Michel Camdessus Central Banking Lecture - Managing Multi-Objective Monetary Policy: From the Perspective of Transitioning Chinese Economy
IMF News, June 24, 2016
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- Published: June 24, 2016
Overview
- Speech delivered discussing post-crisis central banking issues and the objectives, roles and practices of the People’s Bank of China (PBoC).
- Date on page: June 24, 2016.
- Framing: China as both a large transition economy and an emerging market economy, requiring multi-objective monetary policy.
Several questions (framing central banking debates)
- Should central banks have one objective or multiple objectives?
- Pre-GFC: many major central banks focused on price stability and adopted inflation targeting.
- Post-GFC: many central banks strengthened or were given financial stability and financial regulation roles.
- Alternative frameworks discussed include nominal GDP targeting that focuses on both growth and inflation.
- For emerging markets: balance of international payments and capital flows may affect monetary policy—question whether balance of international payments should be an objective.
- Independence of central banks
- Distinguish between independence of central banks and independence of monetary policy.
- Single-objective central banks find independence easier; multiple objectives require coordination and can be sensitive politically (macro-prudential and financial regulation mandates).
- Relationship between monetary and fiscal policy
- Theory: clear division of function.
- Practice: frictions and overlaps; post-GFC underuse of fiscal policy led to over-reliance on monetary policy.
- Specific question: should central banks join rescue programs when fiscal policy is constrained or fiscal resources are limited?
- What is special about central banks in transition economies?
- Early transition: weak market foundations for macroeconomic management, underdeveloped financial markets/products, extremely limited fiscal resources with large financing gaps.
- Central banks may need to promote financial reforms and market development to enable effective monetary policy transmission.
- Transition economies often emphasize economic growth to make up for “lost decades”; this context affects central bank objectives.
Objectives and roles of the People’s Bank of China (PBoC)
- Formal annual objectives historically mandated by the Chinese government include:
- maintaining price stability,
- boosting economic growth,
- promoting employment,
- broadly maintaining balance of payments.
- Additional distinct roles of the PBoC:
- promoting reform and opening up,
- developing financial markets,
- managing exchange rate, foreign exchange market, foreign exchange reserves, gold reserves, and balance of payments statistics,
- working closely with other government agencies.
- Rationale for PBoC’s multi-objective role in transition context:
- Legacy distortions in price/tax systems, non-monetary allocation of goods and services, and highly inefficient resource allocation required central-bank-led reforms to restore healthy financial institutions.
- Massive non-performing loans (NPLs) in transition countries threatened banking system collapse; China faced similar problems aggravated by the Asian financial crisis.
- Fiscal constraints: in the 1990s, fiscal revenue fell to about 10% of GDP at the lowest point; public finance faced heavy burdens from planned-economy legacies, limiting fiscal capacity to rescue banks.
- PBoC actions during transition included splitting non-performing assets from banks, recapitalizing problem banks, supporting large banks to go public and shift to mixed ownership, and strengthening corporate governance and international competitiveness.
- Institutional development efforts emphasized regulatory regime, laws and regulations, accounting and auditing standards, loan classification and financial reporting systems.
- Why develop financial markets:
- Transition economies lacked stock markets, corporate bonds, and derivative instruments; without market-based financial products, monetary policy cannot be market-based nor transmit effectively.
- PBoC promoted financial market development as an inherent requirement to fulfill monetary policy mandate.
- Why pay attention to balance of payments:
- For emerging markets, balance of payments, capital flows, exchange rate and reserves affect macroeconomy and monetary policy.
- Transition economies experienced collapse of international trade and sharp BOP deterioration due to distortions.
- China’s outward-looking strategy increased dependence on trade and foreign capital; BOP influenced money supply and price stability, so PBoC assumed roles related to external sector management.
- Tensions and independence:
- Pursuing multiple objectives impacts independence through required coordination with government agencies and politically sensitive reform tasks.
- When reform tasks are largely completed, the PBoC’s objective function might change and become more simplified.
Challenges brought by multiple objectives
- Can the mechanism be expressed as a multi-objective function that can be optimized?
- Possible forms: linear or log-linear multi-objective functions, with duality relationship to general equilibrium if weights can be appropriately determined.
- Technical and practical challenges summarized:
- Overlap of objectives (e.g., economic growth and employment) — manageable by identifying overlap and assigning weights to non-overlapping parts.
- Conflict of objectives — trade-offs and balancing required; mathematically unavoidable and cancels during optimization.
- Aggregation and weights determination — technical issue manageable via simulated market mechanisms and expert opinions.
- Complicated models and difficulty communicating results — complexity increases after GFC with added responsibilities (supervision, SSM, prudential regulation); communication dilemma between accuracy and public comprehension.
- Linkage with economic globalization — traditional models focus domestically; global spillovers and spillbacks complicate modeling; financial stability is global; multi-objective/multivariate methods face the curse of dimensionality.
Optimization problem of a multi-objective monetary policy framework
- Weights for multiple objectives
- Multi-objective optimization in GE or DSGE setting; key issue: how to determine weights on different objectives.
- Proposal: simulate market process to determine fair-value weights using market supply and demand logic, supplemented by decision-maker and expert opinions.
- Tolerance ranges for objectives allow dynamic adjustment of weights according to deviations within range intervals (examples given):
- During crisis: increase weight on financial stability and soundness of financial institutions.
- During high inflation: increase weight on price stability.
- With large current account surplus or deficit: increase weight on BOP accordingly.
- Dynamic intertemporal equilibrium approach acknowledged as potentially making the objective function unstable but manageable.
- Complication of models with vectors
- Multiple objectives require models with vectors and dynamic relations among many variables.
- Methods such as VAR and SVAR derive behavioral functions but face challenges like the curse of dimensionality.
- Transition economies face limited usable data due to incomparability and structural breaks; for China, samples before the 1980s are almost useless; data from the 1980s and 1990s are also less useful, resulting in small samples for modeling.
- Difficulty in communication
- Vector, dynamic models with lags are hard to convey in scalar, word-based public discourse.
- PBoC emphasizes communication with experts to convey accurate messages that trickle down via experts, while also providing simplified direct communication to the public.
Concluding remarks
- The PBoC’s multi-objective framework was chosen given China’s transition circumstances; costs exist but should not outweigh benefits.
- Compared to other transition economies, PBoC has promoted reform, developed financial markets, maintained financial stability, and created conditions for monetary policy goals — overall gains judged greater than losses.
- Acknowledged problems include excessive credit growth, high leverage ratio and shadow banking when compared to other emerging economies; these are framed as transition-era problems.
- As transition progresses toward a market economy, the PBoC’s objective function is expected to become more simplified and align more with international experience; the PBoC will adjust policy dynamically to meet China’s evolving economic, reform and development needs.
Source: Michel Camdessus Central Banking Lecture - Managing Multi-Objective Monetary Policy: From the Perspective of Transitioning Chinese Economy, June 24, 2016.