RDP 2019-11: China's Evolving Monetary Policy Framework in International Context Non-technical summary for ‘China's Evolving Monetary Policy Framework in International Context’

China's monetary policy framework can be difficult to decipher. This owes partly to China's unique institutional context, where visibility over decision-making processes can be limited and political economy issues are complex. Another reason why China's monetary policy framework can be difficult to trace stems from its constant evolution, alongside profound changes in the economy and financial system. Unlike in advanced economies, the full scope of China's monetary policy framework has never been officially documented, making these changes somewhat harder to contextualise.

With this in mind, the primary motivation of this paper is to take stock of the evolution of monetary policy in China, and place these developments in an international context for the benefit of a reader more familiar with monetary policy frameworks in advanced economies. We focus on four dimensions – the institutional framework, operational framework, communication framework, and the empirical behaviour of monetary policy pass-through. In relation to the existing literature, this relatively broad scope allows for a clearer identification of interconnections across elements of the policy framework, and how these compare to advanced economies. We view this wide lens approach as particularly relevant given that many of the unique features of monetary policy in China can be traced back to the institutional setting for macroeconomic management. Our hope is that this approach facilitates a deeper and more nuanced understanding of the conduct of monetary policy in the world's second largest economy.

The overarching message from our analysis is that while monetary policy has evolved significantly in China, with some aspects now beginning to resemble those observed in advanced economies, key differences remain. Indeed, China's preferred model of institutional and economic development is likely to limit convergence of its policy framework with advanced economy central banks even in the longer-term.

In terms of the four specific areas of focus, our main takeaways are as follows:

• First, on the institutional framework, we note that public accountability mechanisms and the lack of independence over monetary policy decisions remain substantial points of difference between The People's Bank of China (PBC) and central banks in advanced economies. This follows from China's single-party state system, where the levers of macroeconomic management remain highly coordinated under the State Council.
• Second, the targets for monetary policy in China and how they find practical expression in the operational framework continue to have few similarities to advanced economies, although some implementation features are becoming more familiar as China transitions to a monetary system where interest rates play a larger role.
• Third, elements of the PBC's communication framework are broadly evolving along the lines observed elsewhere, with remaining exceptions mostly a result of the PBC being part of a broader policy apparatus and, thus, not having full discretion over monetary policy.
• Fourth, our empirical analysis of monetary policy transmission points to both similarities and differences. For instance, while output and bond yields in China are now more closely related to movements in policy rates than monetary aggregates (reflecting a Chinese financial system that is becoming more developed, as in advanced economies in the 1970s–1980s), the similar average inflation outcomes observed in China and advanced economies have been generated through very different means and for different purposes. If the prospect of high inflation or deflation is viewed by the authorities as grave enough to warrant a whole-of-government counter-response, it may be that standard incentive misalignment and commitment problems cited in the literature on central bank independence and inflation targeting are less applicable in China's unique institutional context.

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