The Orientation of China’s Monetary Policy

From: English Edition of Qiushi Journal Updated: 2012-10-08 15:28
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To cope with complex and unpredictable economic environments both domestically and internationally, and in response to the impact of the international financial crisis, China has flexibly adjusted its monetary policy, comprehensively utilized various policy tools, and correctly determined the key aspects, the intensity, and the timing of its macroeconomic regulation. These efforts have been effective in promoting the steady and rapid growth of China’s economy. In the period ahead, improving and strengthening macroeconomic regulation will continue to be China’s most challenging economic task. Therefore, we need to make further improvements to our monetary policy in response to the current situation and the new problems that China is facing. 

I. The successes of China’s monetary policy

China has gradually developed a unique monetary policy framework since the foundation of the central bank system in 1984. The past 30 years can roughly be divided into four periods according to the different monetary policies that China has implemented. 

From 1984 to 1993, China alternated between tight and loose monetary policies. Controlling the overall supply of credit was the main measure during this period. This was predominantly achieved through direct regulation performed by the central bank, an approach that was typical of the planned economy. Monetary policy alternated between tight and loose in response to economic fluctuation and inflation in this period.

Reporters raise their hands to put questions to leading officials from the People’s Bank of China (PBOC) at a press conference held on March 12, 2012. At a press conference on the sidelines of the Fifth Session of the Eleventh National People’s Congress held at the Beijing Media Center, Zhou Xiaochuan (third left), governor of the PBOC, Hu Xiaolian (third right) and Liu Shiyu (second left), deputy governors of the PBOC, and Yi Gang (second right), deputy governor of the PBOC and director of the State Administration of Foreign Exchange, answered reporters’ questions on China’s monetary policy and financial reform. / Photo by Xinhua reporter Ju Huanzong

From 1993 to 1997, China adopted a moderately tight monetary policy. During this period, the target of monetary policy was to promote economic development whilst maintaining the stability of monetary value. On this basis, the key emphasis of monetary policy was placed on efforts to keep monetary value stable. At the same time, the intensity and timing of regulatory policies were gradually tailored to the targets of reform, thereby avoiding an abrupt slowdown in economic growth. In addition, the People’s Bank of China was legally defined as the central bank, which allowed monetary policy to become more independent. Also, fiscal, investment, and financing policies were increasingly coordinated with monetary policy. 

From 1998 to 2007, China’s monetary policy remained prudent. The implementation of prudent monetary policy in this period ensured that China was able to successfully respond to the 1998 Asian financial crisis and the overheating of the economy in 2003. As China’s economy became more open to the outside, maintaining internal and external economic balances became a problem that our monetary policy would have to address. 

Since the year 2008, China has successively implemented a tight monetary policy, a moderately loose monetary policy, and a prudent monetary policy. In response to the international financial crisis, China made a major switch in its monetary policy, going from a “moderately tight” policy to a “moderately loose” policy. With the recovery of the economy and the emergence of inflation, China has since switched back to a prudent monetary policy. 

Generally speaking, China’s monetary policies have reached a level of maturity following 30 years of development, with the utilization of various tools, flexible measures, and indirect control having essentially been achieved. As a result, our monetary policies have become more forward-looking, more proactive, and more targeted. The characteristics of China’s monetary policy can be summarized as follows. 

The first characteristic is market-oriented reform. The evolution of monetary policy constitutes an important part of China’s economic reforms, and has been characterized by a progressively strong orientation towards the market. In the early stages of the shift from the planned economy to the market economy, China primarily relied on administrative management to realize macro control. This was followed by the gradual introduction of market-oriented practices on the basis of overall planning. Now, China has established an indirect regulatory system in which control is achieved through the application of modern monetary policy tools. At each of these different stages, the evolution of monetary policy and the development of the market economy have not only been dependent on each other, but have also spurred each other forward. 

The second characteristic is clearly defined targets. During the course of China’s economic and social development, monetary policy has been faced with the challenge of finding a balance between keeping the RMB stable, promoting economic growth, ensuring full employment, and maintaining the balance of international payments. Drawing from international experience, and in consideration of domestic realities, China has identified “promoting economic development whilst maintaining the stability of monetary value” as the target of its monetary policy. Fact has demonstrated that this is a right choice. The experience that we have gained from coping with the current and the previous international financial crises and from implementing several rounds of domestic macro-control policies has given new meaning to the concept of stable monetary value. China’s monetary policy has increasingly matured throughout the course of practice. In addition to preventing inflation, it also prevents deflation; in addition to maintaining domestic stability, it also maintains external coordination. 

The third characteristic is the provision of a sustained driving force for economic development. Although China’s monetary policy has alternated between loose and tight at different stages of its evolvement, it has never once over the past 30 years veered away from its core purpose of serving the rapid but stable development of the economy. China’s monetary policy has fully demonstrated the role that currency plays as a primary stimulus and sustained driving force for economic development, acting as an important financial foundation for the realization of China’s economic miracle. 

The fourth characteristic is effective adaptation to domestic and international situations. China’s monetary policy has been adjusted at appropriate junctures and to appropriate degrees in accordance with the requirement of making progress whilst maintaining stability. It has not only allowed China to withstand the impact of the international financial crisis and spearhead the global economic recovery, but has also helped it to establish its image as a major country with a strong sense of responsibility.

II. New situations confronting China’s monetary policy

In order to cope with the complex and unpredictable economic situations that we are facing domestically and internationally, we must make efforts to strengthen and improve our macro-control policies. Our macro-control policies need to be more scientific, more forward-looking, more responsive, and more flexible. They need to be better at actively and prudently balancing the relationship between maintaining rapid but stable economic growth, adjusting the structure of the economy, and regulating inflation expectations. In order to achieve these goals, we must first be fully aware of the new situations confronting monetary policy. 

First, there is increasing uncertainty. At present, the recovery of the global economy is taking place slowly, while the adjustment of economic structures is coming up against significant difficulty. With the monetary policies of various countries differing significantly, the world economic recovery is neither stable nor balanced. China’s economy is showing signs of overall recovery, but there is still a great deal of uncertainty, and the macroeconomic situation remains complex. Commodity prices and asset prices are under pressure to rise, and the country is being increasingly pressured into adjusting its economic structure. In addition, environmental and resource constraints are likely to worsen, and endogenous conflicts in social and economic development are becoming more and more prominent. High uncertainty in domestic and international environments is posing a serious challenge to China’s monetary policy. 

Second, the concept of the monetary aggregate has come to embody a wider scope. The government has long regarded broad money supply (M2) and the total supply of credit as the intermediate targets of monetary policy and the focus of monitoring and control efforts. Over the past decade, as the development of finance has deepened and new financial products have constantly emerged, direct financing and the off-balance sheet business of commercial banks have partially replaced traditional credit. As a result, the monitoring measures and regulatory targets that we currently implement are no longer able to fully reflect the state of financing in the real economy. During the Twelfth Five-Year Plan, the proportion of direct financing will further increase due to the growth of off-balance sheet business in commercial banks, the development of non-bank financial institutions, the market-based reform of interest rates, and the emergence of various financial innovations. Therefore, we should establish a more comprehensive system for the management of financing from all sources, thereby increasing the effectiveness of our monetary policy. 

Third, the economy is becoming increasingly open to the outside world. The Twelfth Five-Year Plan has identified “implementing a win-win opening up strategy and further raising the level of openness” as the general requirements for economic openness. The increasing level of economic openness will exert contrasting effects on the realization of the targets of China’s monetary policy. On one hand, participation in world trade is conducive to the resolution of domestic imbalances between supply and demand. Theoretically speaking, this is able to curb price fluctuations. On the other hand, price fluctuations originating externally will become one of the main factors contributing to the instability of domestic prices over the coming years. Under these circumstances, the difficulty of taking internal and external balances into joint consideration is set to increase. 

Fourth, the public are becoming more sensitive to information. The society we are living in today is a network society in which massive amounts of information can be transmitted almost instantaneously. The information channels that formed under the traditional system are in the process of being replaced by information networks that are more diversified, more closely geared to the market, and more accessible to various social sectors. As a result, economic entities and the general public are much more able to predict monetary policy than they were in the past. Contention between the government and the market in the formulation and implementation of policies is certain to exert a negative impact on the effectiveness of monetary policy. This presents new challenges for efforts to maintain the correct orientation of China’s monetary policy and engage in the effective management of public expectations. 

III. Several thoughts on monetary policy under a new situation

We should fully grasp the laws that govern monetary policy. The past 30 years have taught us that a prudent and moderately tight monetary policy should be the regular approach that we take under normal circumstances, while a moderately loose monetary policy should be exercised with discretion. At the same time, the adoption of a loose monetary policy should be avoided, even at times when the economy is in decline. This is because there is a risk that increases in money supply will be amplified by the market. The adoption of a loose monetary policy in an environment where the impulse to invest is strong is particularly dangerous, as this is bound to result in inflation. 

We should take prudent steps to promote the management of total financing from all sources. Total financing from all sources represents an important theoretical concept and policy area for a new phase in China’s financial development. Giving a more comprehensive reflection of the new connotations of finance and the real relationship between finance and economy, total financing from all sources will gradually become an important intermediate target in monetary policy. This requires the development of supporting systems, policies, and techniques. However, management of broad money supply (M2) and total supply of credit should not be slackened in the short term.

Monetary policy should be coordinated with other policies. We should ensure that there is coordination between monetary policy, fiscal policy, investment policy, and industrial policy. This will better enable us to address complex relationships between the size and structure of the economy, between economic and social development, and between short-term and long-term development. In addition, an emphasis should also be placed on the combination of monetary policy tools. This should be another regular approach that we take in the implementation of monetary policy. 

We should pay attention to balancing the relationship between domestic monetary policy and international cooperation on currency. As China’s economy and financial sector take on an increasingly international orientation, the links between domestic monetary policy and global economy and finance are becoming increasingly close. Therefore, we must find a balance between meeting domestic targets and maintaining economic and financial coordination internationally. Taking both domestic and international situations into consideration is a long-term requirement. 

(Originally appeared in Red Flag Manuscript, No.2, 2012)

Author: Chairman of the Board of Directors of the China Everbright Group

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