May 7, 1996
Order No.: Vol.6, No.6 (In both English and Chinese versions)
$ 10 each + Shipping ($2 each within U.S., $5 each international)
Control of Money Aggregates: Problems and
Prospects in China's Transitional Economy
Dr. YU Qiao and Dr. XIE Ping
YU Qiao is a lecturer at the Economics & Statistics
Department of the National University of Singapore. He received
his B.A. in economics from Sichuan University (China) and Ph.D.
in economics from Michigan State University.
XIE Ping is Deputy Director of the Policy Research
Department at the People's Bank of China. He received his Ph.D.
in economics from the People's University of China.
Summary
This study, conducted from July 1995 through February 1996,
is one of a series research projects of the ongoing "Chinese
Economic Research Program" (1995-1998), which is organized by the
Washington Center for China Studies and funded by the Ford
Foundation.
China's economy has expanded dramatically over the past
seventeen years. It has also, in all respects, been rapidly
monetized so that the money stock now plays a central role in
facilitating economic activities. At the same time, however,
economic volatility, especially in terms of rising prices, has
accelerated. The economic reform process has thus decisively
changed the macroeconomic environment for the conduct of China's
monetary policy, with monetary management becoming the key to
minimizing economic fluctuation.
Having evolved from a pre-reform monobank system, in which
the People's Bank of China (PBC) combined the functions of a
central bank and commercial banks and passively provided
financial assistance to the state production plan, China's
monetary policy is now mainly enforced by PBC's direct bank
credit allocation and interest rate control. Under this "random
monetary policy", the central bank has no control over its assets
(monetary base) and there are multiple, often conflicting goals
for the monetary authorities to pursue. This has constituted a
strong cyclical character often resulted in a high inflationary
pressure on the economy. In recent years, it has become
increasingly difficult for Chinese monetary authorities to preserve macro-economic stability through the plan-based administrative measures.
China's gradual reforms are characterized by two important
structural developments: the establishment of a primitive market
system, and the decentralization of economic decision-making from
the central government to lower-levels. The former alters the
means of resource allocation, while the latter results in the
emergence of non-state economic sectors. These fundamental
changes have eroded the ability of the PBC to control bank credit
directly. The drawbacks of such direct credit control are also
obvious. By and large, the overall credit ceiling is not only
influenced by the government political process, but is also a
compromise of the central bank, state banks, and localities.
Consequently, the money supply is a derivative, which exerts
inflationary pressure. Moreover, under the planned credit system,
administrative control over bank credits inevitably leads to
serious distortions in resource allocation and inefficiencies in
resource utilization.
Because a well-functioning money market does not exist in
China and interest rates are still officially determined, the
policy option for a central bank's control over the money stock
by influencing credit market conditions (such as leading interest
rates) is not realistic in China today. The second approach of
a so-called "quasi-regulated monetary policy", which is based on
controlling the central bank's monetary liabilities (central bank
money) such as bank reserves or the monetary base, thus becomes
the only viable alternative. In order to make monetary policy
more effective in achieving sustained economic growth with low
inflation, the Chinese central government has decided to trans-
form the PBC into an actual central bank and to replace direct
credit control with aggregate money management.
This study addresses issues of China's money supply based
on the PBC's monetary policy practice and monthly statistical
data from June 1985 through December 1994. Using institutional
analysis and econometric modeling, it reaches the following
major conclusions:
(1) Given China's rapid marketization and decentralization,
the economic foundation for direct bank credit control has
deteriorated, while the basic conditions for indirect monetary
management have gradually developed. According to empirical
evidence, money aggregates contain much richer information about
the future movements of macroeconomic variables than bank
credits. Thus, the PBC has economic incentives to develop a more
systematic monetary policy.
(2) The main problem for the People's Bank to undertake a
meaningful aggregate money management is due to the endogeneity
of China's monetary base supply. There exist Political,
structural, and technical barriers impeding the PBC's efforts to
control the monetary base. Political pressure comes from the
efforts of both the central and local governments to reach
aggressive economic growth targets. Structural barriers result
from China's non-commercialized banking system and its commitment
to state sectors with soft budget constraints. Technical problems
are due to the PBC's rudimentary internal management system and
poor balance of payments structure. Improving the PBC's control
over the monetary base will therefore require a comprehensive
adjustment of the relations between the central bank and gov-
ernments, and a restructuring of state sectors including banks.
However, the central bank's efforts to improve its own management
and techniques are also crucially important, including acquiring
greater control over its assets and establishing its authority
in policy enforcement.
(3) China's structural changes often have transitional
shocks on the connection between the central bank money and money
aggregates. However, empirical outcomes of this study strongly
suggest that the long-term relationship between the two is a
stable one. This is largely due to the fact that China's gradual
reforms, while progressively introducing institutional
innovations, have preserved basic stability for the banking
system. This important empirical finding indicates that the PBC
is at least eligible to indirectly manage money aggregates
through controlling its own liabilities in the longer term, even
though this may prove difficult in the very short-term.
(4) Effective money management must rely on accurate
forecasting of the money multipliers. Econometric experiments in
this study not only prove the technical predictability of the
money multipliers, but also provide practical models for
conducting simulations and forecasts of future money multipliers.
In addition, the monetary base multipliers are more accurate than
other central bank money multipliers, making them the most
suitable operating target.
Remodeling monetary policy and operations is a great
challenge for China as the country attempts to move toward a more
efficient market economy while preserving economic stability. The
complex process will require political decisions, systematic
restructuring, and technical innovations. Nevertheless, as shown
in this study, the basic conditions for reshaping China's
monetary policy are already mature in many respects.
The People's Bank of China has officially evaluated this
study and highly recommended both its analyses and policy
suggestions.
Table of Contents
I. Introduction
II. Control of the Monetary Base
1. PBC Loans
2. Foreign Exchange Reserves
3. Recent Developments in Monetary Base Control
III. Relation between the Central Bank Money and Money Stock
1. Structural Breaks
2. Cointegration Relations
IV. Predictability of the Money Multipliers
1. Component Model
2. Aggregate Model
3. Multiplier Forecasts
4. Forecasting Stability
V. Concluding Remarks
Tables and Figures
Data Appendix
Notes
References
