Dean Baker thinks that if the Chinese are really worried about inflation that they should consider giving in to longstanding American demands to let their currency appreciate vis-a-vis the dollar.
This is true. But I think it highlights a broader and more interesting point. China’s currency peg is, in effect, a kind of monetary policy. China, via its peg, is implementing monetary policy that is producing some risks of inflation. And I think that if Baker or Paul Krugman were looking at the American situation they would say that this is the right thing to do. Given the state of the overall economy it’s perverse to be doing anything less than going full-tilt at bolstering employment rates. And that’s what the Chinese are doing.
The question isn’t why is China running such loose monetary policy, the question is why aren’t the western central banks running looser policy ourselves along the lines of the Gagnon Plan or price-level targeting or a higher inflation target or a nominal GDP target. If monetary policy at the ECB, the Fed, the Bank of England, etc. were all much looser, then China would need to choose between either dramatic further loosening of monetary policy or else permitting its currency to appreciate relative to the dollar. Since they’re worried about inflation, they would probably choose appreciation. And that would be the right way to achieve what American policymakers say they want. Merely haranguing China about the need for China to tighten monetary policy in the face of too-tight US monetary policy isn’t going to do much good.
In China, if unemployment goes to ten percent the government is going to get overthrown. So the Chinese government is doing everything possible to prevent mass unemployment. The question should be why our own democratically elected government isn’t doing the same?