People’s Bank of China (PBC)

Role of the PBC in China’s Monetary Policy

Understanding the monetary policy of China, the world’s second largest economy Opens in new window, is more crucial today than ever, and yet it is not widely researched or well understood outside of China.

This series of post attempts to narrow this gap by shedding light on the institutional setting of China’s monetary policy, and by assessing its main tools and current challenges.

As interest rates become more market-based, we need a more authoritative and independent central bank to decide and implement monetary policy — SHEN Jianguang, Mizuho Securities Asia, Hong Kong.

Gone are the days where central banks worked behind “thick walls” and revealed as little as possible about their assessments and decisions. Today, central bank transparency and accountability are regarded as key to achieving low inflation and effectively managing inflation expectations.

In his lecture On transparency given at the Norwegian Academy of Science, the former Deputy Governor of Norges Bank, Jan F. Qvigstad, made the following remark:

Simplifying somewhat, the former view was that monetary policy operated effectively by surprising economic agents. Today, economic theory posits that monetary policy works best if its predictable.

So starting from Qvigstad’s observation that “transparency is now taken for granted among central banks” and that “most central banks are open about

  1. the objective of monetary policy,
  2. its strategy for reaching the objective, and
  3. the background for and the process behind interest rate decisions”,

this post attempts to explore the extent to which this is also the case for China’s central bank, the People’s Bank of China. Its independence, with regard to monetary policy, is the second question.

And thirdly, the post attempts to assess the reasons for, and the relationship of, the answers to the first two questions.

Insights into these key question can help inform the general understanding of Chinese monetary policy, which seems to be under-researched, in particular, outside of China, but increasingly matters for, and hence receives the attention of, global markets, businesses and policy-makers.

The Mandate of the People’s Bank of China (PBC)

Established in 1948, it took the PBC 35 years to become a central bank, and another 12 years before this status was legally confirmed with the adoption of the Central Bank Law in March 1995.

In the 2003 amendment of that law, Article 2, under the heading “General rules”, lists the formulation and implementation of monetary policy as the primary task of the PBC, followed by financial stability tasks, and it also provides a first hint to the thorny issue of the PBC’s indepence:

The People’s Bank of China (PBC) is the central bank of the People’s Republic of China. The People’s Bank of China Opens in new window formulates and implement monetary policy, guards against and eliminates financial risks, and maintains financial stability.

Further key tasks are spelled out in Article 4, and include, inter alia,

  • the issuance of Renminbi (RMB)  Opens in new window and the administration of its circulation,
  • the supervision and regulation of the inter-bank lending and bond markets,
  • the execution of the foreign exchange (FX) administration, as well as the supervision and regulation of the interbank FX market,
  • the maintenance of the normal operation of payment and settlement systems and—most importantly, as it gives the PBC regulatory powers—”the issuance and enforcement of regulations and rules concerning its tasks.”

Article 3 is crucial, as it contains the dual mandate of the PBC’s monetary policy:

The objective of monetary policy is to maintain the stability of the value of the currency, and thereby to promote economic growth.

While, strictly speaking, the formulation leaves it open as to whether the internal (= price stability) or the external (= exchange-rate stability) “value of the currency” is meant here, one could argue that the word “thereby” suggests that price stability best supports economic growth Opens in new window.

But, in an export-oriented economy, which China has become since opening up to the West 40 years ago, the exchange rate also has a huge impact on growth, and, over a long period, the central bank has indeed targeted its stability, and, to a certain extent, still continues to do so, as evidenced in recent speeches by the Governor of the PBC.

During the period from the mid-1990s to July 2005 (and again during the global financial crisis Opens in new window), when the RMB was (re-)pegged to the US dollar (USD), the nominal exchange rate was the main nominal anchor for China’s monetary policy.

Even if, in June 2010, the RMB exchange rate was allowed to float again, within a band that was further widened in April 2012, against the USD and a basket of other currencies, Chinese monetary policy was, until some years ago, still seen by some observers as being “heavily constrained” by China’s exchange-rate policy.

Within the PBC, the “Monetary Policy Department” and the “Monetary Policy Department II” are responsible for monetary policy. The latter was established in 2009 and is also responsible for all tasks related to the exchange rate and to RMB internationalization.

The Role of the Monetary Policy Committee (MPC)

Under the second heading “Organizational Structure” of the revised Central Bank Law, Article 12 (previously Article II) states that “the PBC sets up a Monetary Policy Committee”, and that its “tasks, composition and working procedures are determined by the State Council and reported to the Standing Committee of the NPC”.

Compared with the 1995 version, the amended article has an additional sentence which provides a clue as to the peculiar composition of the MPC, which, unlike those of other central banks, goes much beyond the PBC:

The Monetary Policy Committee of the People’s Bank of China shall have an important function within the macroeconomic management and the formulation and adjustment of monetary policy by the State.

While the monetary policy committees of other major central banks include no (ECB, Federal Reserve, Bank of Japan) or only a few (Bank of England) external members, the PBC’s MPC comprises more external than internal members.

Beyond the PBC Governor, who chairs the MPC (YI Gang), and three Deputy Governors (among them PAN Gongsheng, who also heads the State Administration of Foreign Exchange under the PBC), it includes ten non-PBC members:

  • a Deputy Secretary-General of the State Council,
  • a Vice Minister of the National Development and Reform Commission,
  • a Vice Finance Minister,
  • the Commissioner of the National Bureau of Statistics (NING Jizhe),
  • the Chairmen of the newly merged China Banking Insurance Regulatory (YI Huiman),
  • the President of the China Banking Assoication (TIAN Guoli, who is also Chairman of the China Construction Bank, one of the Big Four) and
  • three academics, including MA Jun, the former Head of the PBC’s Research Bureau and now the Director of Tsinghua University’s Center for Finance and Development.

The MPC’s tasks, composition and working procedures are laid down in the Provisions for the MPC of the PBC first promulgated by the State Council in 1997 and available on the PBC website.

Article 2 of the Provisions stipulates that the MPC is only a “consultative body for the formulation of monetary policy by the PBC”. Article 3 further details the role of the MPC:

The MPC shall, upon the basis of comprehensive research on the macroeconomic condition, and in accordance with the targets of the State for macroeconomic management, discuss and advise on the following monetary policy items: the formulation and adaptation of monetary policy, the intermediate monetary policy targets, the use of different monetary policy tools, important monetary policy-related measures, and the co-ordination between monetary and other macroeconomic policies.

In particular, the last point explains the high number of non-PBC representatives on the MPC, which is not a coincidence but intentional.

To put a positive spin on this arrangement, this multiplicity of actors can allow more diverse views on monetary policy to be taken into account, considering, for example, the impact of monetary policy decisions from the perspectives of fiscal policy, financial sector policy and even real economic policies.

The downside is, however, a risk of interference by other government agencies or even a subordination of monetary policy under other economic policies or the political agenda of the country’s leadership.

The Bank of Japan (BoJ) Opens in new window provides an interesting comparison in this respect, as six of the nine members of its Policy Board also have diverse backgrounds from the financial sector and beyond, but, during their tenure, they are BoJ executives, who are there solely to adopt the perspective of the central bank.