Such is the scrutiny of monetary policy in the west that central bank statements are scoured for tiny shifts in emphasis. Yet policy in China – supposedly the world’s economic future – is largely unfathomable. The People’s Bank of China’s one-line objective is to maintain currency stability and promote growth. That in part stems from China’s managed exchange rate, which theoretically ties its hands on policy. The lack of an explicit inflation goal is logical, although the PBoC does target broad money supply. Some monetary levers used by the PBoC are recognisable. There is a discount rate and standing facilities. The PBoC also conducts open market operations – initially it bought and sold government bonds, and now there are special bills that are actively traded. Money supply is also tweaked by changing banks’ required reserve ratios. These last two tactics can help to absorb (“sterilise”) foreign currency inflows – another burden of currency inflexibility.
But China’s monetary policy is opaque because it operates “under the guidance of the State Council” – that is, it is heavily politicised. The PBoC’s most powerful levers are what it calls “other policy instruments”. These include ordering banks to increase or decrease lending volumes – regardless of the prevailing interest rate – as well as suggesting where loans should go. In effect, monetary policy is subsumed into the government’s wider agenda.
For now this arguably makes sense, as the efficacy of traditional monetary levers remains poor. Many academic studies show that China’s interest rates have minimal influence on money demand. A big reason is because commercial banks – which still intermediate about three quarters of all capital – have excess reserves and are therefore insensitive to interest rates (as, of course, are state-owned enterprises). The state, meanwhile, prioritises its economic growth objectives. Instead of untangling the Central Bank’s process, the key to understanding China’s monetary policy may be its bias towards expansion in order to mitigate social tensions.
