Introduction

Whereas the preceding chapter considered the deflationary damage exerted by an artificially overvalued exchange rate in the 1930s, Taiwan's experience at the end of the 1940s offers a vivid illustration of the inflationary pressures that can be generated by an excessively undervalued exchange rate. Resisting upward pressure on the currency in such a case fuels inflation, inter alia, as undervaluation of the domestic currency triggers capital inflows that drive up the money supply. As discussed in Chapter 1, there were fears that central bank loss of control over the money supply in the face of surging capital inflows would lead to this scenario being repeated in mainland China in 2004. “Hot flows” of funds into China appeared to subside in the face of the gradual appreciation effected during 2005–2007, however, and the actual degree of recent renminbi undervaluation remained subject to considerable doubt (Chapter 1). China's accelerating accumulation of foreign exchange reserves has nevertheless required massive sterilization efforts by the People's Bank of China (Chapter 4), and ongoing concerns about imported inflationary pressures prompted a variety of tightening measures, including a succession of reserve requirement increases and interest rate hikes.