RENMINBI CONTROVERSIES Morris goldstein No topic in intermational monetary economics has probably been more debated over the past three vears than what should be done about Chinas currency regime and about the exchange rate for the renminbi(RMB). In this article, I take up three questions that are at the center of the current debate, namely: (1)Is the RMB undervalued and, if so, by how much?(2) Would an RMB appreciation of 20-25 ercent be particularly harmful for Chinas economic growth and development, as well as for its domestic financial stability?(3)Was the July 21, 2005, currency reform a large or tiny step forward? Is the rMB Undervalued? Among the many approaches available for estimating equilibrium exchange rates, I prefer two: the"underlying balance"approach and the "global payments"approach. In both cases, I am going to assume that no wholesale change occurs in China's capital-account regime over say, the next three years Under the underlying balance approach, one asks what level of the real effective exchange rate-that is, the trade-weighted aver- age of nominal exchange rates adjusted for inflation differentials be ween the home country and its trading partners--would produce Cato Journal, Vol 26, No. 2(Spring/Summer 2006). Copyright Cato Institute. All Morris Goldstein is Dennis Weatherstone Senior Fellow at the Institute for International Economics. He thanks C. Fred Bergsten, Nick Lardy, Mike Mussa, and Ted Truman for helpful comments on an earlier draft, and Anna Wong for excellent research assistance. Another controwersial issue is whether China has been"manipulating" the value of the RMB counter to its obligations as a member of the International Monetary Fund. In Goldstein(2006a), I answer that question in the affirmative On April 14, 2006, the Chinese authorities announced a set of foreign exchange liberal- ization measures, including an easing of restrictions on portfolio capital outflows. Like Anderson(2006), I expect the initial impact of this liberalization on Chinas balance of payments to be quite small. The effect ower the next few years is likely to be moderate but not enough to invalidate the conclusion that China's overall balance of payments is apt to be still in substantial disequilibriumRENMINBI CONTROVERSIES Morris Goldstein No topic in international monetary economics has probably been more debated over the past three years than what should be done about China’s currency regime and about the exchange rate for the renminbi (RMB). In this article, I take up three questions that are at the center of the current debate, namely: (1) Is the RMB undervalued and, if so, by how much? (2) Would an RMB appreciation of 20–25 percent be particularly harmful for China’s economic growth and development, as well as for its domestic financial stability? (3) Was the July 21, 2005, currency reform a large or tiny step forward?1 Is the RMB Undervalued? Among the many approaches available for estimating equilibrium exchange rates, I prefer two: the “underlying balance” approach and the “global payments” approach. In both cases, I am going to assume that no wholesale change occurs in China’s capital-account regime over say, the next three years.2 Under the underlying balance approach, one asks what level of the real effective exchange rate—that is, the trade-weighted aver￾age of nominal exchange rates adjusted for inflation differentials be￾tween the home country and its trading partners—would produce Cato Journal, Vol. 26, No. 2 (Spring/Summer 2006). Copyright © Cato Institute. All rights reserved. Morris Goldstein is Dennis Weatherstone Senior Fellow at the Institute for International Economics. He thanks C. Fred Bergsten, Nick Lardy, Mike Mussa, and Ted Truman for helpful comments on an earlier draft, and Anna Wong for excellent research assistance. 1 Another controversial issue is whether China has been “manipulating” the value of the RMB counter to its obligations as a member of the International Monetary Fund. In Goldstein (2006a), I answer that question in the affirmative. 2 On April 14, 2006, the Chinese authorities announced a set of foreign exchange liberal￾ization measures, including an easing of restrictions on portfolio capital outflows. Like Anderson (2006), I expect the initial impact of this liberalization on China’s balance of payments to be quite small. The effect over the next few years is likely to be moderate but not enough to invalidate the conclusion that China’s overall balance of payments is apt to be still in substantial disequilibrium. 251