China's exchange rate policy and the United States' trade deficits

Purpose – This paper aims to critically examine China's exchange rate policy debate and discuss Chinese financial and capital control reform of recent years. Furthermore, using the empirical results based on a regional general equilibrium model, alternative methods are suggested of addressing American concerns about China's role in contributing towards global financial stability and American trade deficits with China. Design/methodology/approach – Regional general equilibrium input‐output model. Findings – Sino‐American debate on exchange rate policy is a matter of difference of opinion in sequencing of policies China has adopted to reduce capital account control and make her exchange rate regime more flexible. Using the final demand elasticity of exports it is observed that Chinese expansionary fiscal stimuli do have powerful effects in inducing additional exports for the United States and other Chinese trading partners. Research limitations/implications – The model does not include rest‐of‐the‐world economies. Practical implications: – The results imply viable alternatives to renminbi/dollar appreciation policy in dealing with US‐China persistent trade deficit. Originality/value – The paper suggests a new, empirical‐based policy recommendation in dealing with the US trade deficit with China.