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A Framework for Independent Monetary Policy in China

  • Marvin Goodfriend
  • Eswar Prasad

As the Chinese 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. (JEL codes: E5 and P2) Copyright 2007, Oxford University Press.

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Article provided by CESifo in its journal CESifo Economic Studies.

Volume (Year): 53 (2007)
Issue (Month): 1 (March)
Pages: 2-41

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Handle: RePEc:oup:cesifo:v:53:y:2007:i:1:p:2-41
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  1. Maurice Obstfeld & Kenneth Rogoff, 1995. "The mirage of fixed exchange rates," Working Papers in Applied Economic Theory 95-08, Federal Reserve Bank of San Francisco.
  2. Eswar Prasad & Shang-Jin Wei, 2007. "The Chinese Approach to Capital Inflows: Patterns and Possible Explanations," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 421-480 National Bureau of Economic Research, Inc.
  3. 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.
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