Explain the logic of monetary policy regulation in detail! "Getting interest rates and exchange rates right is key", Yi Gang published an article on economic research | People | Interest rates

The 6th journal of Economic Research in 2023 published a paper by the Governor of the People's Bank of China, Yi Gang, titled "The Autonomy, Effectiveness, and Economic and Financial Stability of Monetary Policy.".

Yi Gang provided a framework description of China's monetary policy regulation in the article, and explained the basic logic and operational mechanism.

The key to maintaining stable economic operation and suppressing systemic financial risks at the macro level is to ensure the correct interest rates and exchange rates. Yi Gang emphasized that interest rate policy and exchange rate policy are not parallel, and interest rates are the core and core. Exchange rates are formed by the market under the influence of interest rate policy.

Yi Gang pointed out that monetary policy regulation should first prioritize domestic goals and choose optimal policies such as interest rates to achieve domestic goals. Secondly, it is necessary to create a favorable environment so that exchange rates are determined by the market.

Under the above train of thought, unlike the monetary policy operations of major developed economies, such as significant interest rate adjustments, China's monetary policy operations adhere to the principle of "self centeredness", with a significant increase in autonomy and effectiveness. On the basis of fully considering various uncertain factors such as economic operation and policy effects in regulation, emphasis is placed on cross cycle regulation and cross regional balance. While smoothing out short-term economic fluctuations and maintaining price stability, the actual interest rate should be kept at the golden rule level of approximately equal to the potential economic growth rate, so as to match the interest rate level with the requirements of potential economic growth and maintaining basic price stability.

Yi Gang stated that overall, China's monetary policy regulation has been relatively proactive, with relatively stable and low-cost autonomous monetary policy operations, maintaining the stability of the economic and financial system, responding to multiple shocks from both internal and external sources, achieving good regulatory effects, and promoting high-quality economic development.

Monetary policy is "self centered"

Yi Gang pointed out that the core of monetary policy is to regulate interest rates, that is, to regulate interest rates at a level conducive to the stable operation of the economy and the basic stability of prices. Short term interest rates are mainly determined by the central bank, while long-term treasury bond yields are mainly determined by the market.

Yi Gang stated that in recent years, China's monetary policy regulation has shown obvious characteristics:

One is that monetary policy is "self centered", mainly adjusting based on the domestic macroeconomic and price situation, and has always been relatively proactive, demonstrating stronger autonomy.

Secondly, compared to the significant changes in interest rates in major developed economies such as the Federal Reserve, China has generally adhered to a prudent operating philosophy in monetary policy regulation. Interest rates are moderate and relatively stable, and there is relatively cautious and room for improvement in both tightening and loosening directions.

Yi Gang pointed out that since 2018, there have been roughly three instances of significant asynchronous economic cycles between China and the United States. China has adjusted its monetary policy according to its own regulatory needs, and there has been a clear differentiation in the pace and magnitude of its monetary policy regulation compared to the United States:

One is during 2018. After maintaining a relatively long range of zero interest rates, the United States began a rate hike cycle in 2015, with the Federal Reserve raising interest rates four times in 2018, totaling 100 basis points.

"Considering the intensification of trade frictions between China and the United States, as well as the credit contraction caused by domestic 'several encounters', we did not follow the Federal Reserve in raising interest rates simultaneously." Yi Gang stated that China's 7-day reverse repurchase rate remained unchanged after a slight increase of 5 basis points in early 2018, and began to take countercyclical adjustment measures such as reducing the reserve requirement ratio at the beginning of the year, guiding the money market interest rate to moderately decline. Looking back, these measures have a certain foresight and played an important role in early response to the downward pressure on the economy.

Second, after the COVID-19 outbreak in 2020. In response to the rare impact of the epidemic, the Federal Reserve quickly and significantly reduced interest rates by 150 basis points until returning to zero interest rates. Comparatively speaking, during the same period, the 7-day reverse repurchase rate of the People's Bank of China only lowered by 20 basis points and remained stable. The initial decline in the money market rate was relatively more, but it gradually returned and remained stable after the economy gradually stabilized.

Thirdly, since 2022. In response to the unexpected rebound in inflation, the Federal Reserve quickly raised interest rates and scaled back its balance sheet, raising interest rates ten times in a row to 500 basis points, making it the fastest pace and steepest rate hike curve in its history. Many emerging market economies have also begun to tighten their monetary conditions in response to high inflation and capital outflows.

"In order to help stabilize the macroeconomic situation and support real economic growth, since 2022, we have not only not followed the interest rate hikes, but also timely and moderately reduced interest rates according to regulatory needs. The central bank's 7-day reverse repurchase rate has decreased by 30 basis points, and the monetary market has declined even more. We have guided the one-year and five-year loan market quotation rates to decrease by 25 basis points and 45 basis points respectively, and the loan rates have dropped to historically low levels." Yi Gang pointed out that while maintaining a moderate total amount, we have also adopted structural monetary policy tools to guide funds to provide financial support to key and weak links such as small and micro enterprises and technological innovation in a market-oriented manner. In 2022, China's CPI inflation was 2%, and the average annual CPI inflation in China from 2013 to 2022 was 2%.

Grasp three key points in exchange rate reform

Yi Gang stated that continuously deepening the market-oriented reform of the RMB exchange rate formation mechanism is a reform strategy continuously promoted by the People's Bank of China. In the reform of the exchange rate mechanism, the People's Bank of China focuses on grasping the following points:

One is to continuously enhance the role of the market, which determines the exchange rate of the RMB based on market supply and demand. Macroprudential management and capital controls will be used to make adjustments at marginal and individual time points, but overall, 80% -90% are determined by the market.

The second is to give the people the freedom to exchange foreign currency. Currently, the annual convenience quota of $50000 per person can basically meet the needs of tourism, family visits, and study abroad tuition fees.

China implements current account convertibility, and individuals who purchase or settle foreign exchange under current accounts exceeding the limit can apply at the bank with relevant transaction authenticity proof materials. At the same time, private enterprises should be granted freedom in foreign exchange purchase and settlement through free trade, as well as a certain degree of freedom in investment. From statistical data, in recent years, more than 80% of residents have purchased foreign exchange with a scale of less than $40000 per year, and less than 1% have exceeded the quota of $50000. This indicates that the convenient foreign exchange purchasing needs of individual residents can be fully met.

In the past decade, the proportion of cross-border revenue and expenditure of private enterprises to the total cross-border revenue and expenditure of non-financial enterprises has been increasing year by year, reaching 52% in 2022. The surplus of cross-border revenue and expenditure of private enterprises has also increased from 60 billion US dollars to 400 billion US dollars, mainly due to the rapid growth of net inflow of funds under trade items of private enterprises.

The third is to provide the public and enterprises with as much freedom of exchange as possible, while not committing to capital account convertibility and maintaining the option of capital control in extreme situations.

Yi Gang stated that the above policy combination can not only meet the demand for foreign exchange funds in the market, but also create a "real" exchange rate for market supply and demand. It also adheres to the bottom line thinking and can maintain the bottom line of avoiding systemic risks in extreme situations. At the same time, it is also conducive to maintaining the overall stability of per capita GDP denominated in convertible currencies.

Moderate interest rates and exchange rate levels mutually support each other

Yi Gang pointed out that after the outbreak of the international financial crisis, China expanded domestic demand, especially investment demand, which alleviated the downward pressure on the economy caused by the contraction of external demand, but there were also risks of rapid rise in debt leverage, overcapacity and asset foam. In fact, if there is excessive investment in the economy, the marginal return on capital will decrease, the real interest rate will be lower than the potential growth rate, and consumption will be sacrificed to increase investment.

"In the environment where many other countries and economies implement ultra loose monetary policies such as zero interest rates, we have been relatively modest in interest rate policies, and adhere to maintaining normal monetary policies, especially the interest rate policy range, in order to prepare for a rainy day and try to prevent excessive investment and other tendencies." Yi Gang said that just based on the judgment that the mode of promoting economic growth by excessive investment and debt expansion is difficult to sustain, policy makers made it clear that they would not engage in strong stimulus, but rather combine the implementation of the strategy of expanding domestic demand with the supply side structural reform, and actively implement a series of measures to stabilize leverage, adjust the structure, and curb foam, especially emphasizing support for the real economy and scientific and technological innovation, and guiding funds to "get rid of the false".

From the actual situation, adhering to the implementation of normal monetary policy and moderately playing the role of structural monetary policy tools have effectively supported the development of the real economy and the stability of the macroeconomic situation.

In addition, Yi Gang believes that China's good control over inflation has enabled the People's Bank of China to implement corresponding macroeconomic policies based on its own economic cycle in recent years, regardless of changes in the external environment, thereby stabilizing the market determined RMB exchange rate.

Since 2019, the exchange rate of the Chinese yuan against the US dollar has repeatedly broken below 7, and soon returned to below 7. The market expectation is generally stable, and there has been no unilateral expectation in the foreign exchange market. Yi Gang believes that this is due to the timely release of pressure through a flexible exchange rate mechanism, which functions as an "automatic stabilizer". It is also supported by China's low inflation environment, and the formation mechanism of the RMB exchange rate is becoming more mature and healthy.

The potential economic growth rate in the future is expected to remain within a reasonable range

Yi Gang pointed out that in the next step, in order to continuously enhance the autonomy and effectiveness of monetary policy, and achieve long-term economic and financial stability, efforts should be made to do the following:

One is to maintain a moderate total amount, adhere to the implementation of a prudent monetary policy, and ensure that monetary conditions match the requirements of potential economic growth and basic price stability.

Do a good job in countercyclical and cross cyclical regulation, balance short-term and long-term, economic growth and price stability, internal and external equilibrium, grasp the strength and rhythm of monetary policy regulation, adhere to not engaging in "flood irrigation" and not exceeding the issuance of currency, and provide stronger and higher quality support for the real economy. In the future, China's potential economic growth rate is expected to remain within a reasonable range. If conditions permit, it is advisable to maintain a normal monetary policy, maintain a positive interest rate, and maintain a normal upward slope yield curve shape. Give full play to the role of structural monetary policy tools and increase financial support for key areas and weak links of the national economy.

The second is to deepen reform, continuously promote the marketization of interest rates and exchange rates, and prioritize internal and external balance.

Continue to improve the market-oriented interest rate formation, regulation, and transmission mechanism, improve the central bank policy interest rate and interest rate corridor mechanism, stabilize market expectations, and promote the reduction of comprehensive financing costs for enterprises. Steadily deepening the market-oriented reform of the exchange rate, adhering to the improvement of a floating exchange rate system based on market supply and demand, with reference to a basket of currencies for adjustment and management, enhancing the flexibility of the RMB exchange rate, strengthening expectation management, adhering to bottom line thinking, doing a good job in monitoring and analyzing cross-border capital flows and risk prevention, maintaining the basic stability of the RMB exchange rate at a reasonable and balanced level, and better playing the role of the exchange rate as a macroeconomic and international balance of payments automatic stabilizer.

The third is to strengthen policy coordination, continuously improve the macro prudential policy framework, and prevent and resolve financial risks.

Playing a unique role in the financial system, especially in specific financial fields, by leveraging macroeconomic prudential policies can directly enhance the monitoring, assessment, and early warning capabilities of systemic financial risks, enrich and improve the toolbox of macroeconomic prudential policies, take measures from macro, countercyclical, and anti contagion perspectives, prevent systemic financial risks, and promote the achievement of the dual goals of price stability and financial stability. Strengthen and improve modern financial supervision, with shareholders, local governments, regulatory departments, and central banks each fulfilling their respective responsibilities, and building a risk disposal mechanism that is consistent in rights and responsibilities and compatible with incentives. Strengthen the coordination and coordination between monetary and fiscal policies, implement an independent financial management system of the central bank, achieve a healthy and sustainable balance sheet of the central bank, ensure the lawful performance of the central bank's duties, and maintain currency and financial stability.