It's a pleasure for me to be here and to see so many old and new friends here today. I'd like to takethis opportunity to share some of my thoughts on China's monetary policy and the thinking behind it. In my speech, I'll cover three main points. First, I'll explain how we consider interest rate policy and then let the exchange rate be determined by the market. Finally, I'll touch on our structural monetary policy, especially our efforts to support small and medium enterprises and green finance.
1. Interest rate policy
1.1 What is the appropriate interest rate level?
We are currently implementing a monetary policy, and the Tailor rule is important for us. We think that interest rate is most important in the monetary policy setting. And we consider the long term optimal trajectory and also consider the relationship of the real interest rate and the potential economic growth rate.
I think that the best approach is to set the real interest rate more or less equal to the potential growth rate, both of which are real variables. However, calculating these rates can be controversial. If the interest rate is too high, it can dampen economic growth, while if it is too low, it may fuel inflation and generate bubbles. Therefore, we try to avoid setting the interest rate too high or too low. For practical purposes, if it is difficult to calculate the real interest rate and the potential growth rate, I suggest taking a conservative approach and setting the real interest rate slightly below the potential growth rate. That is the overall strategy.
1.2 How to achieve that appropriate interest rate level?
The literature provides various schools of thought regarding monetary policy, and I think that everyone here, being experts, is familiar with them. Some individuals want a proactive approach, such as monetary policy to do a counter cyclical and Keynesian Theory and Bernanke financial acceleration and also the history of great depression and also the history of great inflation occurred in 1970s. One school of thought suggests that monetary policy should be counter-cyclical and actively intervene in the market with strength, taking into account the financial accelerator.
Another school of thought suggests a more conservative approach, which can be called attenuation. Brainard's (1967) literature on attenuation argues that if there is less certainty about a situation, it is better to act conservatively and leave some leeway when making decisions.
I was trained as an econometrician during my PhD program, and my thesis focused on the Stein estimator. The Stein estimator takes the least square estimator, which is an unbiased estimator, and shrinks it towards the overall mean a little bit. As a result, the risk function, which is the sum of the square deviation, is always smaller for the Stein estimator than for the least square estimator.
What does that mean in interest rate policy? To make the long story simple, when I consider interest rate decision, basically I consider conservative policy or attenuation policy and consider the cyclical as well as across region. Economic cycles have different stages, such as boom or recession, and each cycle takes time. When making an interest rate decision, I consider the current situation of the Chinese economy, but also the duration of the cycle and the next stage it will enter. Additionally, I take into account the cycle and regional averages. Although my focus is on China, I also examine other regions such as the United States, Europe, ASEAN, and Japan. I make decisions cautiously, shrinking towards the cycle and regional averages, which means fully recognizing the time lag of the monetary policy and also looking ahead and trying to act and adjust ahead.
1.3 China’s choice on interest rate policy?
So the philosophy I want to convey is the Golden mean or Golden rule. This is a Chinese philosophy and a philosophy of Aristotle, which means considering the current situation while also looking into the past and future. Additionally, it involves focusing on the Chinese economy while also taking into account other regions of the world. By taking the mean into consideration and shrinking the estimate towards it, we can make decisions cautiously. But the bark of the consideration is still the focusing economy, which is Chinese economy. That is the Golden mean philosophy I'm talking about.
Let me give you a few examples of how this kind of thinking can be implemented in interest rate policy. Consider the period from 2015 to 2023, and specifically the year 2018. The Federal Reserve start to increase interest rate in 2015. And by the time of 2018, the Federal Reserve increased interest rate 4 times during this year. According to balance of payments theory and cross-border capital movement, developing countries should follow the US's lead in hiking interest rates. However, in 2018, we only increased interest rates by 5 basis points at the beginning of the year and then kept them at that level for the remainder of the year.
In 2020, with the onset of COVID-19, the US Federal Reserve reduced interest rates multiple times, as shown by the blue line in the graph. The red line represents the China interbank market 7-day repo rate, which is our benchmark rate. The green line represents the PBOC 7-day repo market operation rate, which we use to target the China interbank 7-day repo rate. Despite the aggressive cuts in interest rates by the Federal Reserve, the People's Bank of China only cut interest rates slightly by 20 basis points. As a result, our market rate went down slightly, but then returned to normal levels. The Federal Reserve cut rates to near zero, but we did not cut as aggressively.
So that was 2020 and the next example is last year 2022. In the last year, because of the inflation pressure, federal reserve hiked rate very aggressively. China was still under covid, China economic situation was pretty much subdued. And the overall demand is weak. So that actually last year we cut interest rate a couple times and also lead the lending rate, or the market rate, went down a little bit.
So that if you look at this period from 2015 to this year, you can see the overall trend of China interest rate is slowly and gradually decreased. But relative to the rest of the world, our interest rate has been fairly stable.
To understand the most important interest rates in China, I have a table here and the following rates are important: the open market operation rate, which is a 7-day repo, currently at 2%; the excess reserve interest rate, which serves as the lower bond of our rate, is at 0.35%; and the standing loan facility, also a 7-day term, currently at 3%. The latter serves as the ceiling of the interest rate corridor, meaning that our market rate should fall between 0.35% and 3%. Our target is about 2%, which is reflected in our open market operation rate.
And then we have the midterm landing facility. The one-year facility currently has a rate of 2.75%. Another important rate is the 10-year government bond yield, which is currently at 2.85%. Additionally, there is the long prime rate (LPR) for 1 year, which is currently at 3.65%, and more than 5 years at 4.3%. This rate is reported by about 20 commercial banks, including 4 or 5 foreign banks, on a monthly basis. To calculate the LPR, we take the average of the rates reported by these banks on the 20th of each month. We exclude the highest and lowest rates, and the average of the remaining rates becomes the LPR, which is a representation of the loan prime rate.
By examining the interest rate table, you can see the floor and ceiling of interest rates. Additionally, the lending rate and 10-year government bond rate are important factors to consider in China. Basically that's the important interest rate in China.
At the beginning, I mentioned my goal of keeping the real interest rate below the potential growth rate. By examining the real interest rate (the red line) and the potential growth rate (the blue line) from 2000 to the present, we can see that the real interest rate is volatile but remains below the potential growth rate.
2. Exchange rate policy
2.1 Interest rate is the core, and the exchange rate is formed by the market under the influence of the interest policy
Now, let me take a few minutes to explain China's exchange rate policy. Interest rates are the key factor and exchange rate is determined by the market. This is the basic message that I want to convey and China have this exchange rate reform for a long time.
2.2 China’s market-oriented exchange rate reform and RMB flexibility
As Adam mentioned earlier, I served as the head of SAFE for seven years. SAFE is responsible for implementing capital control policies. During my tenure, I worked to promote greater freedom for individuals and private enterprises. Governor Zhou Xiaochuan was very supportive of these efforts, and we also reported to the State Council. I believe that providing more choices and freedom to individuals and enterprises, especially those in the private sector, is beneficial.
During my time as the head of SAFE, we implemented several policies to increase the freedom of individuals and private firms. For individuals, we allowed a 50 thousand US dollar quota per year for exchanging currency. Private firms were given more freedom for cross-border trade and investment, provided they had a legitimate economic background. I wanted to give individuals and private firms as much freedom as possible, because I remember how difficult it was to exchange RMB for foreign currency when I was a student and faculty member. I believed that people should have the choice to exchange currency on their own, without having to rely on friends or relatives.
At the beginning, some people were very suspicious of the policy because they believed it would lead to an immediate rush to exchange RMB for US dollars, which could cause a collapse. But this policy has been in place for more than a decade, and contrary to initial concerns, nothing has collapsed. Individuals are given a quota of 50,000 US dollars per year and are free to exchange currency as they please. However, only 1% of people have used up their quota, indicating that most are not constrained in any way. This policy has also satisfied the foreign exchange needs of most private trading and investment firms. By giving the market and households maximum choice, we are promoting flexibility, but we have not declared full capital account convertibility. This is an important distinction to make.
If you look at the RMB versus US dollar, you can see that in recent years it's basically two-way floating and looking back over the past 20 years, the RMB has appreciated by an average of 1% per year against the US dollar, resulting in a 20% appreciation overall. Against a basket of currencies, the RMB has appreciated by about 40% over the same period. Although the overall trend over the past 20 years has been towards appreciation, in the past 7 years there has been a two-way floating of the exchange rate.
This picture displays three instances in the past five years where the exchange rate between the Chinese RMB and the US dollar exceeded ￥7 to $1, indicating RMB depreciation. However, after three to five months, the exchange rate returned to below ￥7 to $1. In 2019, the RMB depreciated due to the trade war between China and the US, while the depreciation in the second instance was caused by the COVID-19 pandemic. The third instance was due to the Federal Reserve's aggressive rate hiking.
Basically the interest rate in China has been stable, as demonstrated earlier. However, since the US has aggressively increased its interest rates, the yield rate of US government bonds is now higher than that of China's government bonds. The blue line on the graph represents the difference between the yields of the two countries. When the blue line falls below 0, it means that the yield rate of the US is higher than that of China. As the US dollar is the dominant currency and China is a developing country, China typically maintains a slightly higher interest rate to achieve equilibrium. Despite the current situation where the US government bond yield is higher than China's, the capital movement and exchange rate remain in equilibrium, indicating that there is no sudden large-scale capital flight or other disruptions.
So that's the exchange rate. And our market is deepen and more firms use the derivative and future tools to hedge against the exchange risk. Basically the exchange rate market is more market oriented.
2.3 The interest rate and exchange rate support each other
So if you have right monetary policy, and then I think you make sure the exchange rate is determined by the market and the central bank intervene as less as possible. We gradually just phase out our intervention to the market.
The history of central bank intervention in the exchange market shows that eventually the market will overcome the central bank's efforts to stabilize the exchange rate. Therefore, it is important to gradually phase out interventions and reduce their frequency to zero. But again, at this time, I haven't announced that we have no intervention. And we still, in the policy statement, we still follow the IMF suggestion that under the extreme capital flight situation, we reserve the right to intervene. And in order to intervene, we requires a strong team to make decisions, which can be challenging since market players are generally more knowledgeable and better paid than government officials. It is therefore advisable to rely on market forces rather than intervention, as the market is ultimately always right.
Thanks to the monetary policy and exchange rate that I have described, China has enjoyed a very stable inflation rate. In fact, last year China's Consumer Price Index (CPI) was 2%, which is consistent with the average CPI over the past 5 and 10 years. Achieving a 2% CPI is the goal of many central banks, and there is often reluctance to deviate from this target. Therefore, it is a coincidence that China's inflation rate has consistently been at this ideal level in recent years.
Looking at China's balance of payments situation, we can see that it has improved as a percentage of GDP. Our policy is not to pursue a current account surplus, and we or I think the best way is that current account more or less balance. And the best way is balance of payments is balanced.
3. Structural Monetary Policy Tools
And I will spend a couple minutes on the structural monetary policy. Currently, there is a structural monetary policy in place which maily aims to provide support to small and medium-sized enterprises. And the outstanding balance sheet at the People's Bank of China is 6.4 trillion RMB, which is equivalent to approximately 1 trillion US dollars. This represents 15% of the People's Bank of China's balance sheet and reflects the extent to which the bank is committed to supporting the structural monetary policy.
In China, an inclusive loan program has been established, which has provided support to small and medium-sized enterprises. This program defines an inclusive loan as being 10 million RMB or less, which is approximately 1.5 million US dollars or less. The program has already reached over 56 million small and medium-sized enterprises, and has helped many of them survive the COVID-19 pandemic.
In addition to the inclusive loan program, we also have a carbon emission reduction facility operated by the People's Bank of China. We have this carbon reduction facility in 2021. This facility has been used by commercial banks to support carbon reduction projects, and has mobilized more than 600 billion RMB in loans. In 2022, this facility helped achieve the equivalent of 100 million tons of carbon reduction. Commercial banks using this facility are required to disclose information related to the carbon print of the products they support, and the information is subject to third-party verification. While there are differing opinions on green climate change policies in China, the People's Bank of China believes that disclosure is crucial, and requires commercial banks to disclose information on a quarterly basis. The bank believes that the quality of information will improve over time, and that disclosure will help enhance social awareness of the urgency of climate change.
So that's the key takeaways and I basically take this opportunity to explain the exchange rate and interest rate policy as well as at the end, I explained a little bit about the structural management policy, mainly supporting the small enterprises and climate change activities.
4. Q&A part
Adam: Before we go to the audience our distinguished colleagues for questions, I'd just like to ask you a couple questions on some things in your presentation then about the world. First one was it was quite compelling you're putting up the chart and mentioning the desire to keep interest rates below the growth rate. Our colleague Olivier Blanchard of course has gotten us all t-shirts saying R minus G you know negative that's good. But this is the first time I’ve actually heard about a policy maker let alone a monetary policy maker talk about that. If you could expand on that a little it was this genuinely a part of the policy discussion to keep in mind the relative growth rate and the interest rate especially when you're setting as you said attenuating policy or is this something after the fact, you're happy to find it worked out this way.
Yi: Yes, this has been a consideration but of course as I said that the most difficult thing is how to calculate it. Right now the real interest rate I showed up in the graph is the bank lending rate minus CPI inflation that's the real interest rate right and the potential growth rate is also very controversial and you see my colleagues at beida and always think that the potential growth rate is very high, and the graph I use the potential growth rate calculated by my colleague in qinghua University so that I think you see it is theoretical ideal situation but as far as it's a policy thinking is concerned it's very difficult to calculate. But despite of that if you have that kind of thinking and as a guideline it doesn’t hurt to have this kind of discussion. But to answer Adam's question in the real economic policy our monetary policy decision making these are smaller than G is a little used.
Adam: I was just surprised following up on again on your Crystal-Clear explanation of interest rate policy. One thing which you did not mention although of course it is part of the bank's remit is the interaction between monetary policy and financial stability. I know that your title and your intent here was the focus on monetary policy practice, but this week we've had a number of central bank governors come through Peterson and make various declarations about the separability of financial stability and monetary stability. Particularly Europeans saying there's no conflict between us raising rates and financial stability. How do you reflect on that question? Has financial stability been separable for you that you can use macro-Prudential and not interest rates?
Yi: I think that's a very good question. It's a very deep question in the normal situation you have to conduct your monetary policy major conquer the inflation and consider the financial stability. You see is a secondary. If this is the normal situations this two decisions could be separate in the normal situation. But in period where you have a real risk especially you might have a systemic risk financial stability danger ahead of you. Then when you make the monetary policy interest rate hiking decision you can’t totally separate with the financial stability situation. So that you really have to think this very carefully because you see as you hiking the rate you have to there is an impact on the credit ability and also there is an impact on the assets that financial institution holding and also there is an impact on other things and all the above, they have implications of could be have impact on the financial stability situation. So that to answer your question for central bankers, they think that in the normal situation these two decisions should be separated but for practical purposes then sometimes especially in a dangerous period, you have to consider them jointly and the People's Bank of China our mandate is price stability and financial stability. So that this is a two-team pillar for us. So that from the mandate we have to consider the both.
Adam: If I could just follow up on that coming out of the two congresses and recent decisions. It's been widely reported that there's a reorganization of some of the Financial supervisory and Regulatory Agencies to some degree in China, leaving aside the issue that this may mean that people in the government will be even lower paid versus people in the market which frankly I think is inverse to worth. But that's just more broadly how should we think about the planned or underway reorganization of financial stability organizations in China, are you creating more of a FSOC like the US aspires to?
Yi: The recent decision is that China will establish the National Financial Supervisory Authority based on CBIRC you see now we have we have CBIRC everybody familiar with that right based on CBIRC. China will establish National Financial Supervisory Authority. I think that probably can strengthen financial supervision. And you see after that People's Bank of China is still the central bank and also, we have the responsibility of part of the banking, we have a supervisory responsibility on something like a payment like cash issuance and something like the infrastructure and so on so forth. But the main supervisory authority and the responsibility will be under the National Financial Supervisory Authority. All the banking and the insurance except the capital market and the security will be continued to be supervised by CSRC. So CSRC remain the same continue to take care of the security and the capital market whereas the new institution established the National Financial Supervisory Authority will take the entire banking insurance including the consumer protection responsibilities.
Adam: Thank you for clarifying. Let me ask one more question or a pair of questions on the exchange rate because it was terrific given your background and your knowledge to have you take us through recent years of the Chinese exchange rate policy. Let me say any of our audience members who wish to ask Governor Yi a question could go to the microphone that's standing there in the middle. I'll be happy to recognize you next Jessica is kindly making the microphone where it should be so on the exchange rate if I could two questions, I mean first off just to say one of the many reasons I and others think of you as a great technocrat is that you have been solely pushing for this more market determined exchange rate in the interest of the Chinese people and talking about freedom as you did. And so, we admire that or at least I do. So two questions, first is amidst your description of the last decade plus there really didn't seem to be much mention of what happened in 2015, where as I recall there seemed to be some market turmoil around a slight opening further of the capital account our mutual friend and colleague you young ding at the time of course was saying former PBOC advisor was saying you know it's terrible to open up, how do you assess this was there a specific trigger of large capital flows? I mean I'm just juxtaposing this with your very striking fact that 99% of the households don't use their 50 000 a year so just if you could put in context why there was such a big capital outflow then and now it seems relatively stable.
Yi: I think we do have market pressures in 2015. RMB have the pressure of depreciation and also you can see obvious decrease of the official foreign exchange reserve during that period. But I think if you look at the back the lesson you want to learn from that episode is that how to manage expectation. I think if you have the household and the enterprise and also plus the foreign investor their expectation getting diverged and then you have a tremendous pressure and also that's the first lesson. The second lesson is that you see even under the pressure you have to believe that market adjustment is by and large and rational and then if you continue to make the policy and the mechanism to be market design exchange rate policy and then eventually it will go back to equilibrium actually in 2015. There is a debate that whether you should take back all the policies like 50000 US dollar per person policy and you should restrict the capital control policy. They use the sum of the macro potential policies but they didn't take back the most important priority like I said the enterprise choice of trade and the investment need of exchange and we didn't take back 50000 per person policy but still the rate getting stabilized, so that is actually a test. I would say that if you have the ability of maintain the have a guidance of market expectation well and also if you believe that the market mechanism, I would say that this kind of uh you see exchange rate mainly determined by the market and demand and using a basket of currencies as guidance. Basically, you can still call it a managed floating regime but it has to be primarily determined by the market, market is still working.
Question1: What are your feelings about the growing use of the RMB in trade in the years ahead?
Answer1: I think the RMB use abroad elsewhere I think it's a market-oriented activity. They respect the choice of enterprises and household if they want use RMB that's fine. If they won't use the US dollar, Euro and the Japanese Yen that's fine too. I think it should be having the level field of equal competition given that China's trade and investment activity getting large scale I think it is natural for some enterprise feel that it's convenient to use RMB and save some foreign exchange cost. I think that is fine. But in our policy, we would like to make the level of paying field in equal.
Question2: I have a more technical question for governor Yi. We have a proprietary indicator on financial conditions on China primarily made of interest rate exchange rate and total social financing growth. So far it has been performing really well as a leading indicator, kind of telling us where the growth would be going towards however in the past four to five years as the increase of the structural monetary policy tools have stepped up, we realized that the financial conditions tracking has not been as accurate as before. So actually, going back to yours what will be a suggestion for your addressing such a problem that there is a divorce between using such policy rates and looking at China's financial conditions?
Answer2: For Qiao Hong’s question, I think I have to look at your question. Your question is a very good question, but I have to look at this situation the financial condition index, and using the interest rate, the exchange rate, total social finance and so on to overall estimate the financial condition. You pointed out a very good question that is suggesting there is there might be some divergence of the policy rate and market rate. That is a phenomenon that I think I want to avoid. Basically, I announced that my policy rate, I think that policy rate should influence the market rate. Basically, the resources allocation and the financial the fund allocation should be allocated by the market rate. That's the design of my policy. But it's a good question I have to look at it and see whether it's a diverge I'll create some problem if you have a writing let me know and send it to me. I will look at it.
Question3: A year ago the United State government froze Russia's foreign exchange reserves in dollars, which might make them seem perhaps unsafe for a country like China which has some friction in its geopolitical relationship with the United States. I'm wondering how that affects the way you think about your international financial stability and the status of your foreign exchange reserves.
Answer3: I think for the first question, we will continue our policy. I think this world is a world a rule of law and there is an international economic and financial architecture. Globalization free trade, we have MF and World Bank, WTO. On the governance, we have a United Nations. I think we have to really think that under this global economic and financial order, and that's the best for the welfare or for people in the world in even for different country that's the best for us.
Question4: A simple question about the Sri Lanka's debt problem. Japan and India and France announced a common platform for talks among rhetorical creditors to coordinate the restructuring the Sri Lanka's debt. Do you think China should join this platform? If not, what kind of idea do you have to resolve this problem?
Answer4: You specifically mentioned the Sri Lanka case and you know that China committed to G20 common framework. Sri Lanka is a middle-income country it's outside of a common framework but I think still that sustainability is very important. If you be a little bit deeper and you'll know that recently if discussed the Sri Lanka case and China accent bank representing. China to issue the financial assure letter to the case so I think for combating the global debt distress, it needs international cooperation and I think certainly in this very serious situation of global debt distress, they should work together and the international cooperation is more important. If we can cooperate, if we can have equal and a fair share of the burden, I think they can solve the problem.
Question5: I know you've emphasized in the past that China is looking to shift to full currency convertibility, when do you see that in your eyes and how do you think that will affect the one either going up or down?
Answer5: To make it simple right now we don't have that date, but I will continue to have the policyto make further convenience for household and business especially small private business to useforeign exchange.
Question6: So, we noticed that Governor Yi have met chair Powell during the spring meetings while the statement is pretty brave so just wondering could you share more about this meeting and what's your take away from that. By any chance if you have any opportunity to have a conversation with security Yellen during the spring meeting because Yellen said she still hoped to visit China just wondering uh could you also comment on that.
Answer6: I think we just had the G20 Finance Minister and Central Bank Governor's meeting, and we have the IMF and World Bank Spring Meeting. I think the overall tone of those meetings and also bilateral meetings are that we have the challenges, and the international organizations predict that the global economic growth of this year is a is not very high number. And you know the IMF prediction and the World Bank production and also the inflation situation is still challenging and plus we have uh energy and food situation it's pretty tough. And also, we have the debt distress problem. So given all the problems we have, it is the spirit of the meeting that international macro policy coordination is important. They should have a concrete consultation and more efficient action to solve those international problems. And then at this time a solidarity and the cooperation and the coordination or exchange of information is important. Of course, we think that for the major economies at this point the communication and the policy cooperation is even more important. That is our thinking. During the discussion of the meeting a lot of people have a very good proposals and discussions, I would certainly like to see those become policy reality, and make the people of the world better off.
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