Introduction
Chapter 1 discussed the more flexible renminbi policy adopted in 2005, and the ongoing gradual appreciation following the initial 2.1% move on July 21, 2005. In addition to the external effects of this policy move, allowing some freedom from the fixed exchange rate constraint promised to increase the People’s Bank of China’s scope for effective monetary control.
Ba Shu- song, deputy director-general of the Finance Institute of the State Council’s Development Research Center, for example, emphasized that the fixed exchange rate had “jeopardized” the independence of Chinese monetary policy.[56] [57] However, the People’s Bank seems, in practice, to have been quite successful in containing the inflationary consequences of the continued buildup of foreign exchange reserves. Although the movement away from the old fixed exchange rate policy undoubtedly helped, the development of more market-orientated policy instruments also significantly benefited the People’s Bank’s monetary control.This chapter begins with an overview of the changing techniques employed by the People’s Bank over the years. The evolving role of open market operations is discussed in conjunction with the emergence of a liquid interbank bond market with a market-determined interest rate. Empirical modeling of People’s Bank policy over the 1990-2006 period relates money supply growth to domestic output growth, growth in foreign exchange reserves, and the real exchange rate - as well as allowing for a shift in policy after the Asian financial crisis. The results yield some evidence of a countercyclical (stabilizing) response to real exchange rate movements and also are consistent with other studies suggesting that the People’s Bank has, in fact, been successful in neutralizing the liquidity effects of faster rates of reserve accumulation. Although People’s Bank policies definitely remained pressured by such external forces, the central bank did not show any signs of being overwhelmed by even the very large reserves inflows seen in early 2007.
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