Perspectives on the Role of a Central Bank

Miguel Mancera, Paul Volcker, and Jean Godeaux

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1991
• eBook ISBN: 9781557752062

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Session I Role of Monetary Policy

Contents

Foreword

Preface

Acknowledgment

Overview

Opening Remarks

Richard D. Erb

Li Guixian

Roy D. Morey

Session I

Role of Monetary Policy

Introduction

Richard D. Erb

Speakers—Li Guixian

Paul A. Volcker

Miguel Mancera

Jean Godeaux

Summary of Discussion

Richard D. Erb

Session II

Implementation of Monetary Policy

Speakers — Zhou Zhengying

Paul A. Volcker

Miguel Mancera

Jean Godeaux

Summary of Discussion

Richard D. Erb

Session III

Role of Regulation and Supervision of the Central Bank

Speakers—Tong Zengyin

Paul A. Volcker

Miguel Mancera

Jean Godeaux

Summary of Discussion

Richard D. Erb

Session IV

Structure of the Central Bank

Speakers—Chen Yuan

Paul A. Volcker

Miguel Mancera

Jean Godeaux

Summary of Discussion

Richard D. Erb

Conference Summary

Speakers—Richard D. Erb

Paul A. Volcker

Miguel Mancera

Jean Godeaux

List of Participants

RICHARD D. ERB

Let us turn now to our first session. Each speaker will address a number of issues, including, for example, the question of whether there is a primary economic task for monetary policy: price stability, exchange rate stability, and growth. What are the relationships between those objectives? Are there differences between the short run and the long run in the pursuit of those objectives? How does the overall structure of an economy influence the role of monetary policy? These and other issues will be addressed in the context of this session, and this will then lay the basis for Session II, which will focus more specifically on issues concerning the implementation of monetary policy.

LI GUIXIAN

It is a great pleasure for me to have this opportunity to discuss the issues of monetary policy with Mr. Volcker and other distinguished guests. I am going to speak on the role of monetary policy and its relation to credit allocation and fiscal policy.

Monetary policy is one of the most important of the macroeconomic instruments. The objectives of monetary policy in a country can be quite different in various periods of time owing to differences of economic development, financial structure, and economic policies. Generally, price stability, full employment, economic growth, and balance of international payments are regarded as the basic objectives of monetary policy. In the present-day world, because consistency and conflict exist between various objectives of monetary policy, central banks usually lay different emphasis on different objectives. They make frequent adjustments to the policy measures in view of the status quo of their country’s political, economic, and social development. In this way, they maintain the equilibrium of aggregate demand and aggregate supply and promote balance and sustained economic growth.

China is developing its planned commodity economy. The central bank has persistently deemed monetary stability and economic development to be the basic objectives of monetary policy. We believe that the key to handling all four objectives is to prudentially balance the relationship between stabilization and development. In fact, stabilization and development are mutually conditional and complementary. Monetary stability is the prerequisite of economic development, and, in turn, economic development is the solid foundation for monetary stability. Monetary stability is regarded as the fundamental, dynamic, and long-term equilibrium of money supply and money demand, not excluding the temporary disequilibrium over time of price adjustment and price structure reform. Only through active stabilization can economic development be best promoted. On the other hand, economic development should proceed at a steady and sustained rate so that economic development cannot only be prevented from disturbing stability but can also help maintain stabilization.

To integrate the objectives of monetary stability and economic development, attention should especially be paid to the following aspects. Emphasis should be placed on a specific objective in a particular period in light of the existing situation. For instance, we have recently been exerting additional effort to tighten monetary policy and promote price stabilization and economic development. In China, the experience of recent years has suggested that monetary policy has developed into one of the main macroeconomic instruments in the Government’s effort to transform direct control over the economy to indirect control. It has played an active role in controlling the scale of fixed capital investment, containing the excessive growth of consumption funds, channeling savings to investment, adjusting the economic structure, augmenting effective supply, maintaining price stability, and promoting balanced economic growth.

Apart from the choice of the objectives, the formulation and implementation of monetary policy also involve the issue of intermediate targets, instruments, transmission mechanisms, and the analysis of effects. I will address the relation of monetary policy and credit allocation.

Credit allocation is a selective monetary policy instrument distinct from quantitative control methods, such as required reserves and rediscount and open market operations. Since this instrument was first introduced in the eighteenth century by the Bank of England, central banks around the world have made use of it in one way or another at different times. Even today, although general quantitative methods have been extensively applied in the developed countries, some of them have not altogether discarded the instrument of credit allocation.

In the developing countries, including China, it remains the dominant one in the apparatus of central banks.

As far as I perceive, a country’s fund allocation system is determined by its economic and financial system, as well as by the maturity of its financial markets. In our case, banks are not only commercial entities conducting banking business but are also units empowered by the state to undertake policy lending—specialized banks especially, as the state banks are not supposed to operate for profit only or, rather, they are required to take on certain functions of macroeconomic regulation and control. Furthermore, as a developing country, China is constantly confronted with an ever-growing demand for funds and the urgent need to adjust its economic structure. Abandonment of the credit allocation system would leave unsecured the sufficient flow of funds to priority sectors and enterprises of economic development and structural adjustment. On the other hand, underdevelopment of financial markets severely limits the central bank’s ability to regulate the economy through open market operations and rediscounting.

Nevertheless, we are aware of the defects of a credit allocation system. We maintain that the key to the effective implementation of monetary policy in the present Chinese context is the coordination of different policy instruments. For this purpose, efforts should be made to perfect the policy instruments in light of the reality of China, while maintaining the system of credit allocation. For instance, steps may be taken to improve the system of loan quotas, special deposits, and required reserves and to adjust interest rates, set lending structure guidelines, formulate a social credit plan encompassing all credit demands, promote the growth of interbank lending market, etc. Much work is also needed to better coordinate the conduct of various instruments to make them support and supplement each other so that the role of each individual instrument will be brought into the most effective play.

Both monetary and fiscal policies are indispensable tools for aggregate demand management. Fiscal policy is effected through the distribution of national income and the change of budgetary expenditures; monetary policy is effected through the adjustment of the money supply. In my view, the combination of these two policies, whether to tighten or to relax both of them or to tighten one and relax the other is determined by the specific conditions of the economic system and the economic operation mechanism of the country in question.

The existing economic operation mechanism in China is quite different from the market mechanism in Western countries. The Chinese economy is an integration of a planned economy and market regulation. Monetary and fiscal policies are conducted not only for aggregate management but also for the needs of structural adjustment. For instance, in view of the current excess of aggregate demand over aggregate supply, the overall direction of monetary and fiscal policy is set to both control aggregates and adjust the economic structure. Therefore, pursuant to the structural adjustment policy, sufficient funds will be granted to priority sectors and enterprises, and fiscal expenditures beneficial to structural adjustment will be expanded despite the fact that both monetary and fiscal policies have been tightened.

With respect to the resource allocation through monetary and fiscal policy, our approach is to maintain the individual balance of fiscal and credit resources, respectively, as well as their overall balance. For those construction projects that have total credit resources, funds will be provided as much as possible from banks. As for those projects that can be financed by neither credit nor fiscal resources, funds will be raised by issuing bonds, through the fiscal sector, to households, enterprises, and financial institutions so as to discourage the direct purchase of such bonds by the central bank. Finally, it should be stressed that the effective coordination and supplementation of monetary and fiscal policy require the concerted action of other economic policies, such as investment policy and the support of various means, such as administrative measures.

PAUL A. VOLCKER

I appreciate personally this opportunity to join this forum and this conference. As Mr. Erb emphasized at the start, China has had remarkable success with its program and process of reform and opening. It is fair to say that you also have a remarkable set of problems. One senses that you are at a particularly critical time in your economic development and, inevitably, have many questions unique to the Chinese economic and political situation. In reading about China before coming here and listening to Governor Li and talking with some of you, I was struck by the similarity of some of our problems, a similarity of problems with countries in quite different states of development. Let me say that, from my particular perspective, I understand it is much easier to give advice than to take responsibility. I am these days in the happy position of giving rather than taking advice, but I have greater respect for those of you who must not simply talk about problems but must act.

I listened to Governor Li’s statement with great interest. He emphasized a unique combination of planning and regulation in China. Many of his comments sounded quite familiar. He described the multiple goals of monetary policy for full employment, for growth, for balance of payments’ equilibrium, and for price stability. I was struck by the fact that those very same phrases appear in all the directives of the Federal Reserve Board in the United States. Sometimes we engaged in great debates as to which of those wonderful four objectives ought to be listed first, second, and third, in particular situations. But, first of all, I want to draw a lesson from that.

Obviously, monetary policy authorities like to do good in all situations. They would like to see the economy operate with growth, full employment, balance of payments equilibrium, and price stability. We all want to be wise and flexible and adjust our policy instruments to achieve all of those objectives. But I am not sure that that is saying much more than as intelligent, humane people we want to do good. The question is whether we can always do good in all directions at the same time. Monetary policy is an important aspect of economic policy, but it is only one instrument of economic policy.

The unique characteristic of monetary policy is that it deals with money and, in dealing with money, it inevitably deals with markets. Money itself produces nothing, but without money there cannot be efficient markets, and, conversely, without reasonably efficient and effective markets, there is no real purpose in monetary policy. What is important, if we are going to have well-functioning markets, is that there be some sense of monetary stability. Without a sense of monetary stability, I do not think we can have a very effectively operating economy—one in which other participants can produce, will be willing to save, will be willing to invest in the future, and will be able to trade freely with other countries.

I am using monetary stability in a very broad sense. I am thinking of reasonable stability in exchange rates. I am thinking of continuity in financial markets so that one can plan today what might reasonably happen tomorrow. I am thinking of encouraging performance on financial contracts and providing for the repayment of debts on a planned basis, of providing for a basis for lending on reasonable terms, and, when I think of monetary stability, I am thinking, above all, of price stability.

A point that I would like to emphasize is that monetary stability is the first priority of monetary policy, and, when there is a choice of objectives, that is the one that should be emphasized. What that means more broadly is that central banking and monetary policy require a constant sense of placing limits on money and credit creation. Those limits may change from time to time depending upon economic circumstances, but we must always think in terms of appropriate limits because, when money and credit creation is excessive, we will lose the monetary stability necessary for economic activity to perform optimally. That does not put central banks in a very popular position. One of my colleagues as chairman of the Federal Reserve Board used to put the point very simply: he said the function of monetary policy and the function of a central bank was to take away the punch bowl just when the party got good. Another American commentator, in a rather critical way, described a central banker as a person who is always fearful that someone else may be happy. The fact is that the function of the central bank is to set limits, to set a framework—which other people may not like—that provides an environment in which growth and stability may be achieved in the interest of the economy as a whole.

I want to quote two different authorities for that view. German monetary policy and central banking is often widely admired. One reflection of that is in the basic law of the German central bank, the Deutsche Bundesbank. A broad instruction given to that body is very uncomplicated; it says defend the stability of the currency; it does not say anything about economic growth; it does not say anything about the balance of payments; it does not say anything about full employment. I do not think it a pure coincidence that the Federal Republic of Germany has had a strong balance of payments or that it has had good growth and a strong economy during the postwar period. My other authority is quite different; I am thinking of Mr. Lenin, who reminded capitalist countries that the greatest danger to their stability would be inflation debauching the currency. The point I am trying to make is not a matter of economic ideology.

Let me just briefly turn to some characteristics of recent U.S. experience. By the standards of elsewhere, we, for many years, have had reasonable success in stability. At least, we have never had extreme inflation. But we did have serious inflation in the 1970s and early 1980s, in fact the most serious inflation in our entire short history—only two hundred years. We had that inflation partly because, with the best intentions, decisions were taken to create more money in the interest of ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Foreword
• Preface
• Acknowledgment
• Contents
• Overview
• Opening Remarks
• Session I Role of Monetary Policy
• Session II Implementation of Monetary Policy
• Session III Role of Regulation and Supervision of the Central Bank
• Session IV Structure of the Central Bank
• Conference Summary
• List of Participants