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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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Keywords: Inflation targeting; Flexible exchange rates; Bank reforms; Central bank policy; Central bank role; Financial systems; Transition economies; Monetary policy; inflation; central bank; low inflation; inflation objective; foreign exchange; independent monetary policy; aggregate demand; money growth; monetary fund; monetary base; reserve requirements; price stability; rate of inflation; financial stability; inflation rate; open market operations; inflation target; monetary policy independence; monetary transmission; macroeconomic stability; monetary policy regime; reserve requirement; transmission of monetary policy; money supply; reserve positions; government securities; price level; macroeconomic performance; actual inflation; inflation rates; rising inflation; monetary economics; liquidity management; monetary transmission mechanism; monetary policy implementation; rediscount rate; monetary policy instruments; monetary policy instrument; money market; wage inflation; inflation targeting regime; high inflation; government securities market; monetary aggregates; real interest rates; monetary policy decisions; monetary targets; discount rate; relative prices; monetary policies; low rate of inflation; changes in prices; monetary policy framework; stable prices; treasury securities; monetary policy operations; monetary frameworks; stock market crash; nominal interest rate; treasury bonds; foreign currency; real rates; high interest rates; measure of inflation; fall in inflation; restrictive monetary policy; monetary stabilization; inflationary pressures; monetary policy transmission mechanism;

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References

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  1. Franklin Allen & Jun Qian & Meijun Qian, 2002. "Law, Finance, and Economic Growth in China," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 02-44, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Frederic S. Mishkin, 2000. "Inflation Targeting in Emerging-Market Countries," American Economic Review, American Economic Association, American Economic Association, vol. 90(2), pages 105-109, May.
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  15. corrinne ho & robert n mccauley, 2004. "Living with flexible exchange rates:," International Finance, EconWPA 0411003, EconWPA.
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  19. Marc Zelmer & Andrea Schaechter & Mark R. Stone & Alina Carare, 2002. "Establishing Initial Conditions in Support of Inflation Targeting," IMF Working Papers 02/102, International Monetary Fund.
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