Intermediary Targets of Chinese Monetary Policy: Selection and Efficiency

1. Intermediary Targets of Chinese Monetary Policy: Selection and Efficiency X. Zhang May 2011

2. Main Messages • Money aggregate and the incremental RMB loan as the intermediary targets of monetary policy are becoming less effective than before. • The PBC launched several initiations to enhance the efficiency • Implement dynamic required reserve requirement • Amend M2 • Compile M3 and “total finance aggregate”. • These measures are yet to be tested in the future.

3. Outline • Related theoretical background and international experience • Evolution of China’s monetary policy, intermediary targets and their efficiency • Recent development and future of monetary policy intermediary targets in China

4. Theoretical background • Keynesian: the economic system is unstable, and money is endogenous that can’t be controlled by the central banks to reach monetary policy targets. • Interest rate is the intermediary target of money policy • Quantitative monetary theory: inflation a money issue, in the long-run, an exogenous increase in money supply will lead to proportionate reaction of the inflation. • Money supply became the most suitable intermediary targets

5. Evolution of intermediary targets Source: websites of various central banks

6. Content of money supply Source: Statistical bulletin of various central banks

7. China in Transition • Financial innovation not active • Financial market less developed • However, with the opening of the financial market and liberalization of interest rate, financial innovation will improve and new financial products thrive. This will increase the endogeneity of money, and pose new challenges to monetary policy and its intermediary targets

8. China’s monetary policy: Objectives (1978-2010) • Prior to mid-1990s: “(the central bank, specialized bank and other financial institutions) should target economic development, currency stabilization and social and economic efficiency enhancement.” (The Provisional Regulation on Bank Management , 1986) • After 1995: “the objectives of monetary policy are to maintain currency stability in order to facilitate economic growth.” (Law on the People’s Bank of China, 1995) • The objectives have been adjusting along with the economic development (Zhou, 2009)

9. China’s monetary policy: intermediary targets(1978-2010) • Prior to 1983: total credit and cash inputs • 1983-1998: credit quota • 1998-2010: incremental loans • 2011 to ?: ??

10. Money supply in China • M0 = cash in circulation • M1 = M0 + checkable demand deposit of enterprises and other entities • M2 = M1 + savings deposit of residence + term and other deposit of entities • Starting January 2010, the PBC started to compile money statistics based on local and foreign currency statistics of all financial institutions in the country according to the IMF Handbook.

11. Efficiency of intermediary targets Targets and actual value of monetary policy intermediaries

12. Efficiency of intermediary targets Financing Channels (RMB100 million)

13. Efficiency of intermediary targets Balance Sheet of PBC: Foreign Assets (RMB100 million)

14. Money aggregates vs. CPI and GDP

15. Money aggregates vs. CPI and GDP

16. Money aggregates vs. CPI and GDP

17. Regression results of CPI and money aggregates Note: A constant terms was included in all equations, and numbers in the brackets are probabilities.

18. Cross correlation of CPI vs growth rates of M0-M2

19. Cross correlation of GDP deflator vs growth rates of M0-M2

20. Cross correlation of GDP growth vs growth rates of M0-M2

21. Impacts of money shock on GDP growth and inflation

22. Recent development • The reduction in the efficiency of the intermediary targets is compounded with institutional twisting in China. • Three newly-introduced measures may be the second best choice of the PBC until the liberalization of the interest rates • Launch of dynamic RRR • Amendment of M2 • Compilation of M3 and “total finance aggregate” 22