Rehabilitating the Dollar Standard and the Role of China

Ronald I. McKinnon

in The Unloved Dollar Standard

Published in print December 2012 | ISBN: 9780199937004
Published online January 2013 | e-ISBN: 9780199980703 | DOI:
Rehabilitating the Dollar Standard and the Role of China

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Although vital, the dollar standard's rehabilitation does not require international monetary reform. Rather, it is largely conceptual, and can be phased in through collaboration within just the G-2. China, a creditor country with a net saving (trade) surplus, can’t eliminate it by appreciation. Instead, both countries should phase out the saving (trade) imbalance by (1) increasing personal disposable income and hence consumption in China, and (2) raising net saving by eliminating the fiscal deficit in the United States. The trade imbalance would then take care of itself. The Federal Reserve Bank should commit to raising short-term interest rates toward 2 percent in the near future while leaving long rates to fluctuate “normally.” China should phase out its sterilization of hot money inflows as U.S. interest rates increase, and keep the yuan/dollar rate stable while continuing with its countercyclical credit policies. Once the G-2 succeed in harmonizing their financial policies, other countries can adjust their exchange rates as they see fit.

Keywords: liquidity trap; financial repression; G-2; rmb-dollar bloc; sterilization; fiscal deficit

Chapter.  4881 words.  Illustrated.

Subjects: Financial Markets

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