News Release - Michel Camdessus Central Banking Lecture Managing Multi-Objective Monetary Policy: From the Perspective of Transitioning Chinese EconomyBy ZHOU Xiaochuan - Washington D.C., June 24, 2016
There have been extensive discussions and reflections on central banking since the outbreak of the global financial crisis (GFC). Country circumstances differ, but there are also a number of issues with common interests. As China has the features of both a large transition economy and an emerging market economy, China’s central bank and its monetary policy are yet to be well understood by the outside world. I would like to take this opportunity to discuss post-crisis issues of common concern on central banking, as well as the objectives, roles and practices of China’s central bank.
1. Several questions
Should central banks have one objective or multiple objectives? Before the GFC, many major central banks focused on price stability and adopted inflation targeting. After the GFC, many central banks strengthened or were given financial stability and financial regulation roles. The persistently sluggish economic recovery also sparked theoretical discussions on monetary policy frameworks other than inflation targeting, such as nominal GDP targeting that focuses on both growth and inflation. For emerging market economies, monetary policy will undoubtedly be affected by balance of international payments and capital flows. Here the question is: should balance of international payments be an objective of central banks?
A related question is the independence of central banks. The general view is that central banks and monetary policy should be independent. Some may argue that the independence of central banks and the independence of monetary policy should be appropriately differentiated and the emphasis should be on the independence of monetary policy. For central banks with a single objective, it is relatively easy to be independent. However, if a central bank has multiple objectives, it may be harder to be immune from the political reality. The reason is that, on the one hand, multiple objectives require more coordination and joint efforts with other government agencies and regulators, and on the other hand, functions such as macro-prudential and financial regulation by themselves are sensitive mandates for central banks.
The third question is the relationship between monetary policy and fiscal policy. In theory, fiscal policy and monetary policy have clear division of function. In practice, they can often have frictions, while sometimes they may also overlap. In the wake of the GFC, fiscal policy was not adequately employed, which led to passive over-reliance on monetary policy. A specific question is: in the event of a systemic risk, especially when fiscal policy is constrained or fiscal resources are limited, should and if so, how do central banks join in rescue programs?
The fourth question is what is special about central banks in transition economies. Economic transition refers to transformation from Soviet-type central planning to a market economy. At the early stage of economic transition, market foundation for macroeconomic management usually lacks, financial markets and products are underdeveloped, fiscal resources are extremely limited with large financing gaps. If central banks do not promote financial reforms or development of financial markets, there would be no healthy financial institutions or market mechanisms, let alone smooth transmission of monetary policy. Furthermore, like other emerging market economies, transition economies have a low level of development and hoped to make up for the “lost decades”. It follows naturally that they would also put emphasis on economic growth. Therefore, we need to take this context into account when trying to understand the objectives of central banks in transition economies.
2. Objectives and roles of the People’s Bank of China (PBoC)
The single objective of maintaining price stability is an enviable arrangement, as it is simple, easy to measure and communicate. However, it is not yet realistic for China at this stage. For a long time, the annual objectives of the PBoC mandated by the Chinese government have been maintaining price stability, boosting economic growth, promoting employment, and broadly maintaining balance of payments. The feature of a transition economy also requires the PBoC to promote reform and opening up as well as financial market development. Reform and financial market development will help achieve financial stability and economic transition from a dynamic and medium-to-long term perspective, and transition will in turn support a more efficient and stable economy. The PBoC attaches high priority to price stability, which is an objective of most central banks. Boosting economic growth and promoting employment are broadly overlapping goals and some central banks also have similar objectives. However, the PBoC has some distinct roles, which include promoting reform and opening up, developing financial markets, and maintaining balance of payments, and the PBoC also works closely with other government agencies. Why does the PBoC have these objectives? Why the central bank, not the ministry of finance?
Why does the PBoC support and carry out reform and opening up? A common problem at the early stage of transition was substantial distortions in price and tax systems, distribution of goods and services through non-monetary means, and very inefficient resource allocation. Banks were not commercial banks in real sense. Commercial banking laws, accounting and auditing standards, loan classification and financial reporting systems were yet to be put in place. The question is: should the central bank use monetary policy to support the reforms to make the price and tax systems more market-based and to distribute goods and services by monetary means? Losses resulting from the distortions in resource allocation usually ended up in the banking system. An observation is that massive non-performing loans (NPLs) have led to the collapse of the banking system in many transition countries. China’s banking system faced the same problem in the process of transition. The Asian financial crisis aggravated and exposed these problems. Indicators such as capital adequacy ratio (CAR) and NPLs of China’s banking sector worsened substantially. Many international observers commented that large Chinese banks were “technically insolvent”. At that moment, in the absence of reform and opening up, there would have been no healthy financial system, no financial stability, impossible to achieve price stability, and no way to make monetary policy transmission effective. Therefore, at that stage of transition from central planning to a market economy, carrying out financial reforms as well as making the financial system healthy and stable may even override the conventional objective of price stability.
When the old banking system in transition economies is distressed and fiscal position is weak, small transition economies may manage to restore the health of financial institutions by selling them. It is also relatively easy to find foreign investors willing to take over. This was a common practice in transition countries in Central and Eastern Europe. But China had a large and multi-tiered banking system, and it was hard to find foreign investors capable and willing to get fully involved. China had to rely on its own efforts to rescue and transform banks. However, fiscal resources at that time were inadequate. In the 1990s, fiscal revenue only accounted for about 10% of GDP at the lowest point. Besides, public finance faced a heavy burden resulting from the legacy of the planned economy. As a result, the PBoC had to consider ways to rescue financial institutions and safeguard financial stability. During this process, the PBoC split non-performing assets from banks, recapitalized problem banks, and supported the efforts by large banks to go public, shift to mixed ownership, strengthen corporate governance and improve international competitiveness. Through reforms, the PBoC safeguarded macroeconomic stability and China recovered from the Asian Financial Crisis. At the same time, focus was put on institutional development, including regulatory regime, laws and regulations, accounting and auditing standards, loan classification and financial reporting systems, which laid the foundation for developing a sustainable and sound banking sector and maintaining financial stability.
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