessment and the author(s) would welcome any comments on the present text. Citations should refer to a Paper on Policy Analysis and Assessment of the International Monetary Fund, mentioning the authors) and the date of issuance. The views expressed are those of the author(s) and do not necessarily represent those of the Fund.
Mr. Paul R Masson
The more advanced Central and Eastern European Countries (CEECs) face an evolving set of considerations in choosing their exchange rate policies. On the one hand, capital mobility is increasing, and this imposes additional constraints on fixed exchange rate regimes, while trend real appreciation makes the combination of low inflation and exchange rate stability problematic. On the other hand, the objectives of EU and eventual EMU membership make attractive a peg to the euro at some stage in the transition. The paper discusses these conflicting considerations, and considers the feasibility of an alternative monetary framework, inflation targeting.