Peoples Bank of China: Monetary Policy Practice

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Peoples Bank of ChinaMonetary Policy Practice

• for the Chinese Economy (ECON6031)
• by Nipa Piboontanasawat (2008966781 )
• on April 1, 2009

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Background

• On 12/1/1948, the ruling Communist party
  consolidated the former Huabei Bank, Beihai Bank
  and Xibei Farmer Bank and established the PBoC
  and put it under the Ministry of Finance.
• Between 1950 and 1978, the PBoC serves the entire
  Chinese financial system as a central bank as
  well as a commercial bank.

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Background (Continued)

• After economic reform took place in 1978, the
  PBoC departed the Ministry of Finance and its
  duties as a commercial bank were divided among 4
  state-owned banks over the years the Bank of
  China, the Peoples Construction Bank of China,
  the Agricultural Bank of China and the Industrial
  and Commercial Bank of China.

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Background (Continued)

• In 1983, the State Council confirmed the status
  of the PBoC as a central bank.
• In 2003, the China Banking Regulatory Commission
  was established to take over from the PBoC the
  role of supervising the financial industry.
• Since then, the main role of the PBoC is to
  formulate and implement monetary policy.

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Management

• The PBoC has a monetary policy committee, which
  consists of 13 members, including Governor Zhou
  Xiaochuan.
• The PBoC is under the leadership of the State
  Council therefore, any decision involving
  monetary policy has to be approved by the State
  Council before being implemented.

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Monetary Policy Tools

• Interest Rates(Lending Rates, Deposit Rates,
  Re-lending Rates and Rediscount Rate)
• Reserve Requirement
• Open-market Operations
• Exchange Rate
• Administrative Monetary Policy

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Interest Rates

• Lending rates -- The rates at which commercial
  banks charge the public when lending.
• Deposit rates -- The rates at which commercial
  banks pay the public in return for deposits.
• Re-lending rates -- The rates at which the PBoC
  charges commercial banks when lending.
• Rediscount rate -- The rate at which the PBoC
  charges commercial banks with discount notes.

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1-Year Lending Rate
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1-Year Deposit Rate
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Divisible by 9 Rule

• On 12/23/2008, the PBoC cut the 1-year lending
  and deposit rates by 27 basis points.
• On 11/27/2008, it cut the same rates by 108
  basis points.
• Interest rates and their changes are divisible by
  9, instead of the increments of 25 used by most
  other central banks. Why?

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Divisible by 9 Rule (Continued)

• Reasons
• 1. Chinese financial calendar has 360 days,
  instead of 365 or 366 days.
• 2. Abacus.
• 3. Superstitions -- the number 9 in Chinese
  language shares a pronunciation with the word
  longevity'' and monetary policy has to be
  sustainable.

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Reserve Requirement

• The proportion of deposits commercial banks put
  aside as reserves.
• Besides the level of reserve requirements, the
  PBoC sets the interest rates at which it pays
  commercial banks for the required reserves and
  the voluntary ones.

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Reserve Requirement
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Open-market Operations

• The PBoC conducts open-market operations
  regularly to directly control the money supply.
• It does so by issuing the central-bank bonds --
  selling them when it wants to reduce money supply
  and buying them back when it wants to increase
  money supply.

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Exchange Rate

• On 7/21/2005, the PBoC adopted a managed,
  floating foreign-exchange system.
• It began allowing the yuan to trade against a
  basket of currencies, with a so-called reference
  exchange rate set daily.
• It also specified the daily fluctuation limit of
  the yuan against the U.S. dollar to be 0.3
  percent. Then, on 5/21/2007, it widened the band
  to 0.5 percent.

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U.S. Dollar/Yuan Exchange Rate
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Euro/Yuan Exchange Rate
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Administrative Monetary Policy

• Because most of the commercials banks in China
  are state-owned, the PBoC is able to conduct a
  so-called administrative monetary policy.
• For example, it will meet with the state-owned
  banks and tell them to reduce loans when it wants
  to tighten monetary policy. It will tell them to
  increase loans when it wants to ease monetary
  policy.

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Transmission Channels

• Bank and Inter-bank Interest Rates
• Inflation Expectations
• Consumption and Investment Behaviors
• Credit Supply
• Asset Prices

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Transmission Channels (Continued)

• When the PBoC changes lending and deposit rates,
  it first directly affects bank interest rates
  because it sets those interest rates, with a very
  limited freedom of a floor for lending rates and
  a ceiling for deposit rates.
• It also indirectly affects inter-bank interest
  rates when it changes the re-lending or
  rediscount rates, or the reserve requirement for
  commercial banks.

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Transmission Channels (Continued)

• The PBoC guides public expectations of future
  inflation and as a result, affects price
  developments.
• The change in interest rates affects consumption
  and investment behaviors by making it more
  expensive or cheaper to fund consumption and
  investment.
• The change in reserve requirement also affects
  the amount of money available for lending to
  households and companies.

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Transmission Channels (Continued)

• Although it is difficult to predict, the change
  in interest rates and reserve requirement affect
  asset prices because of its impact on funding
  conditions and public expectations. The wealth
  effect from higher or lower asset prices then
  affect consumption and investment behaviors.
• Lastly, changes in consumption and investment
  behaviors affect the level of domestic demand for
  goods and services relative to domestic supply
  and as a result, influence price developments.

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How Effective Is It?
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Recommendations

• Liberalize Interest Rates
• Liberalize Exchange Rate
• Increase PBoC Independence
• Increase Monetary Policy Transparency
• Increase PBoC Creditablity

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The End