Today’s markets are being somewhat roiled by news of accelerating inflation in China, leading to worries that China will have to tighten monetary policy. But, you know, that’s not what China is supposed to do in this situation.
There’s an oldie but goodie in international macro known as the Swan Diagram — not instructions for making an origami swan, but the insightful analysis developed by the Australian economist Trevor Swan. He suggested that we think of countries as having two objectives — keeping unemployment as low as is consistent with stable inflation, but not lower — and keeping the trade balance at an acceptable level. He also suggested that we think of two kinds of policies: things like monetary and fiscal policy that affect the overall level of domestic spending, and exchange rate policy that affects the competitive position of exporters and import-competing industries.
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