Impact Of Financial Innovation On The Theory And Practice Of Monetary Policy

Monetary policy theory is part of monetary theories of practical significance. Since the coining into being of the modem monetary theory in the 1930s, the monetary authorities of all western countries have been applying it, trying to make it one of the effective macroeconomic policies. The theory and practice of western monetary policies have also experienced a process of constant improvement and development with the growth of the economy.But such theory and practice have also undergone big changes since the 1990s. The changes mainly manifest themselves in the following: stable price has become the ultimate objective option of monetary policies in the western countries; reserves ratio and rediscount rates have been weakened in their roles and open market operations has been more and more used; interest rate targeting has resurged to become an intermediate target of monetary policy after the application of interest rate and money supply. Some countries have simply discarded the intermediate targets and resorted directly to inflation targeting. The traditional transmission mechanism of monetary policies has been shaken and even failed in some countries or needs readjustments in others. The effectiveness of monetary policies has been questioned. There are many factors accounting for such changes. But the most important of all is the rapid development of financial innovation and its concomitant major changes of the financial market structure.The rapid development of contemporary financial innovation has aroused iull attention from the international academic community. Since the 1980s, western monetary and financial experts have devoted much of their energy to the study and analysis of financial innovation. Their study has different emphases macroeconomically and microeconomically. Microeconomically, efforts have mainly been made to study the financial tools, operational innovation and pricing theories; macroeconomically, efforts have mainly be devoted to studying the relations between financial innovation and the financial system, especially its impact on the theory and practice of monetary policies. While the study in the microeconomic area is quite comprehensive, that in the macroeconomic area, especially its impact on the monetary policy theory and practice, is far from being systematic.The impact of financial innovation on monetary policy theory and practice mainly manifests itself in the following: it has a fairly big effect on money supply and demand; it has brought about changes in the channels for controlling the monetary base by the central banks; it has made the money multiplier more unstable, making it difficult to define and measure money; it has increased the endogenecity of money, causing big changes in the demand structure and amount; it has also brought about profound changes in the financial market structure,'asset structure and asset price and made money demand more and more complicate; it has made it difficult for the central bank to control the monetary policy objectives (ultimate objectives,intermediate targets and operational targets); it has lashed at and enriched the transmission mechanism of the traditional monetary policy; it has weakened, to varying degrees, the effectiveness of monetary policy. In a word, financial innovation has had a profound and far-reaching effect on the theory and praxis of monetary policy. This merits full attention of monetary authorities of all countries.Since reform and opening up, China's financial innovation has experienced the stage from zero to sustained development. At present, financial innovation in China has developed in both category and scale, but still it has lagged far behind western countries. Although financial innovation is the trend of international financial development, traditional financial service still dominates in China. The impact of financial innovation on the theory and praxis of monetary policies is, therefore, very small. So, how to formulate and implement a correct monetary policy by the monetary authorities in China is a p...