Hu Xiaolian, Vice Governor of the People's Bank of China, the country's central bank, published an article concerning China's managed floating exchange rate regime and the effectiveness of the monetary policy on the bank's website on July 26. She pointed out monetary policy, as an important instrument of China's macroeconomic control, has faced many challenges in recent years. A more flexible exchange rate regime will help improve the effectiveness of the policy. Edited excerpts follow:
China is now facing more complicated economic fluctuations arising from the expanding scale of its economy, a deepened marketization level and opening up. The ability to use macro-control is paramount for ensuring a steady, sustained and relatively fast economic growth. At this stage, China's monetary policy needs to take into consideration four macroeconomic objectives: price stability, economic growth, full employment and the balance of international payments. The exchange rate policy has not only played a role in achieving these objectives, but also has an impact on China's international competitiveness, trade relations and resource allocation. Improving the managed floating exchange rate regime and its flexibility will help to enhance the flexibility and effectiveness of the monetary policy.
As an important measure of macro-control, China's monetary policy takes effect via the financial system and influences the economic behaviors of micro-entities. Therefore, the monetary policy has a more profound and systematic influence on both macro- and micro-economies. The complicated and volatile economic conditions require the macroeconomic policy to take into consideration both reform and development at the same time. China's monetary policy has multiple objectives: dealing with inflation, maintaining economic growth and balance of international payments, improving employment and pushing forward financial reform. Under such circumstances, the monetary policy must be flexible and effective.
Since July 2008, the Chinese economy has confronted severe challenges that came with the global financial crisis. Facing extremely complicated domestic and international conditions, China adopted a proactive fiscal policy and a moderately loose monetary policy, and enacted a number of measures to cope with the crisis. This secured a fast recovery, ahead of other countries. However, along with the strong economic recovery and fast inflow of foreign exchange comes increasing liquidity, which brings inflationary pressures and speculation in asset pricing. As a result, how to coordinate fast and steady growth and economic restructuring while managing inflation has become an urgent task for macroeconomic decision makers.
International experiences show inflation is a constant topic for macroeconomic research and can shake social and political stability. Based on current Chinese conditions, low-income groups—especially the 40 million-plus in the urban low-income group and the tens of millions of migrant workers—will be most affected when inflation occurs. Any improper treatment of inflation will damage social equality and stability. As for the central bank, its primary task is to maintain the stability of the currency and prevent inflation. Monetary policy is the most important and most effective macroeconomic measure to manage inflation, hence its effectiveness must be enhanced to ensure stable consumer prices and fast economic growth.
In the current economic situation, the independence and effectiveness of the monetary policy has been challenged by the relatively fast growth of money supply as a result of mounting foreign exchange reserves. Before 1993, China ran surpluses in current and capital accounts alternately. After 1994, both current and capital accounts had surpluses. Since 2001, when China joined the WTO, the surplus in the current account has surged and become an important source for the growth of surplus in China's balance of international payments. Under the context of a relatively fixed exchange rate level, the ever-increasing surplus and influx of foreign currencies forced the central bank to put more money into the market.