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Plan B for the Global Economy

There is growing awareness among policymakers of the risks to the global economy posed by deflation and intensifying financial instability. In mitigating these risks, avoiding a hard landing in China is a necessary but insufficient condition for global recovery.

HONG KONG – In March, meetings of the G-20, the Chinese National People’s Congress, and multiple think tanks all reflected a growing awareness of the risks to the global economy posed by deflation and intensifying financial instability. In mitigating these risks, the path that China takes will be particularly important. But avoiding a hard landing in China is a necessary but insufficient condition for global recovery.

Contrary to the advice of many Chinese economists, the country’s policymakers have opted not to follow the conventional Western approach of using flexible exchange rates as the main shock absorber for volatile capital flows and thereby freeing monetary policy to provide liquidity for domestic structural adjustments. This satisfied both Western economists and global financial markets, which breathed a collective sigh of relief when Chinese leaders reaffirmed their commitment to maintaining a stable renminbi.

The fear was that, if China sought a weaker exchange rate to escape deflation, the result would be another round of global competitive devaluations and even more deflation. Fortunately, China’s leaders recognize that, if the world remains mired in a balance-sheet recession, the lack of aggregate demand, by continuing to weaken trade, will drag down their own country’s growth.

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