Exchange Rate Policy as Monetary Policy

Normally we think of exchange rate policy through the lens of its impact on bilateral trade. If China makes its currency cheaper, that boosts Chinese exports to the U.S. and depresses Chinese consumption of goods. Scott Sumner says this is the wrong way to think about monetary policy during a severe recession:

A managed exchange rate is first and foremost a monetary policy. The Chinese decision to stabilize the yuan was an effective depreciation (given their high rate of productivity growth.) It led China out of its deflationary slump in the dark days of March, and China led Asia out of the recession. Given that US equity prices responded strongly to the Asian rebound in the spring, it is quite likely that the Chinese recovery removed the tail risk of a severe worldwide slump.

The mistake is to view exchange rates through a trade lens, as a zero sum game. During a deep slump an expansionary monetary policy will raise both domestic and world output. Holding other monetary policies constant, a more expansionary Chinese monetary policy means a more expansionary world monetary policy, and this boosts world aggregate demand. When the US devalued the dollar against gold in 1933 it helped the entire world recover from the Depression. When other countries devalued against gold, it further helped the world economy. This time around it was China that led the way.

This sounds plausible to me, but is going to have to go into my “I’d like to hear what other economists have to say” file.