Interest Rate Liberalization And Reform Of Monetary Policy Framework

Since January, lth,1998PBC (People’s Bank of China) had abandoned controlling scale of loans and had constructed quantity-oriented monetary policy framework. However from the monetary policy practice for the last decade, there are still a lot of problems existed. Firstly the controllability and correlation of intermediate target of monetary policy is not robust, thus the effectiveness of money supply as an intermediate target is becoming more and more doubtful. Secondly, with the constant change of social financing structure in China, the traditional quantity instruments (for example, controlling scale of loans, adjusting deposit reserve ratio) cannot efficiently regulate and control direct financing and off-balance-sheet financing, their functions are becoming weaker and weaker. More importantly, Chinese economic growth mode has been shifting from pursuing speed to guaranteeing quality. In the past decades, investment and export was the main engine of Chinese economy. However the extensive economy growth mode, which depends on capital and resource, has becoming more and more unsustainable. Improving the pricing mechanism of production factors, especially fund, will be an important field in next round market-oriented reform. However, the deregulation of interest rate does not mean giving up the managment of interest rate. Based on international experience, the monetary policy framework of major developed economies had gone through the process of transition from quantity-oriented one to price-oriented one along with interest rate liberalization. In September,2012, the12th Five-Year Plan of Development and Reform of Finance Industry stated that strengthening the effect of price leverage such as interest rate, exchange rate gradually to promote the transformation of monetary policy framework from quantity-oriented one to price-oriented one. Building the price-oriented monetary policy framework with the process of interest rate liberalization embodies the spirit of the Decision of the3rd Plenary Session of the18th Central Committee of the Communist Party of China (CPC) that "the core solution of economic reform is the proper relationship between the government and the market, leaving the market to play the decisive role in allocation of resources." This paper starts from theory review and international experience reference and studies the relationship between interest rate liberalization and monetary policy framework reform. Then it sets out the aim of monetary policy framework reform regarding China’s actual conditions. Using Chinese data, it conducts empiriacal studies to test whether China’s benchmark interest rates system has formed and whether China’s interest rate transmission mechanism is efficient to answer the question whether China has equipped with basic conditions for the price-oriented monetary policy framework. Based on this, it builds a DSGE model incorporating "dual track interest rates" to estimate the equilibrium rate in China to answer the question how to operate in a price-oriented monetary policy framework. At last, it gives advices on the reform path of China’s monetary policy framework. This paper’s main innovation points are as follows:(1) This paper reviews the transformation history of monetary policy framework during the process of interest rate liberalization in both developed countries such as America and German and emerging marketing economies such as Japan and Korea. Based on this, it studies the relationship between interest rate liberalization and monetary policy framework reform in depth. It concludes: Firstly the monetary policy framework needs to be transitioned to price-oriented one after interest rate liberalization; Secondly the change of social financing structure is one of the most important reasons of monetary policy framework transformation; Thirdly interest rate liberalization is the necessary not the sufficient condition of monetary policy framework transformation; Fourth monetary policy framework transformation is a gradual process.(2) This paper reviews the developing history of Chinese monetary policy framework and studies the background and reasons of two rounds monetary policy framework reform in China. Based on international experience and China’s actual conditions, this paper sets out the aim of monetary policy framework reform that insists on the framework of multiple goals and multiple instruments, while transforms from quantity-oriented one to price-oriented one gradually.(3)This paper conducts an empirical test on whether the benchmark interest rate and benchmark yield curve can serve as the pricing benchmark of financial markets in China by time-varying parameter model. It concludes:Firstly, except for deposit rate regulation, the main impediment for SHIBOR or Repo becoming short-term benchmark rate is their high volatility which make them difficult to stabilize the market expectation; secondly, the leading effect of treasury yield curve is relatively weaker in long term than in short term which has hindered the treasury yield curve to become the long term pricing benchmark of financial markets in China.(4)This paper sets up a corporation investment decision model including financing constraints and conducts an empirical study on the influence of financing constraints and financing cost on corporation investment decision which uses the data from listed companies’ financial reports. It concludes:Firstly, the state-owned companies and private companies are both sensitive to financial constraints while the private companies are compatatively more sensitive; secondly, the state-owned companies are insensitive to financing cost which is the main factor obstructing interest rate transmission mechanism in China.(5)This paper introduces "dual track interest rates" which is the peculiar institution distortion factor in Chinese finance system into the new Keynesian analytical framework to build a DSGE model including family, enterprises, banks and the Central Bank, estimates the equilibrium interest rate from the second quarter of1998to the third quarter of2012. The result shows that the equilibrium interest rate is a leading indicator to the macroeconomic variables such as GDP growth and CPI, can serve as a new benchmark of price-oriented monetary policy framework.