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There is a target for money supply and the target currently 16% although it is actually running at below 16% So by controlling base money they are trying to control money supply and make sure that for this particular year it's 16%. There is a new concept, a concept that may not actually be used in other parts of the world which is the scale of financing in society, also given the Chinese original words here. In other words how much money you have for financing economic activity, not just through the banking channel, but also through the equity channel and the debt market, the three channels of financial intermediation. So they are also trying to target that particular amount. They also have new loans and interest rates, exchange rate is also a target but it is a very politicized matter now. But I would just like to point out lastly here the use of intermediate target, it's a rather delicate thing. There is a Goodhart's Law which says that as soon as you identify for example M2 as the intermediate target, because you think that M2 had a certain stable relationship with the economy that relationship breaks down simply because everybody acts to circumvent central banking action. That's Goodhart's Law and he is a very good friend of mine. OK? Quickly. Ah this is, you know a distinction between the socialist, market economy versus capitalist, free market economy. As I said the policy transmission mechanism is a lot more efficient because whatever the State Council says, the banks will just follow. Whereas in capitalist society for example in Hong Kong whatever the Hong Kong Monetary Authority says, and if it is not in its authority to say those things, you know in other words there is no law enabling the Hong Kong Monetary Authority to do certain things, they will just turn a blind eye to you. They won't listen to you, OK? But in a socialist market economy
OK? Ah. China pumped quite a lot of money. OK? Of course when they issue paper. That is why. central bank paper to what we call sterilize liquidity in the market and this actually is a chart showing the amount that they have been issuing. Well let's talk about policy instruments. You can take that away and study it if you are interested in central banking to those details. Anyway . look at the two financial crises that we have experienced. and in settlement you just credit you clearing accounts of your counterparties. Very well because as soon as the crisis erupted.these are rather technical things. China did extremely well.it's a lot different. when you sell and buy back. you buy things. So although the policy transmission mechanism is efficient. The People's Bank of China also issues bills. which is a lot less then in a capitalist free market society. That's because lending is done at the instruction of the State Council or the Party Secretary instead of allocated by the market. . because whoever should be getting money may not be getting money but whoever should not actually be getting money may get money. then you decrease base money and then increase it afterwards. that basically central banking. These are the mechanisms for conducting open market operations. 9 trillion for example in 2008. They have effects on the supply of base money these three and the price of base money all four of them have effect on the price of base money. the effect on base money. But of course I mean there is this problem about efficiency and resource allocation. whenever you want more money in the market. When you purchase something. which is a repo. And in terms of the first tool. which is the open market operation. Those on the left are the policy instruments open market operation etc. So that's one characteristics that we have. resources allocation is not necessarily efficient. the banks and then there will be more money in the market. 1997-1998 and then 2008-2009.
then you use the reserve requirement ratio. you know whereas in other market for example in the US treasury market it's by open auction and so the interest rate is actually determined by the market but in the case of the Mainland of China.5%. When you have exchange control. So it's a way of sterilizing that money so that you cannot actually mobilize that money for lending. etc. the reserve requirement ratio has been increased many many times and the latest number is 21. In doing that you are actually injecting money into the market you are creating Renminbi. OK? The reserve requirement ratio is another monetary policy tool. which again is a very inefficient way of operating because the banks. That is. the People's Bank of China would have to buy foreign currency. This has been increasing time and again partly because that there's been quite a lot of inflow of money into China. you know and they will be issuing paper at a high heel. for example. A policy indicator. interest rate ought to be going up. your account. with a lot of money. . depressing therefore. when they issue paper. you are crediting Terence's account. right? And in buying the foreign currency you have to provide the counter currency which is the Renminbi. interbank interest rate. If you were a bank and you have sold foreign currency to the People's Bank and you have received the Renminbi in your clearing account. Because there has been so much inflow. which is you know. and when there is inflow of money. And if the central bank does not want that interbank interest rate to be depressed. you have more and more money in your clearing account. they tend to give a bit of guidance as to what the interest rate ought to be and so this sometimes has also been used as an indicator for policy. a ratio that relates the amount of money in your clearing account with the amount of deposits that you have.they issue at a particular interest rate that can also be used as an instrument for pushing interest rates high. And you would tend to lend that money out.
5%! So how would the banks earn any money? It's very difficult and so if the banks want to make a profit. None. equivalent to 21. OK if I were to lend to Terence you know 100 million OK your clearing account I would add 100 million.in other words. particularly with exchange controls.62%. there is no need for reserve requirement. you know how much are they paying on one year Renminbi deposits for customers? 3. Central bank lending as one tool that is described on the website of the People's Bank of China but it is not frequently used because you know the central bank would be able to inject money into the market if the central bank is to lend to a commercial bank a sum of money. then other assets will have to earn much higher rate of return. And in Hong Kong for example we don't have reserve requirement at all. you need to sterilize the inflow or the injection of money as a result of the inflow of foreign currencies then you need reserve requirement ratio. Bank loans for example would have to charge a pretty high interest rate. But then the central bank would be incurring credit risk of Terence. So he would have 100 million more and the inter-bank market would have 100 million more and therefore interest rate might come down as a result. are holding reserves in its clearing account with the People's Bank of China. OK? Now and they are only earning how much? 1.5% of the deposits that they have. But when you have that sort of a system. Not that they don't have any confidence in the banking system . On the other hand the liabilities. deposits for example. But this is now a rather mechanical tool used for the purpose of sterilization rather than being used as a signal for tightening or easing. OK? So over 20% of their assets are only earning 1. OK? That's a chart showing how it has increased over time.62%. So that actually introduces inefficiency in the banking system. And that actually is something that any central bank would feel uncomfortable.
OK? Interest rates. Governor Zhou of the People's Bank of China has always been talking he's been talking for a long time about interest rate liberalization. a rediscount rate and they pay interest on reserves they pay interest on excess reserves. moving in that direction. In other words. that is the tool and the People's Bank of China is actually in a position to determine quite a lot because the interest rate environment is still very much a controlled environment. That is a rather extensive way of controlling interest rate unlike other jurisdictions. There has been a lot of emphasis on the use of the interest rate tool and I have just outlined some of the statements that have been made. because obviously of the inclination of market economy to use the market in making sure that at whatever the level of interest rate. They have a relending rate. they want to move to a system in which they have just a few. there's an efficient allocation of resources. which is the level of the short-term interbank rates. No no these are the deposit and lending rate for financial institutions. The deposit and lending interest rates are also sort of fixed. kind of like the Federal Reserve Bank. You commercial banks determine your lending and deposit rates and leaving the central bank . OK? And they will also control the maturity structures of various interest rates. But for customer deposits and lending rate to customers they determine a floor for lending rates and a cap for deposit rates. or one policy rate and then allow other interest rates to adjust as a result of any adjustment in the policy rate. but unfortunately the market has not been sophisticated enough for that sort of a system to be implemented. But China is moving in that direction. in the US for example there is one interest rate that the Fed aims to control which is the Fed Funds Target Rate.but then indirectly. the central bank would actually be providing money to a commercial bank. Oh these are the current interest rates. kind of like the ECB.
unlike the situation in the US or in Europe. For example this is the overnight rate.only to determine the policy rate. you know they fluctuate so widely. He's trying to move in that direction but unfortunately the progress is actually quite slow. . If you look at these interest rate charts. and even the 3-month rate have been so volatile. 1-month rate. Of course overnight rate tends to be volatile but look at this. The 1-week rate. But they are moving towards a liberalizing interest rate and concentrating on producing a policy rate for the purpose of monetary policy.
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