A commentary by Zhou Xiaochuan, Governor of the People's Bank of China, published in Caijing magazine, reveals that compared with developed countries with a mature market economy, China follows a multi-purpose monetary policy. Zhou also illustrates the coexistence of price-based and quantity-based regulatory measures and discusses how the significance of reform may, over a period of time, outweigh the independence of the Central Bank's monetary policy. Excerpts follow:

Multi-targeting system

Given China's present economic development, an inflation targeting system will not be taken into consideration for the time being. During the transitional period of the economy, the market plays an increasingly important role in pricing resource commodities, service products and production factors. This will surely impose extra influence on the price and quantity of the currency, a phenomenon that does not exist in mature market economies. If currency instability is to occur in China, it might be attributed to problems relevant to the transitional period rather than the price or quantity of the currency.

At the same time, as a low-income developing country, China regards economic growth and employment as important objectives, and the Central Government has to face up to this reality. The goal of economic growth is indirectly corresponding to those expected to be achieved in terms of employment and the international balance of payments. Although the Central Bank's major function is to stabilize the currency and maintain low inflation, currently, it's still necessary for China to adopt a multi-targeting regime, dealing with inflation while keeping an eye on economic growth, international payment balance, employment and especially the financial reform.

Two types of regulatory instruments

Since the 1980s, China has experienced three high-inflation episodes, which took place in 1985, 1988 and 1995, respectively. However, influenced by the Asian financial crisis, deflation hit China from 1998 to 2000. These experiences show a strong interaction between currency supply and inflation. The People's Bank of China notices that at the current stage of economic development, the monetary aggregates constitute an important part of the monetary policy.

Meanwhile, the role of the money supply varies with the development of the economy. Its impacts on the economy and inflation should never be judged in accordance with rigid rules. In the case of China, we must take into account the monetarization process that always accompanies the reform.

By monetarization we mean that in the market economy, the price of certain products (like houses), which used to be directly distributed under the planned economic system, should also rise in accordance with workers' income. But it has resulted in an unparalleled growth of money supply and nominal GDP. This is also different from the situation in mature market economies. For years, the money supply in China has been growing faster than the nominal GDP and the growth of extra supply is, to a large extent, corresponding to the progress of the monetarization. Of course, this phenomenon will not last forever.

On the other hand, in the transitional period, interest rate and exchange rate regimes, the financial market and the structure of the financial sector are all undergoing gradual improvement, with rising price elasticity. Only by experiencing such a "slow transition" can the effective monetary policy transmission mechanism take shape. Therefore, it's necessary for the Central Bank to make use of both price- and quantity-based tools in carrying out the monetary policy.