China s Monetary Policy Surprise

China s Monetary Policy Choice

It remains to be seen whether the US Federal Reserve will also feel constrained by the political mood on Capitol Hill. Clearly, influential Tea Party supporters would strongly resist any attempt now by Fed Chairman Ben Bernanke to find unorthodox ways to run a more expansionary monetary policy.

Rather strong but unorthodox policy intervention was an integral part of their successful brand of heterodox gradualism tailored to local conditions (Birdsall, et al, 2005 145)

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1. Strongly anti inflationary monetary policy.

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Decisions taken by the leading monetary authorities since the 2008 2009 global financial crisis have been unorthodox, creative, and at times risky. Their high stakes choices today will affect the global economy for decades to come.

Of course, a country s monetary policy does affect exchange rates in the short term. But it does so only in relation to monetary policy in other relevant countries.

The market had strongly expected adjustments to UK monetary policy.

As traditional monetary policy becomes ineffective, other unorthodox policies will continue to be used policies to bail out investors, financial institutions, and borrowers massive provision of liquidity to banks in order to ease the credit crunch and even more radical actions to reduce long term interest rates on government bonds and narrow the spread between market rates and government bonds.

In any case, the success of monetary policy is difficult to deny. As the deflation gap narrows, however, the overall impact of monetary policy will weaken, as it increasingly influences prices more than output.

Still to be argued out within the guild of economists , Samuelson wrote in 1969, is the proper quantitative potency of monetary versus fiscal policy. This question eventually was resolved in favor of monetary policy.

Moreover, unlike major developed economies, most of which have used up all of their conventional monetary policy ammunition by reducing their policy interest rates to zero, China has plenty of monetary stimulus on reserve to address cyclical disruptions. In these circumstances, it makes sense for China to lean more on monetary policy than on fiscal expansion.

Monetary policy needs to look beyond its core focus on low and stable inflation and pay much greater attention to financial stability. The debate now is how, exactly, to factor this imperative into monetary policy, and how to coordinate the work of monetary and regulatory authorities.

This is not the type of volatile monetary policy that Europe wants or needs.

Domestic monetary policy has become the first and last line of defense against growth slowdowns and financial panics, enabling policymakers to avoid pursuing other important, but far more difficult measures. Using monetary policy to compensate for deficiencies in other policy areas constitutes an institutional breakdown monetary policymakers are not necessarily getting it wrong, but they are constrained by the configuration of other policies.

If monetary policy is used to try to push unemployment below some pre determined level, inflation will accelerate without limit and destroy jobs. A monetary policy aiming for sub NAIRU unemployment must therefore be avoided at all costs.

Europe s monetary unification of the 1990 s was supposed to be accompanied by fiscal convergence and harmonization. When budgets move in different directions, pressures shift to regional policy (to redistribute income) and to monetary policy (to boost growth).

The current approach, centered on unconventional monetary policy, is not the answer. Though monetary policy provided a powerful antidote to frozen credit markets in the depth of the global financial crisis, it has failed to spark classic cyclical recoveries.

The ECB has never claimed that its strategy is the ultimate solution to the challenges monetary policy is confronted with. But, it has recognised the need to include monetary analysis in a very broad sense into its policy considerations.

In China, unlike in advanced countries, monetary and sterilization policy are often one in the same. The degree to which monetary policy is expansionary depends on the degree to which the liquidity created by currency market intervention has been sterilized.

The International Monetary Fund continued to assist the Government, through a close policy dialogue, in maintaining macroeconomic stability, especially in the area of fiscal policy.

This is not to say that sudden normalization of monetary policy is a good idea. But, if large scale investment and reform programs were initiated as complements to unconventional monetary policy measures, the economy could move onto a more resilient growth path.

The German fascination with gold is a red herring. Its fear of wayward monetary policy is not.

In principle, the answer is straightforward. If a central bank has two policy targets, then it needs two instruments monetary policy to influence aggregate demand, and regulatory policy to limit financial risks.

Secondly, it would insulate domestic economies from external developments, thereby permitting monetary policy to focus on redressing unemployment.

This simply reflects the reality of monetary policy interdependence if the US Federal Reserve s policy of so called quantitative easing weakens the dollar, others have to respond to prevent undue appreciation of their currencies. Someday, we might achieve closer global monetary policy coordination for now, however, it made sense for Japan to respond, albeit belatedly, to developments elsewhere.

In the early 1930 s, monetary policy incoherence paralyzed US policy, with the Federal Reserve Bank of New York locked in insurmountable conflict with the Chicago Fed over monetary easing (at that time through open market securities purchases). Today s chronic policy disputes between Germany and France are producing a level of uncertainty that is potentially even more destructive.

The proactive fiscal policy that Li pledged at Davos will help, but monetary policy also needs to change. The conundrum facing China s authorities is that monetary expansion would merely fuel a run up in asset prices, rather than resulting in higher credit flows to the real economy.

It remains to be seen whether it can effectively restore some monetary policy influence. However, an important issue is rarely mentioned in small, open economies a description that applies to almost every country except the US the main channel of monetary policy is the exchange rate.

For example, some inflation targeting central banks have reacted to increases in prices of imported commodities by tightening monetary policy and thereby increasing the value of the currency. But adverse movements in the terms of trade must be accommodated they cannot be fought with monetary policy.

BERKELEY When an economy falls into a depression, governments can try four things to return employment to its normal level and production to its potential level. Call them fiscal policy, credit policy, monetary policy, and inflation.

BERKELEY When an economy falls into a depression, governments can try four things to return employment to its normal level and production to its potential level. Call them fiscal policy, credit policy, monetary policy, and inflation.

Countries now seem to think that monetary policy measures are their only option. But, whereas fiscal stimulus boosts growth at home and abroad, enabling mutual reinforcement through world trade, monetary policy is guided primarily by domestic goals, and, in the short term, one country s gain can be another s loss.

The OMT scheme s German opponents argue that it is unconstitutional, because it is not monetary policy, but fiscal policy aimed at financing insolvent and lethargic eurozone governments. They argue that it is not the ECB s job to rescue the euro or to prevent countries from exiting the monetary union.

The new business cycle also embeds a monetary policy that replaces concern with real wages with a focus on asset prices. Whereas pre 1980 monetary policy tacitly aimed at putting a floor under labor markets to preserve employment and wages, it now tacitly puts a floor under asset prices.

As a result, questions about the role of monetary policy and the independence and accountability of central banks, once confined to rarefied academic discussions, are fixtures of broad policy debate. But, rather than try to define a single approach, central bankers should aim to develop individualized approaches within the orthodox monetary policy framework, which revolves around price stability and independence.

Yet widespread concerns persist. The International Monetary Fund for example, has argued that any rate hike by the Fed would need an effective monetary policy communication strategy a polite way of saying that any monetary tightening in the US and other advanced economies would be premature.

Monetary policy would have been more effective in the US had more attention been devoted to credit blockages for example, many homeowners refinancing problems, even at lower interest rates, or small and medium size enterprises lack of access to financing. Japan s monetary policy, one hopes, will focus on such critical issues.

Zhou is an intelligent and internationally respected expert on monetary policy and finance. As the head of the PBOC, he has favored more market based monetary policies and increased internationalization of China s currency, the renminbi.

Almost all major crises in emerging markets have been connected with shifts in exchange rates and monetary policy in advanced countries.

The search for a monetary rule during the latter period had two phases in the earliest attempt to construct a basis for stable monetary policy, the emphasis was on monetary targeting. In the second, more successful, phase, an increasing number of countries adopted either explicit or implicit inflation targets.