Prudent Monetary Policy Should Be Flexible And Moderate.

The executive meeting of the State Council has announced that it will adopt "differential deposit rate" and other means to encourage financial institutions to encourage and restrict interest rate pricing, and strengthen industry self-discipline and risk prevention.

This is the first time the differential deposit reserve ratio has been announced for interest rate regulation.

The people's Bank of China said that as an important aspect of the MPA system, interest rate pricing will help to curb irrational pricing and reduce financing costs.

The gradual weakening of the correlation between money supply and real economy means that even if the money supply is not regulated, it may not be able to achieve the goal of regulating the real economy. In the past few decades, almost all developed and middle-income countries have abandoned the monetary policy framework with monetary supply as the intermediate target and turned to the framework of policy interest rate as the intermediary goal.

In China, from the point of money supply as the intermediary goal

The framework has been discussing for many years the pition to a new framework based on policy interest rate, but a paradox faced by this pformation is that commercial banks in China still use the central bank's benchmark deposit and lending rate as the pricing basis rather than using market interest rates as the pricing basis.

If this situation does not change, it is difficult to form a market acceptable policy interest rate and effective interest rate pmission mechanism, and the pformation of monetary policy framework will be faced with bottlenecks.

In contrast, the pricing of bank deposit and loan interest rates in developed countries and regions is based mainly on market interest rates, such as the pricing of many European and American banks, based on LIBOR bonds or Treasury yields, and the pricing of many bank products in Hongkong based on HIBOR.

Due to the high correlation between policy interest rate and short-term interest rate and the important role of short-term interest rate in pricing formula, the pmission of monetary policy in these countries and regions is relatively smooth in the normal stage of economic cycle.

Our preliminary empirical study shows that the pmission effect of market interest rate to loan interest rate is only about half of that in the United States.

The main reason why China's commercial banks are unwilling to use market interest rates (such as SHIBOR or short-term repo rate) in the past is the short-term interest rate volatility.

If choose

The average daily interest rate divided by the average interest rate is used as an indicator of interest rate volatility. During the period from January 2012 to June 2015, the amplitude of overnight SHIBOR in China was 1.7 times that of the US dollar overnight LIBOR interest rate, 1.9 times the overnight interest rate in Korea, 3 times the overnight interest rate in Japan, and 4.4 times the overnight interest rate in India.

In the first 7 months of 2015, China's one-year benchmark deposit rate gradually decreased by 75 basis points, but in the first 4 months, the 7 day repo rate dropped by about 300 basis points, while the 7 day repo rate rose by nearly 100 basis points between May and early July.

The volatility is too large, so that short-term interest rate itself can not represent the trend of monetary policy (monetary policy from loose to tight, or tight to loose change is generally a cycle every few years, rather than short-term volatility), if such short-term interest rates are used as the pricing basis, enterprises are unwilling to accept, will also artificially increase interest rate risk faced by commercial banks.

In addition, from the beginning of 2012 to the middle of 2015, the correlation between China's short-term interest rates (such as the 7 day repo rate) and the average financing cost of enterprises was also low (only 46%).

Only by stabilizing short-term interest rates and raising the correlation between short-term interest rates and corporate financing costs can we set up the expectation that some short-term interest rates will become the policy interest rate in the future, and guide commercial banks and other financial institutions to use short-term interest rates as a basis for pricing.

In addition, only when the market generally believes that a short-term interest rate will be more likely to become a policy interest rate, financial institutions will be willing to develop corresponding derivatives (such as interest rate futures products based on the 7 day repo rate) on this basis, and provide interest rate hedging tools for financial products based on this pricing basis.

The development of the hedging tool market will strengthen the benchmarking of such short-term interest rates in order to cultivate this interest rate as a solid foundation for future policy interest rates.

Two, the number of exogenous money targets and the stability of interest rates can not be both.

A large number of documents have proved that monetary demand has been unstable during the pition of monetary policy framework.

Money demand depends on many factors, such as financial product innovation, technological change, expected change, investor preference change and macroeconomic factors.

Generally speaking, financial innovation is the most important factor in the change of money demand.

Financial innovation introduces more financial products to the market, some of which belong to the broad money defined by the government and some do not belong to the broad money in the definition. Therefore, the reconfiguration of assets among various financial products will cause the rapid change of money demand.

In addition, technological innovation will improve the efficiency of payment and paction system, thereby reducing the demand for money.

The acceleration of monetization will increase the demand for money.

In addition, under the opening of capital account, the uncertainty of foreign demand for local currency will also increase the fluctuation of money demand.

China is no exception.

The results of Liao and Tapsoba (2014) show that China's currency demand is facing structural changes since 2008.

We use HP filtering to eliminate the trend factors in the 7 day repo rate, and analyze the short-term interest rate volatility in the past fifteen years.

It was found that in 2006, the standard deviation of short-term interest rate fluctuations increased by nearly four times to 0.90 over the previous 0.24, indicating that the instability of China's demand for money has increased significantly in recent years.

In addition, we use quarterly data to explain the explanatory power of money demand function. We find that between 1999 and 2006, the coefficient of money demand function is 0.51, while in 2007 to 2015, this coefficient dropped to 0.38. This also shows that China's currency demand has become more unstable in recent years.

In the case of unstable monetary demand, the growth rate of money supply will be maintained at a fixed level, which will artificially cause large fluctuations in market interest rates.

This is because the market interest rate is the equilibrium result of money demand and supply. If money supply is fixed, but the demand for money is changing, interest rates will fluctuate.

The cross country empirical study of data from 12 countries in the pition of their respective monetary policy frameworks shows that the faster the growth of money supply in a country, the greater the volatility of short-term interest rates in the country.

Excessive interest rate fluctuations will produce a series of adverse consequences: from the real economy, interest rate fluctuations make it difficult for enterprises to predict future ROI, thereby reducing investment willingness.

Our preliminary results from an empirical study based on Chinese data show that the rise in interest rate volatility will lead to a decline in medium and long-term loans after controlling other variables.

In addition, for some financial institutions, the risk of interest rate volatility will make them excessive accumulation of liquidity, while many financial institutions at the same time hoarding liquidity may lead to sudden interest rate soar.

Three, the use of quasi quantitative tools should be based on a stable short-term interest rate.

A more traditional understanding of the relationship between quantitative indicators (such as M2) and price indicators (such as interest rates) is that the two are one-to-one correspondence, that is, as long as the money supply is increased, interest rates will drop.

Therefore, in order to reduce the cost of social financing, we only need to reduce the reserve ratio frequently (because the reduction can effectively increase the M2 by multiplier effect).

However, due to the acceleration of China's financial innovation, and the expected role of the market in guiding financial behavior, the above-mentioned one-to-one relationship has been gradually broken.

If the timing and intensity of the timing are not well controlled, the short-term interest rate will fluctuate sharply, which may further weaken the interest rate pmission.

For example, from the point of view of the pmission of the bond market, if the short-term interest rate fluctuates too much and the market can not judge the orientation of the central bank policy, it is difficult to influence the medium and long term bond yields through the expected channel.

From the point of view of the pmission of the banking system, if the short-term interest rate fluctuates too much, many customers of the bank will not accept the loan based on the pricing basis because they can not predict the future financial cost. Even if the risk of hedging is greater, the bank itself is also unwilling to provide the financial products based on this price because it is difficult to hedge the risk, so that the short-term interest rate can not be pmitted to the loan interest rate.

In the process of changing the monetary policy framework from quantity to price, we should gradually reduce the attention to quantitative objectives and accurately understand the conditions needed for the role of quantitative tools, such as adjusting reserve ratio.

In the future, when using quantitative tools, it should not be regarded as a policy tool that can directly affect the real economy, but more consideration should be given to how to use these tools to achieve the desired level of policy interest rate, thereby affecting the real economy through the pmission of interest rates.

To be more specific, decisions on the intensity and frequency of the reserve requirement ratio should be based on a reasonable level of short-term interest rates.

In addition, in the environment of gradual opening of capital account, the use of quasi quantitative instruments should also consider the impact of capital flows.

If the reduction is too large or too frequent, it will lead to the excessive downward trend of short-term interest rates in the mainland, which may aggravate the capital outflow, which will be hedged by the effect of increasing the monetary multiplier and expanding liquidity.

Four, strengthen the regulation and guidance of market interest rates, and dredge the pmission mechanism.

In the process of pformation to the new monetary policy framework, we should gradually strengthen the regulation and guidance of market interest rates, and foster market awareness and acceptance of policy interest rates.

In addition, we need to push forward reforms in many non monetary policies to help clear the interest rate pmission mechanism.

Specifically, in terms of interest rate regulation, we can strengthen the use of the tools of open market short-term repurchase and standing loan facility (SLF) to build a de facto interest corridor, and gradually foster the awareness of policy interest rates.

In the past few months, the central bank has made a lot of efforts in stabilizing short-term interest rates, especially the 7 day repo rate, and cultivating awareness of interest rate corridors, and has achieved some positive results.

However, only a few months' stability will not allow the market to fully establish its confidence in the future interest rate stability and interest rate corridors. As long as there are one or two major fluctuations, efforts to stabilize market expectations may be wasted before.

International experience shows that the credibility of monetary policy (Credibility) is an important foundation for the central bank to effectively guide market expectations, but building and maintaining credibility is much harder than destroying credibility.

Some market participants believe that if the short-term interest rates can be stabilized for more than a year, the market acceptance of the interest rate corridor will be significantly improved.

In addition to stabilizing short-term interest rates, the central bank should also play a moderating role in medium-term and long-term liquidity, such as refinancing, MLF and PSL, to guide and stabilize medium and long-term market interest rates.

By weakening the reliance on quantitative tools, improving the macro Prudential management framework, improving the yield curve, and developing the derivatives market, we can dredge the interest rate pmission channel and enhance the central bank's monetary policy to the medium and long-term interest rates, especially the credit market interest rate and the real economy's pmission efficiency.

In terms of liquidity management, we should consider reasonably adjusting the liquidity of the banking system through flexible use of tools such as open market operations, rediscount, refinancing, and medium term lending facility (MLF).

For refinancing and rediscount tools, some views are concerned that they may have "stigma effect".

In fact, unlike other countries in Europe and America, China's refinancing and rediscount tools are mainly used in structural adjustment, and the frequency of daily use is relatively high. The market generally does not link it with liquidity relief, and there is basically no "stigma effect".

Moreover, from the international experience, the use of tools such as refinancing and rediscount will be extended to more banks, and the coverage of tools will also be improved, and the "stigma effect" will also be eliminated.

Finally, we should also realize that in order to pform the abundant interbank market liquidity and low short-term interest rates into lower corporate financing costs, we must reform in many non monetary policy areas to help clear up the interest rate pmission mechanism.

For example, it is necessary to establish a sound guarantee mechanism to reduce the risk aversion of banks and other investors to technology, green and some small and micro enterprises, thereby reducing the risk premium; we should continue to expand the financing channels of various capital markets, reduce the mismatch of time mismatch and risk preferences mismatch caused by excessive reliance on banks and the resulting financing difficulties; we should continue to relax restrictions on access to private banks, support the development of small and medium-sized financial institutions serving small and micro enterprises, and ease the difficulties of financing and financing because of insufficient financial services.