Monetary Liquidity, Asset Prices And Monetary Policy Choices

The huge movement of asset prices is usually accord with the volatility ofeconomy growth, and it also changes while monetary liquidity switches betweenadequate and shortage. The radical movement of asset prices is consistent with thechanges of monetary liquidity, which obviously isn't a coincidence, there is closerelationship between asset prices and monetary liquidity. The fluctuation of assetprices, which causes macro economy instability in some way for both developed anddeveloping countries, brings great challenge for policy makers, especially for centralbanks. When policy makers decide how to deal with the fluctuation of asset pricesthey are confront with dilemmas: they are afraid of the chosen policy crush economybubble, which may drag the economy into recession, like Japan did in1990s; if let thepolicy unchanged, bubble would grow bigger and bigger until it is unsustained, thenthe economy suffers even more damages, the situation in China houses market is avivid example. If the movements of asset prices aren't caused by its fundamentals,meanwhile asset prices' fluctuations have strong influence for the real economy, andthen policy makers must response to the movements of asset prices. But taking assetprices into policy objectives or not, policy makers should be very careful because badpolicies could lead to asset prices more volatile, even the purposes of the policy aregood. Beside, different policy choices have different effects on economy welfare andcost. So it's an important and emergent problem for policy makers how to cope withthe fluctuations of asset prices.The theme of this paper is about the relationship between monetary liquidity,asset prices and central bank policy choices. To figure out this question, our researchis going to carry on in following aspects: first of all, we summarize characteristics forthe situation of China's liquidity in recent years and find out there are much evidenceof excess liquidity, the resources of excess liquidity in China comes from bothdomestic and abroad, such as households have very high saving ratio, commercialbanks' rapid capital expansion, double surplus accumulation and so on; then we consider the interaction between monetary shocks and asset prices, in this part weinclude monetary supply in G7in total monetary supply, so we could analyze thespillover of monetary between China and G7. It turns out asset prices in China hadupward pressure when there were rapid money growth in G7, a positive correlationbetween G7money growth and Chinese asset prices exists; after that we study on thechallenges central banks faced, which are caused by the fluctuation of asset prices. Inresponse to these challenges, such as price stability, financial stability, and policydilemma, the central bank must choose the implementation of monetary policy rules;Finally, in the real business cycle model, New Keynesian model and the NewKeynesian model with financial accelerator, we consider two different shocks,expectation whose main impact comes in the future, and net worth shocks which isabout the problems that appear to arise between borrowers and lenders after largeasset price movements. It turns out that although asset prices and the economy as awhole can express large movements in response to these shocks. We don't find astrong case for including asset prices in monetary policy rules.On the basis of the above studies, this paper proposes the following policyrecommendations: Given the ample liquidity situation in China has been going on foryears, although in times of economic downturn it is necessary to stabilize theeconomy. But the negative effects of the long period of monetary stimulus cannot beignored, the central bank should be timely adjustments to monetary policy, pricestability on a more important position; optimizing the current foreign exchangemanagement system, phasing out compulsory settlement, to encourage theinternationalization of the RMB settlement and offshore business, and expand theinfluence of the Yuan, also need to be alert to the speculation of foreign capital on theequity asset class, and to strengthen its monitoring of short-term capital; Asset pricesare usually closely linked to output and investment, policy options for central banksshould be more concerned about the core economic variables, severe inflationthe goalis still the focus of central bank monetary policy.