There is some risk that appreciation of the exchange rate, if greater flexibility were allowed, could precipitate deflation. What this really highlights, however, is the importance of framing the debate about exchange-rate flexibility in a broader context. Having an independent monetary policy that could counteract boom-and-bust cycles would be the best way for China to deal with such risks.
Contrary to those who regard the discussion of an alternative monetary framework as premature, there are good reasons for China to begin right now to build the institutional foundation for the transition to an independent monetary policy. Indeed, early adoption of a low inflation objective would help secure the monetary and financial stability that China needs as it allows greater exchange-rate flexibility.
Marvin Goodfriend is a professor at the Tepper School of Business at Carnegie-Mellon University and was previously senior vice president and policy adviser at the US Federal Reserve Bank of Richmond, Virginia. Eswar Prasad is chief of the Financial Studies Division in the IMF's Research Department. Copyright: Project Syndicate
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