*1. The value of the Chinese* currency
For decades, overall U.S. current account is deficit. Trade deficit with China has exploded. The Chinese are accused of manipulating the value of their currency (renminbi). The renminbi is not a fully convertible currency. It allows the Chinese government to limit exchange rate fluctuations and provide some insurance against an exchange rate shock. If one claims that the renminbi is undervalued, one is saying that it is below purchasing power parity. According to REER, the Chinese currency does appear to be undervalued by about 8 to 10 percent.
2. The dollar and U.S. inflation in the 1980s
During the late 1970s and early 1980s, the U.S. economy experienced inflation. U.S. increased real interest rates. Large inflow of capital into the U.S. produced both large financial/capital account surpluses and current account deficits. The dollar appreciated by about 50 percent between 1980 and 1985. From the tight monetary policy, inflation rate was decreased. But the decline in inflation was quite large. It goes to large appreciation of the U.S. dollar. After all, appreciating currency tend to reduce inflationary pressures.
3. The Japanese Economy in the 1990s
Japanese economy is the world’s second largest economy. The economic boom in Japan during the 1980s suddenly ended in a recession in the early 1990s and never recovered. Fiscal policy has been aggressively expansionary. But monetary policy has not been as expansionary as it looks. A mix of expansionary fiscal and monetary policy should produce higher growth in GDP, a higher price level, and an uncertain effect on the current account. What actually occurred is stagnant growth in GDP, a falling price level, and a current account surplus.