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A Framework for Independent Monetary Policy in China

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  • Marvin Goodfriend
  • Eswar Prasad

Abstract

As China's economy becomes more market based and continues its rapid integration into the global economy, having an independent and effective monetary policy regime oriented to domestic objectives will become increasingly important. Employing modern principles of monetary policy in light of the current state of China's financial institutions, we motivate and present a package of proposals to guide the operation of a new monetary policy regime. Specifically, we recommend an explicit low long-run inflation objective, operational independence for the People's Bank of China (PBC) with formal strategic guidance from the government, and a minimal set of financial sector reforms (to make the Chinese banking system robust against interest rate fluctuations). We argue that anchoring monetary policy with an explicit inflation objective would be the most reliable way for the PBC to tie down inflation expectations, and thereby enable monetary policy to make the best contribution to macroeconomic and financial stability, as well as economic growth. The management and monitoring of money (and credit) growth by the PBC would continue to play a useful role in the stabilization of inflation, but a money target would not constitute a good stand-alone nominal anchor.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/111.

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Length: 52
Date of creation: 01 May 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/111

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Related research

Keywords: Inflation targeting; Flexible exchange rates; Bank reforms; Central bank policy; Central bank role; Financial systems; Transition economies; Monetary policy;

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References

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  1. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
  2. Maurice Obstfeld & Kenneth Rogoff, 1995. "The Mirage of Fixed Exchange Rates," NBER Working Papers 5191, National Bureau of Economic Research, Inc.
  3. Corrinne Ho & Robert N. McCauley, 2003. "Living with flexible exchange rates: issues and recent experience in inflation targeting emerging market economies," BIS Working Papers 130, Bank for International Settlements.
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  5. Frederic S. Mishkin, 2000. "Inflation Targeting in Emerging Market Countries," NBER Working Papers 7618, National Bureau of Economic Research, Inc.
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  8. Harold L. Cole & Lee E. Ohanian, 2001. "New Deal policies and the persistence of the Great Depression: a general equilibrium analysis," Working Papers 597, Federal Reserve Bank of Minneapolis.
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  10. Eswar Prasad & Raghuram Rajan, 2006. "Modernizing China's Growth Paradigm," IMF Policy Discussion Papers 06/03, International Monetary Fund.
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  12. M. H. Khalil Timamy, 2005. "Debate," Review of African Political Economy, Taylor & Francis Journals, vol. 32(104-105), pages 383-393, June.
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  14. Morris Goldstein & Nicholas R. Lardy, 2004. "What Kind of Landing for the Chinese Economy?," Policy Briefs PB04-07, Peterson Institute for International Economics.
  15. Richard Podpiera, 2006. "Progress in China's Banking Sector Reform: Has Bank Behavior Changed?," IMF Working Papers 06/71, International Monetary Fund.
  16. Ronald McKinnon, 2006. "China's Exchange Rate Trap: Japan Redux?," American Economic Review, American Economic Association, vol. 96(2), pages 427-431, May.
  17. Alfred Broaddus & Marvin Goodfriend, 1996. "Foreign exchange operations and the Federal Reserve," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-20.
  18. Eswar Prasad & Qing Wang & Thomas Rumbaugh, 2005. "Putting the Cart Before the Horse? Capital Account Liberalization and Exchange Rate Flexibility in China," IMF Policy Discussion Papers 05/1, International Monetary Fund.
  19. Eichengreen, Barry, 2004. "Chinese Currency Controversies," CEPR Discussion Papers 4375, C.E.P.R. Discussion Papers.
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