Therefore, by increasing the flexibility of the exchange rate scheme, the developing country can enjoy the advantages of fixed exchange rate system and avoid some problems of tight pegged exchange rate system. Based on the macroeconomic IS-LM model, there are no effects from expansionary monetary policy on a fixed exchange rate system because the government would like to peg the exchange currency at a certain level (Suranovic, 2005). On the other hand, through the flexible exchange rate regime, the trade balance can be improved and the capital account deficit is financed through an increase of exports because the market force determines the equilibrium on the currency (Rita, 2002). Lots of the arguments with other countries arise because of the trade imbalance between them. China can therefore improve the trade balance and the relationship with the US and other Western countries through slowly increasing in the flexibility of the exchange rate scheme.
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