RETHINKING MONETARY POLICY
LI Bo3
In the aftermath of the 2007–09 global financial crisis, the zero interest
rate, quantitative easing, and credit easing have become the most-used
monetary policy instruments to stimulate the economies of postcrisis
developed countries (please see Appendix for the corresponding
presentations, including figures and tables). The crisis poses a significant
challenge to monetary policy framework.
First, it challenges central
banks’ objectives, including the rationale for the single objective of
targeting price stability. It raises questions on whether price stability is
enough to ensure financial stability and whether more-flexible inflation
targets should be considered. Second, it challenges the operation of
central banks, including whether the policy interest rate is effective and
whether quantitative tools should be introduced. Third, it challenges
central banks’ independence. Since the financial crisis, central banks have
been under varying degrees of pressure from governments, markets, and
the public. New debates on central bank independence have arisen. For
example, which is more important, independence from the government
or independence from the legislature? The pressure from voters and the
political process in democratic politics poses a challenge to central bank
independence. Fourth, it challenges monetary policy strategy.
In the
aftermath of the crisis, the unconventional monetary policy operations of
the major central banks created significant shocks to the rules-based
monetary policy strategy of the precrisis period. Discretionary policy
making became the norm. The postcrisis experience has shown that the
dichotomy between rules-based and discretionary policymaking is
perhaps an oversimplification that fails to capture the complex options
central bankers are facing in the real world.
3
Li Bo is Deputy Director General in the Monetary Policy Department II, People’s Bank
of China.
3
New Issues in Monetary Policy: International Experience and Relevance for China
The financial crisis has presented us with a new perspective in
studying the coordination between monetary and fiscal policies.
Monetary and fiscal policies differ in many respects including objectives,
constraints, tools,
and the decision-making mechanism. Complementary
monetary and fiscal policies can create a hybrid governance mechanism
for the macroeconomy. In the short term, the fiscal decision-making
process is complex, protracted, and often constrained by parliamentary
procedures. Therefore, during times of crisis, when “stimulus” is needed,
fiscal policy often is not as flexible as monetary policy and appears to be
inadequate in the short term. “Expert-governed” monetary policy can
compensate to a certain degree for insufficient “legislature-governed”
fiscal policy during a downturn. In the long term, fiscal policy is
characteristically “imprudent.”
Voters are subject to fiscal illusion, and
politicians seeking votes favor immediate tax cuts and spending
increases. Although intergenerational redistribution models vary, most
models show that electoral politics lead to higher current fiscal deficits.
Partisan competition causes delays in fiscal consolidation and creates
excessively high fiscal deficits and debt buildups. Imprudent long-term
fiscal policy may eventually lead to financial and economic crises and
create pressure for monetary policy easing, which leads to the
monetization of public debt. Foreign citizens or future generations will
bear the cost through inflation and asset bubbles. Imprudent fiscal policy
challenges the independence of monetary policy and renders the latter a
“subordinate policy” to fiscal policy. Since the crisis, many countries have
realized the flaws of democratic politics and reflected on fiscal policy,
which has led to a debate about fiscal policy independence. At the same
time, countries are paying more attention to the long-term sustainability
of fiscal policy.
