The China’s Puzzle

Excessive money supply will lead to inflation, which is one of the basic proposition of economics, however, this relationship is not established in our country.On the one hand, the tatio of M2/GDP always at the rising stage, by the end of 2014 the ratio reached 2.01; in the same period, on the other hand, the inflation rate is at a low level, and even some years there will be deflation. Neither traditional Keynesian framework nor the new quantity theory of Monetarism can give explanate it.This article based on the perspective of China’s monetary policy operation, study how the coexistence of high M2/GDP ratio with low inflation come out, we thought the cause of this phenomenon lies in the unconventional monetary policy tools which people’s bank of China adopted.Under the Mandatory settlement system, in order to stabilize the RMB exchange rate against the US dollar, the people’s bank has to buy lost of dollars.As the current and capital accounts surplus continue for years,Funds outstanding for foreign exchange has become the main channel of sending Monetary Base,and the legal deposit reserve and pedestrian issue financial bonds become sterilisation method. With this mechanism, the people’s bank has lost control of the quantity of money, so it chosed to control the total amount of credit which created by the financial institutions to control the quantity of money again,and then to affect the operation of macro economy.In China, the economic growth mainly depend on the investment, and the credit amount is the most important influence of the investment,so as it,indirectly, the change of output and inflation rate will be subject to the credit amount.With analysis above,we thought the coexistence of high M2/GDP ratio and low inflation rate can be interpreted as,M2 was affected by the Funds outstanding for foreign exchange and total amount credit,but GDP was mainly affected by the total amount of credit so a difference came out, at the same time, the rate of inflation due to the the people’s bank’s credit control remains at a low level.This paper first introduces the monetary policy system of people’s bank, and then introduce the different variables and transmission channels of monetary policy framework with corresponding theory, at last introduces the domestic research in this area, most of the literatures support the people’s bank take the amount of money supply as the intermediary goal of monetary policy, and the credit transmission channel takes the dominant place.With these studies, the paper used the macro data, further confirmed the conclusion above.In the operation of the policy of the people’s bank, the monetary base is determined by the Funds outstanding for foreign exchange,legal deposit reserve and pedestrian bonds as a passive sterilisation tools, and,pepleo’s bank use the credit control to affect the real economy, which is the core of the system characteristics.It is the pedestrian these unconventional policy operating ultimately led to the formation of high M2/GDP, and the reality of low inflation coexist.This paper used cointegration test, granger causality test, variance decomposition and impulse analyse with statistics data which come from the people’s bank of China and the national bureau of statistics confirmed the above qualitative analysis.According to above analysis results, this paper argues that the future reform direction of the monetary policy system should focus on two aspects:changing the current exchange rate regime into floating exchange rate system;pushing forward the interest rate liberalization.