The Choice of Exchange Rate Regime:The Relevance of International Experience
to China’s Decision
John Williamson
Senior Fellow,Institute for International Economics
Outline of a lecture at a conference on exchange rates organized by the Central
University of Finance and Economics in Beijing on September 7,2004.The author is
indebted to Nicholas Lardy and Edwin Truman for comments on a previous draft.
Copyright Institute for International Economics:All rights reserved.
Introduction
Whether a country should choose a fixed or flexible exchange rate,or some intermediate
regime,is one of the oldest policy questions in economics.It is also one of the most
important.Many countries have encountered crises that interrupted their growth because
they made a bad choice.Others have never got growth going because of misguided
decisions.Obviously this is not to say that exchange rate policy is the only thing that
matters,but it is to claim that a flawed exchange rate policy can bring the rest to naught.
How should one evaluate China’s current policy,of pegging its exchange rate in
terms of the US dollar?This has not,at least as yet,led to a crisis that interrupted growth,
and it certainly has not prevented an impressive growth performance.This does not mean
that China’s current policies deserve to be perpetuated,but it does imply that any change
needs to be evaluated carefully to make sure that it will not risk undermining China’s
success.
I start by describing what I see as the two most important lessons of international
experience with exchange rate regimes in the period since World War II.I then proceed
to lay out the conditions that are necessary in order for a fixed exchange rate regime to
make sense.Since some of those conditions are clearly not satisfied by China,I describe
some intermediate regimes that might be desirable where a fixed rate is inappropriate.
Finally I turn to discuss what the analysis implies as regards contemporary China.
The Crisis Problem
The postwar period has been punctuated by foreign exchange crises.In my own country,
Britain,we used to have a sterling crisis more or less every other year (usually in odd-
numbered years) until the late 1960s,after the pound was devalued.These crises
regularly provoked a set of deflationary measures that interrupted growth.Other
industrial countries often had similar crises (though with less regularity),which was a
major factor leading to abandonment of the Bretton Woods system in 1973.The majority
of these crises were associated with an attempt to prevent a currency being devalued,but
in the late 1960s there were also speculative runs into several currencies,like the
Deutsche mark and Swiss franc,that were eventually either revalued or allowed to float
up.
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