Editorial: Monetary Policy Reform Needs Steady Hand

China’s monetary policy framework is still undergoing a transformation.

Recently, the People’s Bank of China released its “2017 Q4 China Monetary Policy Implementation Report.” Most analysts looking at the report have focused on short-term variables like the liquidity level in the new year. These factors are, of course, important. However, even though the policies include many interim and targeted measures, we must not overlook an important thread running through the report: the transformation of China’s monetary policy framework from one based on quantitative control to one focused on price-based regulation.

The central bank’s report, which in a sense provides an annual summary and outlook, has an article analyzing the relationship between changes in M2 money-supply growth and the real economy. The analysis clearly points out that as financial markets and financial products become more complex, M2 becomes less measurable, less controllable and less correlated with the real economy. While improving our measurement of the quantity of money, there should also be more attention focused on interest rates and other price indicators, and a gradual promotion of the transformation from quantitative control to price-based regulation. This signal is worth paying attention to.

China began transforming its monetary policy around 2012. At the time, as the surplus of liquidity caused by foreign exchange inflow gradually subsided, the central bank began to experiment with creating a liquidity management tool that takes into account both volume and price, and prepared to cease its frequent adjustment of the reserve requirement ratio. At the same time, interest rate marketization was accelerating. By the time the central bank removed the ceiling on bank deposit interest rates in October 2015, the formal marketization of the interest rate was basically complete. Then work began on building the interest-rate corridor.

Significant progress has been made in the transformation of the monetary policy framework, but there is still a long way to go. According to research by CEBM Group, a subsidiary of Caixin, the marketization of the interest rate is often associated with economic transformation, appearing during a period of economic slowdown. At the moment, the global economy is recovering and differentiating, and China is in an economic transition period, with monetary policy playing a relatively important role. In order to complete the transformation of the policy framework, it is necessary to coordinate multiple goals. This requires the monetary authority to have clear goals, a firm conviction and excellent operating skills.

As the central bank’s report notes, the Chinese economy is “currently at a crucial stage of transforming its means of development, optimizing its economic structure, and adjusting its growth momentum.” Monetary policy needs to strike a better balance between stabilizing growth, adjusting structure, promoting reform, deleveraging and preventing risk. As China deepens its anti-corruption drive, increases supervision over finance and continues rectifying financial chaos, tidying up the financial regulatory system and promoting the healthy development of the financial industry, there is great need for a stable currency.

After the expected amendment and rollout of new unified financial regulations drafted by the central bank and the banking, securities and insurance regulators, there will inevitably be an impact on short-term capital supply, accompanied by short-term fluctuation in the financial markets. At the same time, with the U.S. economy recovering and experiencing a rise in core inflation, the Federal Reserve will increase its pace of raising interest rates and shrinking its balance sheet. China’s monetary policy is bound to face pressure. In this situation, it is the rational choice for the central bank to implement sound and neutral monetary policy, maintain a reasonable and stable level of liquidity, and control the “floodgates” of the money supply. These internal and external factors make transforming the monetary policy framework quite a complex issue. 

The shifting of China’s monetary policy framework toward price-centered regulation requires the interest rate and the core elements of the financial market to be fully marketized. It also requires the cultivation of a perfect market interest rate system, and the formation of a smooth interest rate transmission mechanism. However, these requirements are still a long way from being met, and China must relentlessly deepen the marketization reform of interest rates and exchange rates.

The price of hesitation is immense — something the central bank understands clearly. The central bank’s report elaborates on deepening relevant reforms — for example, it urges financial institutions to further improve their internal controls, enhancing their ability to manage risk and independently and reasonably set prices. The report also mentions exploring the interest-rate corridor mechanism, enhancing interest rate regulation capabilities and further easing the transmission of the central bank’s interest rate decisions into the financial market and the real economy. It also mentioned taking advantage of the important role of the market’s interest rate and price self-regulation mechanism. Obviously, these goals all refer to “slow” variables, requiring a long journey before success is achieved.

It must be noted that China’s monetary policy reform cannot progress on its own, but rather requires a simultaneous “smallest package” of reform in other fields. “Smallest package,” a Chinese phrase dating back to the 1990s, refers to the smallest group of related reforms necessary to solve an issue. Deepening the reform of the financial supervision system and realizing the coordination between macro- and micro-prudential policy are important ways to guarantee the smooth completion of this transition. In addition, it is also necessary to deepen the reform of state-owned enterprises. Only when soft budgetary restraints become truly sensitive to changes in the price of money, and all enterprises engage in fair competition in the capital market, will there be better realization of a survival-of-the-fittest situation, reducing the number of “zombie” enterprises, improving the rational allocation of scarce capital resources, and promoting China’s economic transformation and upgrading.

At the 13th session of the National People’s Congress, institutional-reform solutions will be a hot topic. The financial regulatory system will change, and new central bank and regulatory department personnel will also be appointed. Many, both inside and outside the market, are eagerly looking forward to these new changes. We deeply hope that the new system will fall into place as soon as possible and achieve its intended results. We also hope that the leaders of each department maintain the audacity to push forward marketization reforms, have the wisdom to get the job done, and unite to complete the transformation of China’s monetary policy framework.

Promoting this transformation is in the current zeitgeist. However, it cannot be achieved in a single leap. Quantitative monetary policy is still justified in some ways by reality. During the transition period, it will be normal for the central bank to use a combination of price, quantity and macro-prudential tools. As the experiences of the U.S., South Korea and other countries show, the transition period has a fundamental logic: Deleveraging makes banks’ funding tighter, increasing their sensitivity to the interest rate in the money market. At the same time, with the rapid development of direct financing, the money supply becomes gradually decoupled from the macroeconomy, and quantitative monetary policy loses its basic function. After the financial market becomes fully developed, the interest rate transmission mechanism will work smoothly, and price-focused monetary policy will finally become the main tool. South Korea previously experienced a roller-coaster ride of liberalizing, followed by tightened control, followed by liberalizing again, due to excessively radical reform. This shows that the transformation of China’s monetary policy must instead advance steadily.

In the past 40 years, the reform and opening-up of the financial industry has been China’s outstanding achievement. In the five years since the third plenary session of the 18th Communist Party Central Committee, financial reform led by the central bank has become one of the stars of deepening reform. The transformation of China’s monetary policy framework involves the essential factors of marketization, construction of a market system, and even the national governance capacity. At present, China’s economy is stable and improving, providing good conditions for the transformation, which should be steadily promoted and completed in the future.

Translated by Caixin reporter Teng Jing Xuan (

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