Abstract: Since 2020, the People's Bank of China has rolled out a number of structural monetary policy tools, which have played an active role in many fields. As these tools gain importance in the central bank's policy toolkit, it is necessary to assess the boundaries of such tools, and better balance five relationships, i.e. those between: government and market, structural policy and policies that affect all industries, regions and entities, monetary policy and fiscal policy, partially optimal policy and overall optimal policy, and the number and the effect of structural tools.
The People's Bank of China has rolled out a number of structural monetary policy tools since 2020, which have made effective contributions to fighting against the pandemic and ensuring supply, promoting resumption of work and production, protecting business entities, supporting low-carbon transformation, ensuring coal supply, supporting technological innovation, and providing elderly care.
Structural monetary policy tools have a number of advantages. They can reflect central bank’s policy orientation, leverage more funds, and make full use of commercial banks’ on-the-ground knowledge about businesses and projects. Compared with traditional policy tools such as RRR and interest rate cuts, structural monetary policy can more easily achieve “precise irrigation” by channeling funds directly to targeted groups. In this way, big goals can be achieved at low cost.
As structural monetary policy tools grow in number (around ten as of now) and importance and inject more sizable funds into the economy (the outstanding balance is estimated to surpass three trillion yuan), it’s time to make an assessment as to whether it’s always better to have more such tools. If that’s not the case, where are the boundaries of the use of such tools? To answer this question, we have to consider the following five relationships.
I. FIVE RELATIONSHIPS TO BE CONSIDERED IN THE USE OF STRUCTURAL MONETARY POLICY TOOLS
1. The relationship between government and market
A necessary condition for the introduction of any structural monetary policy tool is unsatisfactory credit allocation formed by market forces. In this case, the central bank must use structural tools to influence banks’ credit structure and business decisions.
Despite the funds provided by the central bank and the incentives embedded in such tools, structural monetary policies play their roles also through the policy intentions they express and regulatory pressure they exert during implementation. The price of central bank funds is not much different from that of banks' own funds, and the amount allocated to each bank is rather limited. At the same time, restrictions are imposed on the interest rate of these loans. Thus, structural monetary policy can hardly provide the incentives to materially change banks’ behavior.
Actually, more use of structural monetary policy means more administrative intervention in bank credit allocation, lower proportion of credit allocated by the market, and greater influence of the central bank on business decisions of commercial banks. Therefore, the use of structural monetary policy should fully consider the relationship between the government and the market. The market should be allowed to play the decisive role in resource allocation and the government should do its own job well.
2. The relationship between structural policy and policies that affect all economic operations
Instead of flooding the market with liquidity, the central bank can use structural policy tools to channel a small amount of funds to companies, industries or regions that are in urgent need. This is an important advantage of structural policy and an important justification of their use. But the application of such tools must be prudent so as to retain their advantages, for the following reasons:
First, funds flow, so precision is a relative concept. There is essentially no difference between the funds injected by the central bank into the market through structural policy and those through other tools such as RRR cuts and open market operations. Although the funds provided by the structural policy have some restrictions on their use and usually come in the form of relending (i.e., commercial banks have to issue loans to targeted businesses and sectors before they can receive the relending funds from the central bank), once flowing into banks, they are no different from the rest of the funds that banks have.
Moreover, every 1 yuan of base money provided by the central bank can roughly create 10 yuan of M2. Even if the central bank can control the use of the 1 yuan it directly puts into the market, it can hardly control the subsequent use of the money and the 9 yuan created by credit. That is to say, the precision of structural tools is a relative concept.
Second, structural monetary policy also has effects on aggregate money supply. When structural tools are not frequently used and the amount is small, their impact on the aggregate monetary supply is limited and can be ignored. But when such tools are used on a large scale, their effect can no longer be overlooked.
Over the past two years, structural policy has actually become one of the main channels for the central bank to increase base money. Therefore, it not only affects the structure, but also the aggregate of money supply. It is necessary to recognize this effect that structural policy may bring.
3. The relationship between monetary policy and fiscal policy
In terms of policy goals or policy means, structural monetary policy stands in the middle of monetary policy and fiscal policy.
From the perspective of policy goals, structural monetary policy aims to provide financial support to specific industries, regions or economic entities, which is usually the role of fiscal policy in most developed countries.
From the perspective of policy means, the central bank provides low-cost funds or even direct subsidies, while fiscal discounts or subsidies can also achieve the same effects.
Therefore, structural monetary policy can be said to have strong fiscal policy features.
That monetary tools have the features of fiscal policy is not a problem in itself. This is seen both internationally and domestically. However, when structural monetary policy is used on a large scale, the relationship and boundaries between monetary policy and fiscal policy must be carefully evaluated. If the central bank assumes too many fiscal functions, it may affect both monetary and fiscal discipline.
4. The relationship between partially optimal policy and overall optimal policy
A key element of structural monetary policy is to choose specific areas to support, which leads to the problem of how to balance between partially optimal policy and overall optimal policy.
From the perspective of individual departments or regions, they would consider themselves the one that needs support most and would attempt to obtain more resources from the central bank. The central bank also has its own considerations when selecting key areas to support. But these are choices that may be good for some, but not necessarily best for all.
Assessment of effectiveness of structural monetary policy should take into account not only whether the policy has achieved the goals set, but also the necessity and urgency of the specific areas receiving support from an overall perspective, and the irreplaceability of monetary tools in providing said support.
5. The relationship between the number of tools and the effect of tools
The relationship between the number and the effect of structural policy tools might be inverse: the more tools there are, the less effective a single tool will be.
This is because more tools disperse the focus, and it is difficult for both the central bank and commercial banks to juggle many tools at the same time. Different tools require different management, target different groups, and have different interest rates and term structures, so the difficulty of management will rise exponentially with the increase of their number. Too many tools will also lead to fragmentation of balance sheet management for both the central bank and commercial banks.
II. POLICY RECOMMENDATIONS
1. Set the conditions
The introduction of new structural monetary policy tools should meet at least three conditions. First, market failure in credit allocation requires policy intervention. Second, monetary policy tools are better than fiscal policy, regulatory policy, or credit policy at achieving the desired results. Third, direct, clear, and effective transmission channels exist for these tools to take effect. If the above three conditions cannot be met, structural policy tools should be introduced cautiously.
2. Control the amount
Controlling the total amount of structural monetary policy tools means two things. First, set an upper limit on the number of tools. For example, no more than 6-8 structural tools should be used at the same time, making it easier to focus and manage. When introducing a new tool, an existing tool should be withdrawn. Second, set a cap on the amount of funds injected through structural policy tools. Too much capital will flood the economy and weaken monetary and fiscal discipline. It is recommended that annual increase of funds injected through structural monetary policy not exceed RMB100 billion.
3. Do policy assessment
The evaluation of the effect of structural monetary policy should be done promptly. On top of internal evaluations conducted by relevant government departments, third-party evaluations can be done by universities and think tanks, which requires more information disclosure to the society. Tools that perform well can stay, and those that perform poorly should be phased out.
This article is part of the CF40 Briefing Series.
