Money and marketization

 Money is also a resource, a scarce resource. Hence, the marketization of interest rate is very
important, and the RMB interest rate, which is determined by the supply-demand relationship of
the market, must not be distorted. Only in this way can the resources be allocated in a marketbased manner. The interest rate shaped by the supply-demand relationship also reflects risk
premium. If your risk is relatively high, then the market will require a higher interest rate. By
contrast, if your risk is relatively low, then your risk premium will be low as well, which enables
you to borrow at a lower interest rate. There is profound knowledge in market allocation of funds.
Regulation tools are necessary in achieving the goal of monetary policy. The tool system of
China’s monetary policy is relatively simple. First of all, there is open market operations (OMO)
for injecting or withdrawing liquidity; second, the PBC can adjust money supply with central bank
lending and central bank discount; third, depository financial institutions can be required to park
deposit reserves in the PBC; additionally, we can also supply liquidity to the market with the
medium-term lending facility (MLF), the standing lending facility (SLF) and other tools.
Just now I mentioned marketization of the interest rate. You may have heard a phrase called
“interest rate corridor”. 

The central bank can adjust and control the interest rate between a floor
and a ceiling level, which is called “interest rate corridor”. In the times of planned economy, loan
quotas were set and resources allocated through administrative measures. After that,
commercial banks came into existence, the planned economy was replaced by market
economy, and the interest rate determined by market supply and demand came among. At this
point, an important question is, “What is the appropriate level of the interest rate?” We can see
that central banks in various countries all concentrate on the adjustment and control of the
interest rate. The Federal Reserve mainly regulates the federal funds rate by adjusting it to a level
deemed as appropriate, which will then affect the interest rates on deposits, loans and treasury
bonds and thus forming market interest rates.
At present, the focus of China’s monetary policy is gradually shifting from quantity control to price
control. You may ask, “currently what is on earth the focus of the PBC, 

quantity control or price
control?” My answer is, we are in a transition from quantity to price control, and both tools are
employed during this process. Price control has been more important than it used to be, but at
the same time, with the impact of our basis and systems as well as people’s thinking pattern,
quantity control is not yet discarded and remains very important. Hence at present, both quantity
and price controls are playing their part.
This figure is an illustration of interest rate corridor. In the corridor an important interest rate is
DR007, namely the seven-day repo rate in the inter-bank market. A repo is a loan secured
against collateral, which is a transaction between institutions. Why is it important? Because it
involves enormous trading volumes and can affect all market interest rates.
As you can see, the red line of DR007 lies between the blue line on the upper side and the green
line on the lower side. The blue line represents the interest rate of SLF and the green one is the
interest rate of excess reserves. The interest rate of excess reserves stands at 0.72% now, so
2 / 15 BIS central bankers' speeches
the market interest rate must be higher. Why? Because as an absolute minimum, you can enjoy
a 0.72% return by putting your money in the central bank, and this is also the safest way to keep
your money — hence this is the lower limit of interest rates. The upper limit is the interest rate of
SLF. When financial institutions run out of money, they can borrow from the central bank via
SLF, and the interest rate is moderately higher than DR007. Why? Because the incentive
mechanism will not work if it is lower than DR007. You can see that the market interest rates
fluctuate between the upper and lower limits. You may consider the figure quite simple; but it is
not easy to establish such a mechanism in the market, nor is it effortless to keep DR007
between the two limits.
Recently there is a buzzword called “macro-prudence.” We know that the requirement of
establishing two-pillar regulatory framework of monetary and macro-prudential policies has been
proposed in the report to the 19th National Congress of the CPC. I have just explained the goal,
transmission and tools of monetary policy. Then I’d like to explain what is macro-prudential
policy. It is mainly aimed at ensuring financial stability and forestalling systemic risks and
characterized by counter-cyclical adjustments. The monetary policy can practice both quantity
and price control. Quantity control is a simple tool, as quantity can be specified clearly. However,
it still has drawbacks, and the biggest problem is that the specified or allocated quantities may be
wrong and fail to conform to market conditions. Moreover, the quantities, which are allocated in
Beijing, may go wrong when it comes to provincial, municipal and county levels. Also, problems
like rent-seeking, tunneling and corruption may also arise in the process. Price control sounds
like a fine tool, but sometimes it is not very efficient and may not achieve regulatory goals. Hence
in practice, especially following the global financial crisis, countries around the world have been
increasingly aware of the importance of macro-prudential policy. This is also why we have
decided to establish two-pillar regulatory framework of monetary and macro-prudential policies.
The following four items can give us some direct impression of macro-prudential policies. Firstly,
the PBC has established the macro-prudential assessment (MPA) system to assess whether
financial institutions work in line with macro-prudential requirements. The MPA system contains a
number of indicators, such as capital adequacy ratio and liquidity measures. We all know the
Basel Accords, and Basel III has proposed many requirements centered on capital adequacy
ratio. The MPA system should assess whether commercial banks have satisfied these
Secondly, macro-prudential policies shall be in place for cross-border capital flows. Sometimes
the inflow and outflow of capital may cause herd behavior or irrational panics among market
entities. In such a case, we need to consider employing macro-prudential policies.
Thirdly, macro-prudential policies concerning housing finance. For example, we all know there is
down payment ratio of housing loans, 

and this ratio can be used for counter-cyclical
adjustments. It varies from country to country and from stage to stage in the economic cycle.
Differentiated measures can also be taken for first-time and second-time homebuyers. All these
are effective practices of macro-prudential policies in different countries, and the core is making
counter-cyclical adjustments to protect people and ensure security of financial assets.
Fourthly, we are attempting to practice macro-prudential management over financial
infrastructure. Financial infrastructure, mostly including clearing, payment and trusteeship
systems, also requires macro-prudential mentality in regulation.
The monetary policy includes quantity and price control, and it should be aligned with macroprudential policy in the regulatory process. As the monetary policy tools and framework are not
enough to ensure stability

, macro-prudential policies can be implemented simultaneously to
maintain financial stability and prevent systematic financial risks. The two-pillar regulatory
framework of monetary and macro-prudential policies can provide additional guarantees when
the PBC considers and addresses the overall situation. The National Financial Work Conference
3 / 15 BIS central bankers' speeches
has proposed that the Financial Stability and Development Committee under the State Council
should be established to enhance the PBC’s responsibilities concerning macro-prudential
management and systematic risk prevention.
The second part of my lecture is about how monetary policy supports the real economy. I want to
talk about the macro-economic situation and the response of monetary policy. Some basic
judgments are necessary, for example, we need to have a profound understanding of the “new
normal” of the economic development. At present, China’s working-age population is decreasing,
and labor shortages begin emerging in some industries. The proportion of the service sector in
the economy is becoming increasingly larger, growing to exceed 50%. Under this circumstance,
China’s economy has been transitioning from a phase of rapid growth to a stage of high-quality
development. Hence the economy will not grow at double-digit rates as it used to, which is
associated with our population structure. Currently, our economy is moving toward high-quality
development. China is the second largest economy in the world, with its GDP exceeding USD 12

which is a large base. Consumption is the major driver of economic growth. Meanwhile,
we have been acting on the understanding that “lucid waters and lush mountains are invaluable
assets” to enhance environmental protection, as evidence by the increasingly harsh
environmental standards imposed on many industries. All these show the necessity to pursue
high-quality economic development. The growth rate may be a bit lower than before, but we will
be able to achieve sustainable development as long as we can ensure high-quality development,
full employment and “lucid waters and lush mountains.” By saying these things, hopefully I can
make you understand that while thinking about the monetary policy, we need to take into account
the basic feature of economic development: China’s economy is moving towards its goal of highquality development

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