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UPDATED: May 12, 2015 NO.20 MAY 14, 2015
A Comprehensive Monetary Policy Framework
By Yuksel Gormez  

Editor's Note: At the end of 2014, Chinese President Xi Jinping put forward the strategic layout of the Four Comprehensives--comprehensively building a moderately prosperous society, deepening reform, advancing the rule of law, and strictly governing the Communist Party of China. Later, the new guideline for development became the overall framework for the current leadership's work and has aroused interest at home and abroad. From Issue No.17 onward, Beijing Review publishes a series of commentaries by foreign researchers commissioned by Renmin University of China's Chongyang Institute for Financial Studies.

Since the Four Comprehensives concept was unveiled in December 2014, President Xi Jinping has continued to reiterate the theory on a number of occasions. The Four Comprehensives have been a topic on everyone's lips during the annual sessions of China's National People's Congress and the National Committee of the Chinese People's Political Consultative Conference in March. It shows a strong intention of Chinese leaders to design a new political framework that will shape the future of China not only in terms of political strategy, but with implications for monetary policy as well. This leads us to the relevance of the Four Comprehensives to G20 discussions--next year it will be China hosting the meetings, bringing global attention back to Beijing only shortly after last year's APEC meetings.

The aim of this article is to look at the Four Comprehensives from a central banking point of view. During the last two years that I stayed in Beijing as a central bank representative, I have faced difficulties understanding and analyzing the Chinese economy. There are many hurdles to sorting out its extreme complexities, which arise from the massive transformation that has been going since the second half of 1970s. Change has become the norm since those years and one may easily argue that it will not stop in the near future.

It is not difficult to understand the need for a roadmap or strategic plan that is easy to read, not just for national or local government officials in China but also for foreigners. Without proper guidance, it becomes challenging to form expectations, which is critical for success. From this perspective, the Four Comprehensives are a framework for all stakeholders in the Chinese economy, both national and international.

Let us analyze the goals of the Four Comprehensives one by one. First, being moderately prosperous balances the great success of the last four decades with the massive challenges of the next two decades. There is no need for exaggeration to argue that China will still be fighting poverty for a while. Thankfully, there is already no famine in China and poverty reduction is only second best to Viet Nam in terms of generally accepted measures. On the other hand, it may be adventurous to push beyond limits and create a welfare society in China within 20 years. This may need much longer periods with intergenerational reforms including education and social security with long term horizons. As a result, being moderately prosperous but still progressing toward a welfare society is the most optimal and easily quantifiable target for China from a central banking perspective. It will support neither fast nor high, but rather sustainable, growth to lead to sustainable welfare enhancement.

The second is to deepen reforms, an objective that will remain relevant for many more decades. China has a very long list of fundamental issues to be addressed sequentially and comprehensively. Since the beginning of the reform in the 1970s, China never fell into the trap of reform fatigue. However, old successes do not guarantee future ones, as we may easily observe from many other developing countries. In order to prevent the occurrence of this risk, a sustained and strongly declared commitment is needed.

A permanent reform agenda that covers the extremely challenging social and economic reforms that must be faced to sustain the gains of the last three decades must be followed unwaveringly. From this perspective, we may expect Chinese officials to be roused by this strong wakeup call on the reformist side and increase their confidence for success on the road to create a moderately prosperous society.

The third comprehensive may not be relevant to central banking or macro economic discussions in the short run, but rule of law is generally accepted in many circles as one of the main determinants of potential growth in the long run with a strong impact on entrepreneurial skills. Corporate China will surely benefit a lot from transparency. As firms and citizens may understand what the government allows with which limits; they will be more innovative and create more value added to open the way toward a welfare society and to decrease the total cost of achieving that aim in the long run.

The last comprehensive is relevant to long term growth in terms of governance issues. It is well documented that good governance is the key to both increasing contributions to the society at the government and corporate level. Party discipline aims to increase the quality of governance. Without this, corporate regulation is a far away dream. Last but not least, without good corporate regulations, it is almost impossible to expect any progress on civil regulations.

Now, lets take a look at the monetary policy framework that supplements such challenges. Monetary policy has always been a complicated issue especially since the fall of Bretton-Woods. In the beginning, it was emerging countries that struggled in the face of high and volatile inflation leading to the loss of capital adequacy. Since the 2008 global financial crisis, it was also developed countries that lost the easy and efficient conduct of monetary policy to rely on credibility for long-term economic stability. Japan is still struggling decades after its recession, while Europe is pushing the boundaries of monetary policy into uncharted territories.

China looks like an interesting case in this light. First of all, inflation has never been a major destructive issue compared to Latin American or transition countries. Secondly, growth volatility looks extremely low, which decreases the cost of ups and downs on the economic activity. Thirdly, central planning has been downgraded for many decades up to 2008 and has been attracting much more interest lately as more countries admire 10-year roadmaps for economic growth in China.

People's Bank of China, the central bank, has a flexible monetary policy framework and it is also moving toward better adaptation toward the management of an international yuan in an open economy with liberal financial markets and financial service provisions, putting them in a uniquely advantageous position.

The central bank has never hurried financial reforms. Adaptive learning has always stayed in a corner to eliminate major mistakes that might have led domestic financial collapses. Neither interest nor exchange rate volatility led to losses of public resources. Massive accumulation of reserves created an opportunity to secure national monetary policy reform independence without any external funds from international resources including IMF funds. At the same time, interest rate liberalization has been put forward step by step, including eliminating or flexing ceilings and floors and innovating operational new tools that have been added to the tool-kit to be used in times where tailor made operations may be needed. From this perspective, interest rate transmission has been perfected gradually and progressively.

Furthermore, the central bank did not rush policies such as inflation targeting. By staying away from inflation targeting, falling into a single instrument transmission trap was avoided. Required reserves were kept aside as a supplementary tool and short term rates were changed when there was a permanent need, whereas temporary shocks were addressed with reserve policies. The central bank still has the option to use tailor made reserve policies by creating institution based rates or by creating regional or sectorial difference. For example, it may be possible to support residential investment in poorer regions without the help of preferential sector and institution based reserve levels.

The central bank may be regarded as the most development friendly central bank among major developing countries by directly helping to catch up annual development goals and by setting aside policies that help achieve growth targets. Not only in developed countries but also in developing ones, the role of central banks is under discussion once again--whether independence is the most secure? Is it best to support development through price stability only? Should there be direct responsibility for central banks to also be responsible for growth? This is a discussion that has been in China and little confusion exists around the dilemma, at least relative to other emerging countries. With a strong reserve level helping independent national monetary policy execution and with a comprehensive operational tool-kit composed of strong ammunition to fight back against national and international shocks, the central bank of China seems like well-positioned to face future challenges including financial liberalization and yuan internationalization.

Finally, one may argue that non-yuan ammunition for the central bank of China to conduct an efficient and effective monetary policy for welfare enhancement compares to no other emerging countries. Not only the direct impact of the very high level of foreign exchange reserves but also the indirect benefits of yuan internationalization help the central bank to execute a monetary policy that has no external limits or boundaries such as destructive side effects of dollarization or external funding needs of corporate China or import dependence of export. Under this situation, an independent monetary policy execution is possible without relying on external preferences such as the European Union bargains with South European countries. China does not need forced access to external money and capital market liquidity as urgently as most other emerging countries. Major commodity price movements or heightened financial volatility for one reason or another is relatively becoming not a major concern for growth at least from a comparative perspective. As an open economy for trade, of course global financial conditions will have an impact on the economic activity, but with the help of a comprehensive monetary policy operation framework from the central bank, it is obvious that the cost of managing these shocks will be much lower compared to many others.

The Four Comprehensives will help design a Xism to be used as a tool to analyze macroeconomic developments in China. For national and international China observers, this Xism will provide a common ground for targets and allow the measure of performance with aforementioned four criteria or areas. One of the institutions that is most ready for these targets is the central bank of China, as the current operational framework looks complicated but comprehensive. China's central bank has the tools to deal with almost all types of shocks to growth arising from local or national imbalances. Extreme external shocks may also be managed with very strong ammunition against that type of risks including massive amounts of foreign exchange reserves that is almost close to $4 trillion. The yuan internationalization including swap agreements with other central banks can only help.

One may wonder, what happens if an extreme global shock hits? I would argue that global governance structures necessary to address extreme events have not developed to a level that can satisfy. As Turkey has been leading the G20 initiatives and next year it will be China's turn, I am sure global decision makers will keep looking to develop better governance structures to address financial collapses and mitigate the risk controllably. There is hope at the end of the tunnel as communication quality within G20 has been increasing progressively. However, this doesn't mean there is no space for correction or further perfection.

On this road to find better ways to manage unavoidable extreme financial events that may prevent the realization of global potential rates, I believe there is a synergy that benefits China and Turkey mutually. We can only make sure that we can leave a better life quality to our children than the one we received from our grandparents if we can work together in a world that has been more and more interconnected. Xism and the Four Comprehensives increased transparency and accountability from China side, which will also help ease the burden of global macroeconomic developments. On this side, we can argue that it is a direct contribution for the G20 initiatives that tries to bring better global governance structures for all of us. China will benefit from this development next year when G20 meeting comes to Beijing.

The author is Economic Councellor of the Central Bank of Turkey

Copyedited by Kieran Pringle

Comments to zanjifang@bjreview.com


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