Chinese Monetary Policy – How Does It Work?

April 12th, 2013
in econ_news

by Dirk Ehnts, Econoblog101

The Chinese financial system is different. The central bank, the People’s Bank of China, conducts monetary policy differently from Western inflation-targeting central banks. This has created much confusion about how Chinese monetary policy works. Finn M Körner and I have finally published our working paper online. You find it here. This is the full abstract:

Follow up:

Chinese monetary policy constitutes a marked example of a clash between theory and practice. In theory, a fixed exchange rate regime with capital mobility turns the money supply into an endogenous variable while expansionary pressure can be alleviated by the central bank by foreign currency transactions. For China, this standard view is contended by the ‘compensation thesis’ as proposed by Lavoie and Wang (2012) according to which the central bank maintains discretion over money supply by using alternative balance sheet instruments. In this paper we show that the People’s Bank of China’s (PBoC) activities can be better characterized by the ‘compensation thesis’ view of alternative money supply operations. In addition, we can thus characterize the PBoC’s policy stance as being directed at targeting inflation and exchange rate stability via a five-phase policy mix using sterilization bonds and reserve requirements according to macroeconomic conditions. After downgrading the loans-to-deposits ratio of 75% to the status of an indicator and given the rise in lending despite a high reserve ratio, the quantity-driven approach to monetary policy of the PBoC faces an uncertain future.

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