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Unconventional Monetary Policy

Unconventional Monetary Policy refers to the tools that help the recovery of the economy and the return of inflation when there are concerns of deflation (or current deflation) during the period when the interest rate is zero. The two types of unconventional monetary policy tools include large bank asset purchases and central bank communication.

China

China has unique characteristics that support the usage of monetary policy as their tool for rapid growth.

·       High Savings, High Investment, and Rapid Growth

·       Bank Dominated Financial Sector

·       Huge Monetary Stock

·       Semi-economic Agents

·       Home Bias in Capital Flow

The five unique characteristics push the central bank of China to implement the “special” unconventional monetary policies.

People’s Bank of China is the central bank in China with the power to formulate and implement monetary policies and promote economic stability and managing inflation, deflation, and interest rates. The PBOC along with the State Council has the responsibility to impose monetary policies during high asset bubbles to stabilize the economy and promote financial stability. The PBOC’s implementation of unconventional monetary policy has three objectives:

·       To maintain price stability

·       To maintain long term sustainable growth

·       To maintain the stability of the system

As China is considered a place that is more “volatile” in its stock market than the US, the People’s Bank of China needed to ensure that its commercial loan financing was focused on controlling and monitoring the banks to not exceed their limits of lending.

Quantitative Easing

The Central bank can choose to implement one of the unconventional monetary policies, Quantitative Easing, by buying government bonds to inject liquidity into the economy when the interest rate is too close to zero. The purchase of bonds creates new money into the banking system promoting lending and economic activities. During the 2007 financial crisis, large asset purchases lowered long term interest rates. For example, the Federal Reserve in the United States bought $880 billion of assets leading to the advances of banks, financial firms and instruments. Five years later, the total asset value reached $4 trillion, increased more than four times the initial value during the crisis and keeping the interest rate close to zero bound.

Argument

Quantitative Easing and Conventional Monetary Policy does not work in China. As of January 2019, there is currently no specific quantitative easing policy adopted by the Chinese government and central bank. Rather, the Chinese leadership has a traditional way of pumping liquidity into the banking system. Everbright Securities economist, Xu Gao, claims that the purchase of bonds or stocks by the central bank and the conventional monetary policy works in European countries and Japan, but not in China. China has experienced a bankroll state spending period in the 1990s that lead to state-owned enterprises accumulating 200 billion yuan of debt. Since then, China imposed Central banking law that bans PBOC from buying government bonds. Instead, PBOC has created their version of bond purchasing that helps Beijing in meeting the goals:

-         Alleviate Debt and Repayments

-         Rollover existing debt

o  Short Term Bank Loans

§  Long Term bonds with low-interest rates

Former PBOC governor, Zhou Xiaochuan criticizes quantitative easing will make the US dollar stronger and increase capital flow into US markets. For the rapid growth and recovery of China after the 2007 financial crisis, the Chinese government increased social financing to control liquidity.

Forward Guidance

Central Bank Communication is the second type of unconventional monetary policy that the central bank takes to control the uncertainty during the financial crisis. Central Bank Communication is split between two different forms: written communication and oral communication. Written communications are published by Monetary Policy Committee (MPC) which is also called the content analysis where they are split into three types: tightening, neutral, and easing which gives different effects during a high asset bubble period. As for oral communication, communication events are based on the narrative approach that the current People’s Bank of China governor and deputy governors, paying attention to the transformation points of the monetary stance. Blinder et al. claim that creating news and informing the citizens were a way to reduce noise and control the financial stability and macroeconomic outlook. For example, in China, decision making transparency has positive effects the first year but starting the second year the central bank communication had a decline of response due to the implementation of forwarding guidance.

In the long term, the effect of central bank communication is higher than the effects of large monetary asset purchases in china. The Chinese version of Quantitative Easing isn’t sustainable in controlling asset prices in the long term. In the long term, central bank communication can be the guidance from the government to its investors and citizens about the next steps and current conditions on inflation. A key factor in China’s rapid recovery is the central bank’s effective guidance in investment expectations and monetary policies.

Argument

Central bank communication doesn’t work in countries like United States. American economist, Benjamin M. Friedman, believes that by comparing the two forms of unconventional monetary policy, the Central Bank account asset purchases (even with policy interest rate at or near zero) was more useful than influential public statements that will impact further monetary actions. He argues that there is never full transparency of monetary policy that will fulfill market satisfaction, while asset purchases will open market operations for the increase in reserves.

Challenges

China’s monetary policies will face challenges in the future. The director of the Center for China in the World Economy (CCWE), David Daokui Li, argues that the Chinese monetary policymakers along with other policymakers will face these challenges if there isn’t any close communication and collaboration with each other. China needs to be able to implement projects promptly, implement their reforms, and control interest rates to achieve the economic goals.