Friday, January 08, 2010

Questions and Answers

I have long wondered why if China's exchange rate policy (ie. their peg) is so far away from the "true" market exchange rate, then how has that monetary expansion not lead to a rapid pick up in Chinese inflation? James Hamilton offers an explanation. Its there, just hidden in relative prices:

So why hasn't domestic inflation in China undone the stimulus from the exchange rate? I've been forming the opinion that U.S. inflationary dynamics may be more governed by relative price changes than was historically the case, and raise the possibility that China could be ground zero for this phenomenon. Specifically, I'm wondering if the pent-up inflationary pressure takes the form of inducing consumers and businesses in China to try to acquire any hard assets they can, with the result that rather than overall inflation we see remarkable increases in the relative prices of such items. I've commented before on this interesting account from last September:

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