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Understanding the PBC’s Neutral Monetary Policy

Jun 29 , 2013
  • Yi Xianrong

    Researcher, Chinese Academy of Social Sciences

From an international perspective, many countries are dreaming of reenergizing their weakening economies through quantitative easing, with the United States and the European Union continuing their monetary policies of quantitative easing and some other countries following each other to lower their benchmark interest rates. Here in China, most of the macro economic data released in April fell below market expectations. Given the situation, some people have predicted that the People’s Bank of China (PBC), China’s central bank, will most probably lower the reserve requirement ratio and the benchmark interest rate to stabilize economic growth for this year. But they have been proved wrong, and the PBC has been mopping up market liquidity instead.

Yi Xianrong

As a matter of fact, the PBC has taken the move to save the country from copying the monetary policies of United States and European countries as seen during the 2008 global financial crisis. China has a national condition different from those of the United States or European countries. First of all, what is at issue now is not the acceleration or deceleration of the growth speed of the Chinese economy, but the sustainability of growth. It is precisely based on this consideration that a basic consensus has been achieved in China after the 18th National Congress of the Communist Party of China that the focus on economic growth should be shifted form speed to quality. In other words, the traditional growth pattern should be remodeled for its unsustainability. It is only too natural for the Chinese government to keep a close eye on the speed of economic growth, but it will never take quantitative growth as its top goal. Now that it is ready to tolerate a moderation of economic growth, the Chinese government will not rush to endorse any monetary policy of quantitative easing to stimulate the economy, even when its growth slows down.

China also differs from the United States and European countries in terms of their financing markets. After the outbreak of the global financial crisis, investment demand withered dramatically in the United States, Japan and European countries, where enterprises hated to borrow and banks refused to lend. As a result, both investment and financing demands kept contracting. But the scene was totally different in China, where the investment thirst of enterprises and local governments never subdued throughout the years. A supportive example is the fundamental changes that have taken place in China’s financial market in recent years. When the government tightens its control over financing, shadow banking would take the place of official banking to meet financing demands.

As a result, from January to April total social financing amounted to 7.91 trillion yuan, rising 63 percent above the year-on-year figure to set a new record. The ratio of bank credits to the total amount of financing during this period, meanwhile, stood at 45 percent, falling more than half from the 2003 ratio. All these pointed to the fact that unlike in the United States and Europe, where investment demand remained surprisingly weak, there was a feverish financing demand in China. Thanks to this great demand, financing tools kept growing in number and size regardless of the policy ceilings set by the government, and international capital flooded into China in all forms.

As a result, broad money supply (M2) in China rose by 16.1 percent in April, much faster than the rate set in the 2013 Government Work Report. Also, hot money kept flooding into China, enlarging the country’s January to March position for foreign exchange purchases by nine times from a year ago to 943.3 billion yuan. Instead of going into the real economy, the enlarged liquidity either circulated idly inside the financial system or flew into the real estate sector. Given the growth of housing sales by 41 and over 60 percent in area and sum respectively in April, no funds hesitated to rush into the housing market. Under such a circumstance, any quantitative easing by the central bank will only further push up the housing price rather than lend any help to the real economy.

Viewed as a whole, the biggest headache plaguing the Chinese economy is the real estate bubble and its burst. Already there, this bubble will not only retard the country’s pace of industrial restructuring and endeavor to improve the quality of economic growth, but also lead to misdistribution of social incomes. Any monetary easing by the central bank will just add new air into this ballooning bubble.

In addition, the economic situation at the international arena is becoming ever more changeable and unpredictable, while uncertainties are cropping up one after another in the world economy. As its economic situation turns for the better this year, for instance, the United States may gradually forego its policy of quantitative easing. At the same time, however, Japan has opted for a monetary policy of qualitative and quantitative easing, a move that will produce some considerable impact not only on its own economy but also the world economy as a whole. It will lead to the remodeling of the interests pattern of the world economy, and the re-orientation of the flow direction of the international market. China’s failure to see this clearly and rush into action as a result will expose its economy to some considerable impacts and uncertainties. In view of all these uncertainties at the world arena, the PBC has opted for a neutral monetary policy so as to meet changes with constancy and volatilities with stability.

For all the wave of interest cuts sweeping across the world, the PBC will not go with the stream and opt for a monetary policy of quantitative easing to stimulate the Chinese economy, even if its growth slows down or the inflation rate remains low. Instead, it will follow a neutral monetary policy in line with China’s practical condition to maintain the steady and sustainable growth of its economy and rein in the ballooning of its property prices. It is unlikely; therefore, for the PBC to lower the reserve requirement ratio or the benchmark interest rate any soon.

Yi Xianrong is a researcher of the Finance Institute of Chinese Academy of Social Sciences.

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