On China’s Exchange Rate Flexibility and Stability: The More Flexible against the U.S. Dollar, the More Stable in Effective Terms

The Chinese authorities have often emphasized the importance of maintaining the renminbi＇s stable exchange rate without stating explicitly how this stability should be measured. This paper argues that the relevant concept for this stability should be in terms of the rnminbi＇s effective exchange rate, rather than its rate against any particular currency, such as the U. S. dollar. Under the current circumstances where key currencies＇ exchange rates fluctuate freely, if the authorities wish to maintain the stability of the renmnibi＇s effective exchange rate, they would want to let the renminbi＇s exchange rate fluctuate much more against the U. S. dollar than in the past because such fluctuations would greatly reduce the magnitude of the renminbi＇s fluctuations against other key currencies and thus its effective exchange rate. This point has been demonstrated by illustrative figures and by comparing the renminbi＇s hypothetical, greater exchange rate fluctuations with its actual fluctuations.