Monetary Policy Implementation in East Asia

Understanding the monetary policy of China, the world’s second largest economy, is more crucial today than ever, and yet it is not widely researched or well-understood outside of China. This chapter tries to narrow this gap by shedding light on the institutional setting of China’s monetary policy, and by assessing its main tools and current challenges. It finds that, despite the progress and sophistication of Chinese monetary policy in recent years, for example, by moving from quantity-based to more price-based tools, its implementation suffers from shortcomings in communication and a lack of independence from political interference. Ultimately, it seems to be the Chinese Communist Party (CCP) that determines the “room for manoeuvre” that the People’s Bank of China (PBC) has in order to maintain monetary and financial stability in the rapidly changing domestic and global environment. As a result, even in terms of communication, the PBC seems to deviate from today’s central bank norm of taking transparency for granted for effectively managing inflation expectations.

The implementation of inflation targeting in Korea highlights the importance of distinguishing between its symmetric and asymmetric operations. When Korea suffered from high inflation, the Bank of Korea set the inflation target at 3%, instead of 2%. Given its underlying intention to lower the inflation rate to below 3%, rather than to maintain it centred at around 3%, its operation of inflation targeting was not necessarily a failure even when the inflation rate fell below 2%. In contrast, it would be a complete failure if the inflation rate rose above 4%. Clearly, this asymmetry cannot be applied to the operation of many advanced economies which, by adopting a target set at 2%, have endeavoured to insure that inflation is neither running persistently above nor below this target.

This chapter discusses the declared exchange-rate policies of East Asian central banks and compares these with the de facto policies. Central banks that officially proclaim a fixed or managed exchange rate tend to intervene more in foreign exchange markets than central banks which officially follow a floating regime. However, even central banks that have implemented inflation-targeting frameworks with floating rates appear to carry out interventions. Several countries that self-describe their exchange-rate regime as “managed floating” appear to have been heavily engaged in foreign exchange-market interventions.

Cross-border capital flows account for a significant share of Taiwan’s interbank foreign exchange transactions, and some active foreign investors play a key role in the total of foreign capital flows. Large and frequent short-term capital movements pose one of the major threats to financial stability in Taiwan. Confronted with this challenge, the Central Bank of the Republic of China (Taiwan), or CBC, employs a range of measures to manage the foreign exchange market and capital movements. This practice fulfils the CBC’s legal mandate of maintaining the stable value of the new Taiwan dollar (NTD) to underpin economic growth in Taiwan. Because of great dependency on imported energy, high foreign portfolio investment, the lack of International monetary Fund (IMF) membership and reserve currency status, Taiwan’s reserve holdings stay at a relatively high level, which provides a necessary buffer to reduce excess volatility in the NTD exchange rate, instead of any attempt at competitive depreciation.

Singapore’s monetary policy is centred on the management of the Singapore dollar exchange rate against a trade-weighted basket of currencies of its major trading partners. The Monetary Authority of Singapore (MAS) manages the Singapore dollar exchange rate within an undisclosed band by intervening in the foreign exchange market as necessary through the purchase and sale of the Singapore dollar against the US dollar. In the context of a small open economy, the choice of the exchange rate as an instrument of monetary policy implies that the domestic interest rate is endogenous. As such, MAS’ money-market operations are aimed at ensuring adequate liquidity in the banking system to meet the demand of banks for reserves both for the statutory reserve requirement as well as for the settlement of interbank transactions. Given Singapore’s status as an international financial centre and the attendant high degree of capital mobility, monetary policy operations in Singapore—involving foreign exchange interventions and money-market operations—are not without their challenges. This chapter discusses the key features in the market mechanisms and operating procedures that enhance the effective implementation of monetary policy operations in Singapore.

The planned and the realised asset purchase programmes of the European System of Central Banks (ESCB) have spurred highly controversial debates. Not least, legal concerns have been expressed, mainly in Germany. A score of decisions of the German Federal Constitutional Court and two judgments of the Court of Justice of the European Union have so far been the result. A novelty here was the reference to the European court for a preliminary ruling by the highest German Court in 2014. A second referral took place in 2017. The final judgment of the German Federal Constitutional Court (GFCC) on the purchases in the framework of the Public Sector Purchase Programme (PSPP) of 5 May 2020 could not be considered any more; for a first evaluation see Siekmann, Europäische Zeitschrift für Wirtschaftsrecht, p. 491–500.

This chapter highlights exchange-traded funds (ETF) purchases conducted by the Bank of Japan under Quantitative and Qualitative Monetary Easing with Yield Curve Control. The policy to purchase stocks indirectly is unprecedented in terms of both scale and duration among major central banks. The purpose of this policy is to promote portfolio re-balancing among individuals, in addition to achieving the 2% price-stability target. While stock prices have more than doubled, individuals have remained largely risk-averse, and foreign investors have increasingly dominated the stock market. Moreover, the BoJ has become one of the largest (silent) investors, with the growing impact on stock prices through the reduction of the downside risk and the possible overvaluing of some small-cap listed firms. Given that achieving 2% inflation is a distant future prospect, the BoJ may find it necessary to unwind the policy gradually by purchasing ETFs only when the stock market is under severe stress, and thereby reduce the annual pace of ETF purchases from about ¥6 trillion. This view is in line with the BoJ’s adjustments announced in July 2018 on introducing flexibility and changing the composition of ETF purchases. Whether the BoJ will be able to take a clearer, more decisive step remains to be seen, however.