CATO JOURNAL option is to combine a sizable RMB revaluation with an expansionary fiscal policy directed at pressing social needs(e. g, pension, health and education programs). In this way, the expenditure-switching role of revaluation can be retained while fiscal policy reduces the contrac tionary effect of revaluation on aggregate demand. This could be accomplished without exacerbating China's already excessively large share of fixed asset investment in gDP by focusing increased gov ernment expenditure on remedying deficiencies in Chinas social safety net. Once Chinas external imbalance declines to an appropri ate level, fiscal policy can revert to a more normal, longer-term stance. A second (not mutually exclusive)option is to reduce some what the size of the initial revaluation so that it is still substantial enough(say, 10-15 percent)to make a credible down payment on reducing external imbalances but not so large as to depress economic growth unduly. The second stage of revaluation could then take place hen domestic demand growth was more buoyant. I want to stress that these two options are advisable only when there is a conflict between achieving internal and external balance and when the scale of the external imbalance has grown so large that a very big revaluation would be needed to eliminate it fully in one go If the Chinese economy were to return to the overheating days of 2003-2004 and if Chinas current account surplus were to return to the 34 percent of GDP range of that period, a one-shot revaluation along with a widening of the band (followed a few years later by a floating of the RMB)without fiscal expansion--would remain as my first choice maintaining a much undervalued RMB by engaging in large-scale, prolonged, one-way intervention in exchange markets risks inducing a protectionist response in Chinas major export markets. This cannot be good for Chinas growth prospects. On April 6, 2005, 67 U.S r the schumer raham amendment that called for imposing an across-the-board tariff of 27.5 percent on Chinas exports to the United States if negotiations between the United States and China on the value of the RMB proved unsuccessful. In its May 2005 Report to Congress on International Economic and Exchange Rate Policies, "the U.S. Treasury(2005a) warned that "if the current trends continue without substantial alteration, Chinas policies will likely meet the statute's technical requirements for designation(as an iSee Goldstein(2006b)on the links between perceived"unfairness"in exchange rate policies and protectionismoption is to combine a sizable RMB revaluation with an expansionary fiscal policy directed at pressing social needs (e.g., pension, health, and education programs). In this way, the expenditure-switching role of revaluation can be retained while fiscal policy reduces the contrac￾tionary effect of revaluation on aggregate demand. This could be accomplished without exacerbating China’s already excessively large share of fixed asset investment in GDP by focusing increased gov￾ernment expenditure on remedying deficiencies in China’s social safety net. Once China’s external imbalance declines to an appropri￾ate level, fiscal policy can revert to a more normal, longer-term stance. A second (not mutually exclusive) option is to reduce some￾what the size of the initial revaluation so that it is still substantial enough (say, 10–15 percent) to make a credible down payment on reducing external imbalances but not so large as to depress economic growth unduly. The second stage of revaluation could then take place when domestic demand growth was more buoyant. I want to stress that these two options are advisable only when there is a conflict between achieving internal and external balance and when the scale of the external imbalance has grown so large that a very big revaluation would be needed to eliminate it fully in one go. If the Chinese economy were to return to the overheating days of 2003–2004 and if China’s current account surplus were to return to the 3–4 percent of GDP range of that period, a one-shot revaluation along with a widening of the band (followed a few years later by a floating of the RMB)—without fiscal expansion—would remain as my first choice. Third, it should be recognized that continuing the present policy of maintaining a much undervalued RMB by engaging in large-scale, prolonged, one-way intervention in exchange markets risks inducing a protectionist response in China’s major export markets.13 This cannot be good for China’s growth prospects. On April 6, 2005, 67 U.S. senators voted for the Schumer-Graham amendment that called for imposing an across-the-board tariff of 27.5 percent on China’s exports to the United States if negotiations between the United States and China on the value of the RMB proved unsuccessful. In its May 2005 “Report to Congress on International Economic and Exchange Rate Policies,” the U.S. Treasury (2005a) warned that “if the current trends continue without substantial alteration, China’s policies will likely meet the statute’s technical requirements for designation (as an 13See Goldstein (2006b) on the links between perceived “unfairness” in exchange rate policies and protectionism. CATO JOURNAL 258