China | Economics | Finance
Central banks increasingly use communication as a key lever of monetary policy. Gone are the days of ‘never explain, never excuse’, as put by the Governor of the Bank of England, Montagu Norman (1920–44). Today, central banks, especially in countries with developed financial systems, communicate regularly. This includes low-frequency communication about their policy frameworks and objectives, as well as high-frequency communication of views on current macro-economic conditions, forecasts related to output and inflation, and the rationale for policy decisions.
China’s unique institutional set-up
Compared with other public institutions, central banks are often at the forefront of communication. The People’s Bank of China (PBC) is no different. Over the past few years, it has strengthened its communication and is keenly aware of the heightened global interest in information about the country’s monetary policy. The increase in the number of press conferences and speeches has coincided with sharp stock market adjustments, changes to the exchange rate framework, interest rate liberalization, and greater financial market volatility in 2015–16. However, communication has not yet become as potent a policy tool as in many advanced economies (such as at the US Federal Reserve or the Bank of England) and some important emerging markets.
In many respects, China is at a communications crossroads, driven both by domestic and, increasingly, external factors. Compared with other central banks in advanced economies or emerging markets with modern policy frameworks, China’s central bank communication is more constrained. This is due to its unique institutional arrangements. In particular, China has multiple and overlapping objectives across institutions. The key constraints are as follows:
First, the PBC does not have full decision-making power over money supply targets and interest rate policy, and it has only limited operational independence at the monetary policy instrument level. Thus, the central bank is constrained in the information and forward guidance that it can convey. At the same time, the PBC drafts and executes monetary policy and has some operational independence, such as in setting short-term interest rates through open market operations, short-term liquidity operations, or rates on standing and medium-term lending facilities. However, key decisions need to be approved by the State Council (China’s equivalent to a government cabinet). Approval is needed, for example, for changes in the benchmark interest rate, reserve requirements, and the setting of annual monetary aggregates. For these key policy instruments, the PBC usually proposes policy plans when key economic indicators such as GDP growth and inflation deviate from the targets set at the beginning of each year by members of the State Council, who then review the plans and make the final decision. These members also regularly approve the wording of the monetary policy stance.
Second, monetary policy decisions are the result of consensus-building among various stakeholders. State Council members have a broad range of economic and financial sector objectives, and requests for monetary policy changes can be submitted to the State Council not only by the PBC but also by other ministries or agencies. From the central bank’s perspective, therefore, both the outcome and the timing of important monetary policy decisions are uncertain, limiting the PBC from providing forward guidance.
Third, China’s monetary policy has numerous objectives. The PBC is not an inflation-targeting central bank and its objectives go beyond price stability. As the previous PBC governor stated, ‘the annual objectives of the PBC mandated by the Chinese government have been maintaining price stability, boosting economic growth, promoting employment, and broadly maintaining balance of payments.’ These multiple objectives often involve trade-offs and reduce transparency.
As China’s monetary policy framework is increasingly moving from using quantitative targets to a more price-based framework, effective central bank communication is becoming even more important. While the process is not complete, the government in 2018 reiterated its commitment to deepen reforms to make both interest rates and the exchange rate more market based.
Following China’s integration into the global economy four decades ago and its accession to the WTO in 2001, developments are now taking place in its capital and bond markets. In this IMF study, 34 specialists including staff of the IMF, People’s Bank of China and China Securities Regulatory Commission analyze topics relating to China’s sovereign, credit, local government and green bonds, and examine potential measures to improve market liquidity, risk pricing and investment
The emphasis on quantitative targets has declined. Since 1994, China has had quantitative monetary targets. However, reflecting financial innovation and a rapidly changing financial system structure, its intermediate quantitative monetary target, M2, is correlated less and less with inflation and growth. In addition, the M2 outturn has deviated from the target over the past couple of years. As a further indication that emphasis on quantitative targets has declined, the 2018 Report on the Work of the Government (Annual Work Report) did not specify a specific target or projection for the monetary aggregate (M2) or for credit aggregates (such as total social financing). Compared to previous Annual Work Reports, this was an important step forward. Instead, the language was more vague: ‘Our prudent monetary policy will remain neutral, with easing or tightening as appropriate. We need to make sure that the value of M2 money supply, credit, and aggregate financing ensure a reasonable, stable level of liquidity.’
China’s monetary policy framework remains in transition and is currently a hybrid. On the one hand, despite formal interest rate liberalization, banks are still guided by corresponding deposit and lending benchmark rates; changes to these rates go beyond the authority of the PBC and require State Council consent. On the other hand, other policy rates, such as medium-term lending and the pledged supplementary facilities, as well as the use of instruments such as changes in required reserves, undermine transparency and complicate communication.
The empirical analysis suggests that while the PBC has made a number of important improvements to its communication, the timing for further strengthening communication and undertaking associated institutional changes is propitious.
Institutional changes take time and require resources and political capital. But as China develops its financial system, particularly market-based financing, the need for transparent, clear, timely, and comprehensive communication will continue to increase. Failure to address existing institutional shortcomings may limit the benefits of liberalization and slow economic development.
While larger institutional changes will take time, practical actions could improve communication in advance. In fact, these suggestions are better if implemented in advance of or at least in tandem with greater operational independence. For example, the Bank of England first published its Inflation Report in February 1993 when it did not have control over UK monetary policy. When it became operationally independent in June 1997, the central bank’s thinking and analytical tools were already well understood by the market. Lack of independence should hence not be viewed as a reason not to press ahead.
As a matter of fact, certain ‘low-hanging fruit’ could be implemented quickly:
• Making information available in a timely fashion, in one place, and in English: This would go a long way and would also be consistent with the intention to make capital markets more attractive, as well as with China’s participation in global forums, and its renminbi internationalization strategy.
• Expanding the PBC’s economic forecasting capacity and publishing forecasts regularly, as well as making information available about the associated framework and models: This would reduce surprises, making monetary policy more predictable. While the PBC’s Research Bureau released economic forecasts in 2015 and 2016, each with a mid-year update, these were discontinued in 2017. Of course, strengthening forecasting would require appropriate resources and expertise; here the PBC could tap into the experience of modern central banks, as well as technical collaboration with the International Monetary Fund.
• Holding regular press conferences: A regular communication mechanism could reduce information asymmetry between the central bank and the market and allow markets to better interpret decisions and hence reduce uncertainty. As with forecasting, it is useful to begin these efforts even in advance of greater operational independence. Such a process will help the PBC learn how to communicate with the market directly and to build credibility that will serve it well, if it is—as is warranted—to become operationally more independent.
Central banks are increasingly using communication as a lever of monetary policy and are often at the forefront of communication. The same is true for the PBC, which has taken important steps to improve communication. Given China’s global footprint and stated policies to further liberalize its financial system and continue moving toward price-based monetary policy, further improvements in communication will be critical.
This chapter assesses the impact of the PBC’s communication on financial markets using four types of communication: the quarterly published MPER, the quarterly released Minutes of the Monetary Policy Committee Meeting, press conferences and speeches by governors and deputy governors, and a novel channel, including informative OMO notices. The daily absolute change of several market interest rates in the money and bond markets, as well as equity market prices, are calculated to represent market reaction. They are regressed on PBC communication and control variables to estimate whether PBC communication affects market reaction and volatility.
The empirical analysis highlights that communication can have important benefits and that greater central bank transparency and independence would help further improve the PBC’s effectiveness, including through forward guidance. The introduction of OMO information notices, for example, reduced volatility and improved monetary policy effectiveness. While some institutional changes are likely to take time, some low-hanging fruit could be adopted in the short term. For example, providing timely information in one place (in Chinese and English), expanding PBC forecasting resources and capacity, and holding regular press conferences would not only be helpful for monetary policy, but also increase the attractiveness of China’s capital markets and advance renminbi internationalization.
In 2018, the PBC reiterated its commitment to further strengthen communication and transparency and has already taken additional steps, including through more press conferences and interviews, deeper analysis, and more informative MPERs to guide market expectations. In addition, at the end of 2018, the central bank set up a new working group to translate policy statements and news releases into English to better provide information to international investors ...
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