Monetary Policy of Central Bank of China - Statistics Project Example

Monetary Policy of Central Bank of China Contents Introduction 3 Discussion 3 Unemployment 3 Dynamics of Inflation 4 Trade and Exchange Rate 5 Monetary Transmission Mechanism and Aggregate Demand 6 Short Term Prediction for People’s Bank of China 8 Reference List 9 Introduction Monetary policy is defined as the systems and postulates through which government and central bank of an economy tends to control the economic activities and all the macroeconomic variables. In the post 2008 period, the structure of global economy has changed drastically due to the aftermath of great recession and financial crisis. In this paper, the functioning of the Central Bank of China, known as the People’s Bank of China will be discussed in order to monitor how the central bank has managed all the macroeconomic variables of the country efficiently, especially in the post- 2008 period (Hammond, Kanbur, and Prasad, 2009). Discussion Unemployment The unemployment rate of China is moderate with an average rate of 4.7%-4.9%. The central bank of China puts substantial effort to keep the unemployment rate under control, even at a cost of slower economic growth. The unemployment rate is 4.1% as on 2014. Figure 1: Movement in Unemployment Rate in China since 2008 to Present (Source: The World Bank, 2015) In 2010, the census observed that the population is rapidly aging as a result of one child policy imposed by China Government. Hence, the policy makers expected that the demand from the labour market in order to replace the aging labour force will improve the employment ratio of the country. However, it has been observed that due to the existence of acute level of corruption and political unrest a large part of the young population with sound technical and professional knowledge base are immigrating to other countries for protecting their future. As per the statistics of 2014, almost 10 million Chinese moved to the developed western countries deliberately, keeping the actual unemployment rate of the country at an ambivalent stage. Therefore in order to mitigate the problem, the People’s Bank of China along with the government of the country has decided to slowdown the economic growth in order to improve the rate of unemployment. In fact, the policymakers are of the opinion that the economy is ready to accelerate the employment rate at the expense of 7.5% economic growth as well (Haacke and Preston, 2013). Dynamics of Inflation Figure 2: Movement in Inflation Rate in China since 2008 to Present (Source: The World Bank, 2015) Inflation is a constant problem in China. Hence, the central bank of the country has to monitor the level of money supply in the economy and the level of inflation in a continuous basis so that the inflation rate can be kept in control. During the period of 2007, the inflation was approximately 7% which was expected to grow upto 8.7% till 2008. Inflation was most prominent in the food price segment which had shown a sharp increment of 18.2% during the time period. In order to control the situation and stabilize the price level, the central bank of China imposed strict restrictions on the activities of manufacturers and wholesalers in order to control hoarding and cheating. In spite of all such efforts, the inflation touched all time high at 7.1% in January 2008. The inflation even increased upto 8.7% in the next month of the year and combining with the inflationary pressure, the effect of severe winter storm resulted in excessive food shortage. Nevertheless, in order to recover the country from the unfavourable situation, the central bank adopted continuous sterilization of money supply. Sterilization is an instrument of monetary policy through which the central bank controls capital inflow and money supply in the economy in order to keep check on inflation. Such an attempt taken by the central bank successfully safeguarded the economy from the grasp of inflation. During the period of November 2010, the level of inflation reduced to 5.1% whereas the food inflation decreased up to 11.7% from the previous years. Currently, it is hovering around 2%-2.5%. Trade and Exchange Rate International trade contributes a sizable portion towards the growth of China Economy. China is engaged in import and export activities with a number of European and Asian countries. As the effect of 2008 financial crisis affected the western countries more severely, this reflected in the volume of international trade of China as well. During 2007-2008, China’s international trade decreased to $2.17 trillion. The People’s Bank of China intervened into the situation and changed the direction of international trade and influenced the economy to engage in trade more with Asian countries. Rather than depending upon big economies such as the United States and United Kingdom, China tapped lucrative business opportunities in the emerging nations such as, India, Korea, Brazil and Pakistan. Gradually, the volume of international trade started increasing due to the central bank’s modulation in the monetary policy regarding international trade (Liao and Tapsoba, 2014). In fact, when the large economies started recovering, expanding avenues for China again to involve into trading relationships, the economy of China again engaged into trade with the western countries. This is reflected when the volume of trade exceeded $4.16 trillion in 2013. Figure 3: Movement in Exchange Rate in China since 2008 to Present (Source: The World Bank, 2015) From the above graph, it is evident that high level of fluctuation in the exchange rate of China immediate after the financial crisis of 2008 significantly hampered the acceleration of international trade. However, imposition of strict control on the floating exchange rate system as well as current and capital account, the People’s Bank of China successfully managed the volatility in exchange rate through monitoring and controlling inflation and interest rate of the country. Since 2008 the degree of volatility has sharply decreased as a result of sound modulation of monetary policy by the central bank of China, broadening the path of international trade for the economy (Li, 2011). Monetary Transmission Mechanism and Aggregate Demand Monetary transmission mechanism signifies the functioning through which interest rate changes are executed to rectify the existing rate of inflation and the level of aggregate demand in the economy. In general, as the interest rate increases, the individuals’ propensity to save becomes very high, reducing the disposable income in the economy. Therefore the aggregate demand of the economy decreases due to tightened money supply within the economy (Sun, 2011). Such transmission of interest rate is controlled by the central bank of the economy and the People’s Bank of China has been successfully conducting such functioning for diminishing inflationary pressure and encouraging economic growth since 1984. However, during the post recession period, when the inflationary pressure tended to suppress the economic growth, the central bank of China took the initiative for running open market operations and influenced the commercial banks of the country to increase their reserves in order to control money supply in the economy of China (Lardy, 2012). Figure 4: Movement in Interest Rate in China since 2008 to Present (Source: The World Bank, 2015) Consequently, the ceiling of maximum deposit has been increased by the People’s Bank of China. The central bank also enhanced the interest rate during the period of 2008-2009 so that the commercial banks do not face any difficulty to meet their reserve requirement (Hammond, Kanbur and Prasad, 2009). Once the inflation has been controlled by this transmission mechanism, the central bank again tightened the interest rate in 2010-2011. In this way, the money transmission mechanism has been executed by the central bank of China, especially during the post recession period. Aggregate demand was also affected through such random changes in the transmission mechanism by the People’s Bank of China. When the central bank reduced the interest rate during 2010-2011, the level of money supply also increased in the economy, enhancing the disposable income of the individuals. As the disposable income increases, the economy tends to engage more into international trade. Purchasing power of the citizens also increased which in turn increased the aggregate demand to a great extent. Conversely, the central bank again increased the interest level in 2012-2013, in order to control inflation rate which had drastically increased during the previous couple of years, as a result of less tightening of monetary policy. Consequently, money supply in the economy decreased, decreasing the purchasing power of the individuals. Therefore, the aggregate demand reduced as an immediate consequence of such formulation of monetary policy. Short Term Prediction for People’s Bank of China Figure 5: Prediction for Decreasing Interest Rate and Increasing Inflation (Source: The World Bank, 2015) Considering the short term predictions for People’s Bank of China, during the first and second quarter of 2015, it is expected that the central bank will explore new sources of cheap cost of credit for stimulating the scope for investment and thereby accelerating economic growth. In order to achieve that, the central bank is predicted to lower the interest rate for augmenting national disposable income. As the inflation is already low at 2% in 2014, keeping the food and oil prices at a lower side, the level of inflation is expected to show a moderate rate in the next two quarters as a result of increasing money supply. As the aggregate demand will increase due to increase in disposable income and purchasing power, it is justified to infer that the central bank is expecting to experience supply boom in short run and formulating the short term monetary policy accordingly. Reference List Haacke, J. and Preston, P., 2013. Contemporary China: The Dynamics of Change at the Start of the New Millennium. London: Routledge. Hammond, G., Kanbur, S. M. R. and Prasad, E., 2009. Monetary Policy Frameworks for Emerging Markets. Cheltenham: Edward Elgar Publishing. Lardy, N. R., 2012. Sustaining Chinas Economic Growth After the Global Financial Crisis. Washington DC: Peterson Institute. Li, Y., 2011. Economic Reform and Development in China. Cambridge: Cambridge University Press. Liao, W. and Tapsoba, S. J., 2014. China’s Monetary Policy and Interest Rate Liberalization: Lessons from International Experiences. Washington DC: International Monetary Fund. Sun, L., 2011. Monetary transmission mechanisms and the macroeconomy in China: VAR/VECM approach and Bayesian DSGE model simulation. College of Social Sciences, 1(1), pp. 20-62. The World Bank, 2015. Data. [Online] Available at: [Accessed 17 March 2015]. Read More