Money Supply As The Intermediate Target Of Monetary Policy In China Discussed

Since 1996, China began to use money supply as the intermediate target of monetary policy, so money supply has the important position in China's monetary policy system. However, there are still lots of controversies about this monetary policy framework, in addition, about which measure of money aggregates should be the right one to target. Therefore, it has the theoretical and realistic significance to further discuss the effectiveness of the money supply as the monetary policy intermediate target.This paper first investigates the theoretical basis and the evolutionary process of money supply as the intermediate target in western countries, and analyzes the monetary policy environment in China, from the perspectives of financial system structure, interest rate liberalization stage and the central bank independence. This paper argues money supply still has the advantage to be the intermediate target in China's current political, economical and financial environment.From the money demand and money supply perspectives, this paper makes empirical studies on the relatedness and controllability of money supply as the intermediate target. It discovers that China's money demand function is relatively stable with low interest rate elasticity, and money velocity could be forecasted. So from the angle of money demand, money supply could be the intermediate target of monetary policy. Furthermore, the empirical study shows that the narrow money has a closer relationship with the price, so narrow money as the intermediate target has the advantage.From the angle of money supply, this paper argues our central bank still could control the monetary base in spite of challenges of current foreign exchange system. It re-evaluates the volatility of money multipliers based on the adjusted monetary base (AMB), discoveres that the volatility of money multipliers substantially decrease after taking monetary policy change into consideration. Monetary base explainds most part of money supply volatility while the money multiplier contributes rather little proportion in money supply volatility. In short term Ml has a closer relationship with monetary base than M2, however, if lagged influence is taken full consideration, the controllability of M2 is better than M1.On the basis of discussion above, this paper compares the overall effectiveness of Ml and M2 as the intermediate target of monetary policy, and finds that M2 is more suitable to be the intermediate target of monetary policy if taking money demand and supply effects in a single framework, which means that the central bank should target M2 growth. Based on Taylor Rule, this paper also studies the money supply targeting practice in China and finds that the interest rate elasticity is substantially enhanced and the change of nominal interest rate is larger than that of inflation rate since China applied money supply as the intermediate target in 1996. So the money supply targeting in China reduces the economic volatility and improves monetary policy practice. In addition, the empirical study also shows that PBOC declared money growth target has substantial influence on its monetary policy actions and PBOC pays more attention to M2 growth in practice.This paper concludes that the monetary policy framework of money supply as the intermediate target is consonant with China's current financial system and insists that it should be kept on. This paper also forwords the policy suggestions, including enhancing central bank independence, strengthening supervision on the central bank, implementing more flexible exchange rate system, raising required reserve ratio and canceling excessive reserve interest, etc.