Scott Sumner: belief

Transcript context

…Now, in very late 2024, I was reading a Wall Street Journal article that reported on how many different price indices in China were showing deflation, sustained deflation. This is considered to be bad for the Chinese economy. Chinese aren’t stupid. They have a sophisticated central bank. Why is China tolerating this? Why don’t they end the deflation with a more activist monetary policy? Okay. Good question. First of all, the deflation they’re going through, I would argue, is very similar to the deflation they went through in the late ’90s and early 2000s. It’s due to the Chinese government being reluctant to weaken the currency sufficiently in the foreign exchange market to maintain positive inflation. That reluctance seems to be partly due to political reasons, but as you know, governments around the world have traditionally viewed the exchange rate as a very important variable. If you focus on a certain set of goals for your exchange rate, you’re inevitably going to let go of your ability to control macroeconomic aggregates like nominal GDP and inflation. The most extreme example of that is Hong Kong, which has pegged their currency to the dollar for 40 years. Essentially, the Hong Kong business cycle and the periods of deflation in Hong Kong are completely correlated with the strength of the US dollar. If we go back to the late 1990s, most countries in East Asia devalued sharply. There was a severe crisis. China did not. The consequence of China’s decision not to devalue when all its competitor countries were devaluing was deflation. That was a political decision they made. More recently, China has allowed a little bit of weakening of the yuan, but not nearly to the extent that you see in places like Japan. Japan, despite large depreciation in the Japanese yen, has still only suffered very mild inflation. In China, where the currency is much stronger than in Japan, you get outright deflation. It’s a question of prioritizing exchange rate over macroeconomic stability that leads to these kind of unfavorable outcomes in terms of inflation. Any time you prioritize any variable above your core goal of either inflation targeting or nominal GDP targeting, you will end up with negative outcomes. Why don’t the Chinese just give up the exchange rate target? On your account, it sounds like a big mistake. You’re saying they’re stupid in a sense, right? They don’t import that much, so it’s not going to be a problem there. It would help their exporters marginally. It certainly wouldn’t hurt them. Why not just push the button and do what Scott Sumner says?…

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