China: Strengthening Monetary Policy Implementation

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. The People's Bank of China (PBC) has made great strides in modernizing its monetary policy frameworks but their effectiveness will diminish as the sophistication of the economy increases. Empirical evidence supports maintaining a reference to money in China's monetary strategy and enhancing the role of interest rates in its conduct. We advocate adoption of an eclectic strategy involving the monitoring of several indicators, and of a short-term interest rate as the operational target. The PBC should be granted discretion to change its policy rate, and there are no technical obstacles for such a move to occur in the near future.

Monetary policy, asset prices and consumption in China

“…Both results remain statistically significant for more than one year. The link in the opposite direction, from money supply to consumer price inflation, is also confirmed to accord with results found in the earlier papers on China's monetary policy (see, for example, Koivu et al, 2009;Laurens and Maino, 2007).…”

“…While the studies on the advanced economies typically use a policy interest rate as the monetary policy indicator, the role of interest rates in the Chinese economy is known to be very modest (see e.g. Koivu 2008;Laurens and Maino 2007;Mehrotra 2007).…”

Trilemma Challenges for the People's Republic of China

“…Laurens and Maino (2007) describe the process of setting the monetary policy framework in the PRC in the following way: the monetary authority first sets numerical targets for the quantity of money supply and credit growth as its intermediate quantity targets at the beginning of each year, and then monitors these intermediate targets closely during the course of the year and fine-tunes deviations from these targets by a number of policy instruments such as reserve requirements, open market operations, policy interest rates, and window guidance measures. Liu and Zhang (2010) argued that the use of short-term interest rates alone would be inadequate in the PRC, due to the weak interest-rate transmission channel, partly reflecting the dominance of stateowned commercial banks with a penchant to lend to state-owned enterprises (SOEs).…”

Reforming China's Monetary Policy Framework to Meet Domestic Objectives

“…For example, Geiger (2006) argues that changes in interest rates have had a limited impact on aggregate macroeconomic variables and that the transmission of monetary policy via the interest rate channel is distorted. In a VAR-based analysis, Laurens and Maino (2007) also find that changes in short-term interest rates have had a minimal and statistically insignificant impact on GDP. In another VAR study, Koivu (2008) reports that the transmission of interest rate changes to the real economy is weak over the sample period 1998 to mid-2007mid- .…”