Central Bank Governor Says M2 Lacks Precision as Monetary Policy Tool

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The head of the People’s Bank of China has confirmed that the central bank will focus more on price-based measures when implementing monetary policy, highlighting the declining importance of the M2 money supply as an indicator and policy tool.

The conspicuous absence of a concrete M2 growth target in China’s 2018 Government Work Report has prompted analysts to conclude that the Chinese central bank is tilting monetary policy towards price adjustments.

In 2017 M2 money supply growth fell to record low levels, yet this did not stop China from posting a sizeable GDP rebound for the year.

The People’s Daily has pointed out that the relationship between M2 and economic growth is on the decline, as the factors affecting the money supply as well as its relationship with the broader economy become more complex.

Remarks by People’s Bank of China governor Zhou Xiaochuan would appear to vindicate speculation of a shift towards price-based monetary policy tools.

“M2 isn’t an extremely precise tool for weighing up the loosening or tightening of monetary policy,” said Zhou¬†at a press conference held on 9 March as part of China’s 13th National People’s Congress.

“If M2 readings do not change significantly within the short-term, how should we view this?

“If M2 and nominal growth are basically consistent, then from the perspective of broad money supply we aren’t loosening or tightening. If M2 is greater than nominal GDP growth, then monetary policy is loosening slightly, if it’s lower then it’s tightening slightly.”

Zhou also noted that monitoring GDP alone is not enough for monetary policy, and that policymakers need to look at both prices and employment levels when weighing up either tightening or loosening.

“In future the focal point will perhaps shift from quantitative changes in broad money to a focus on prices.”

With regard to whether China will follow the US Federal Reserve’s interest rate hikes, Zhou said that the recovery of the global economy meant that many countries were gradually withdrawing from quantitative easing, and this meant that we were likely bidding farewell to an era of low interest rates internationally.

Given that China is part of the global economy, Zhou said that “impacts in these area can be expected.”

Zhou also noted that the Chinese economy is undergoing a shift in terms of its growth model, transitioning from the pursuit of growth in quantity to high-quality growth.

“The total volume of broad money in China’s economy is already quite large, and when pursuing quality growth, we will perhaps cut down on prior growth methods that were heavily dependent upon capital support.

“Under these circumstances, there will be corresponding repercussions in the areas of monetary policy and foreign exchange policy.”

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