China Currency Exchange Rate Essay

The currency regime adopted by China is neither fixed nor flexible exchange rate system. China has announced in 2005 the â€Å"end of its firm peg against the dollar, instead allowing it to trade within a narrow band against a basket of currencies.† China regime is managed floating system where the currency increases very slowly year by year and the China government prevent the currency from changing quickly in the short term. The reason why Chinese government intervene in the currency market is to lower exchange rate to increase employment, maintain a fixed rate to maintain stability and improve their current account deficit. China government manage its currency rate by buying foreign currencies to increase supply of China currency, therefore lowering its currency value. They also lower the value of its currency by lowering their interest rates. In the case of China, it is very difficult and challenging for them to adopt the fixed exchange rate system due to their disadvantages. Firstly, China government must always adjust its interest rate so maintain the exchange rate. Changing the interest rate frequently will cause fluctuations in investments and growth and also stable employment. There is also a possibility that the export rate may be set at the wrong level. For example, if it was set at a higher level, this could affect China export competitiveness and their domestic market will suffer. Question 4b Though China has been heavily criticised by some foreign countries like USA for their practice, there are some advantages to managed flow system. Firstly, the managed flow system will ensure stability in China compared to floating. This is because if China suddenly appreciate their currency, their exports production will suffer and there will be lots of unemployment as a result. However there are disadvantages to managed floating system as well. People will try to challenge the earn funds from the currency as this system is very prone to speculative attack. Experiences have shown that speculative attacks could decrease the growth of a country’s gross domestic product by 6 percent or more.