Why China's central bank wants to emulate the US Federal Reserve

Yet still toe the party line on Beijing's control of macroeconomic policy

The Chinese central bank could soon resume its purchases of government bonds, after putting the practice on ice at the start of the year.

The move would mark the relaunch of an ongoing reform campaign to bring China’s execution of monetary policy more closely in line with traditional mainstream practice, as embodied by the open market operations of the US Federal Reserve.

It would also serve to further cement China’s distinctive macroeconomic system, which involves the joint coordination of monetary and fiscal policy, instead of their rigorous separation as mandated by other major economies.

How China’s macroeconomic system is distinct

Macroeconomic policy refers to government policies that affect the economy as a whole - in particular aggregate levels of demand. Its two primary branches are fiscal policy - which concerns government spending and taxation decisions, and monetary policy - which involves adjustments to interest rate levels and the money supply.

A distinctive feature of modern China’s macroeconomic policy system is the unified control and coordination of both monetary and fiscal policy by the State Council - Beijing’s government cabinet.

This stands in sharp contrast to the macroeconomic policy systems of other major economies, where there is usually a rigorous formal separation between fiscal and monetary policy formation.

Monetary policy - in the form of the setting of interest rates and adjustments to the money supply - is determined by a central bank that in theory operates independently of the incumbent government.

This central bank is headed by a government-appointed official, who is privilege a lengthy tenure that insulates him or her from the fickle exigencies of the election cycle.

By contrast fiscal policy - in the form of decisions on government spending and taxation - is determined by elected officials drawn from the ranks of whichever party currently wields power.

The granting of independence to central banks is designed to prevent democratically appointed governments from improving their election chances by means of the opportunistic loosening of monetary policy.

While this can boost the economy in the short term, it can also lead to painful inflationary consequences further down the road.

Because China is under the control of a single party, there is no need for concern that policymakers will use monetary policy to prime the economy during election seasons, for short-term gain at the cost of potential long-term pain.

This gives Beijing the arguable advantage of being able to employ fiscal and monetary policy in unison, to make more coordinated and potentially more effective macroeconomic adjustments.

Despite Beijing’s long-standing fetish for the rhetoric of reform, this distinctive feature is set to further continue as an embedded part of the Chinese system.

This was signalled by the establishment of a Joint Work Team (联合工作组) by China’s central bank and the Ministry of Finance (MOF) in the final quarter of 2024, to strengthen the coordination of fiscal and monetary policy decisions.

China wants to mainstream monetary policy

The launch of the Joint Work Team shows China is undoubtedly intent on maintaining the distinctiveness of its macroeconomic system when it comes to the unified formulation of fiscal and monetary policy.

When it comes to monetary policy specifically, however, the Chinese central bank is headed in the opposite direction.

It’s pursuing reforms that normalise its implementation of monetary policy, bringing it more closely in line with traditional mainstream practice as embodied by the open market operations of the US Federal Reserve.

The Chinese central bank has long employed seven-day reverse repos and medium-term lending facilities (MLF) as its chief means for injecting liquidity into the financial system.

This process essentially involves collateralised lending to select financial institutions by the Chinese central bank via its open market operations. The interest rates for reverse repos and MLFs are considered to be China’s official “policy rates” for short and longer term tenors respectively.

The Chinese central bank has been pushing for reforms, however, to instead use the trading of government securities to achieve adjustments to the money supply and interest rate levels - the traditional method for the implementation of monetary policy employed by the US Fed and the world’s other leading monetary authorities.

Central bank governor Pan Gongsheng (潘功胜) made the pursuit of such reforms clear and explicit in a landmark speech he delivered at the 2024 Lujiazui Forum held in Shanghai’s iconic financial district last June.

Pan called for “gradually making secondary market trading of government bonds a part of the monetary policy tool kit.”

“Following the rapid development of China’s financial markets, and the gradual increase in the scale and depth of the bond market, the conditions are gradually ripening for the central bank to use secondary market trading of government bonds to release base money,” he said.

Central bank officials have since referred to government bond trading as “an important means of diversifying the monetary policy tool kit and strengthening the management of liquidity.”

“The chief purpose of trading in government bonds is to inject base money and manage liquidity - we will both buy up and sell out.”

China’s macroeconomic coordination continues…

The Chinese central bank made good on the words of Pan Gongsheng in the second half of 2024, just following his landmark speech at the Lujiazui Forum in June.

During the five months from August to December 2024, the central bank made monthly net government bond purchases of 100 billion, 200 billion yuan, 200 billion yuan, 200 billion yuan and 300 billion yuan. This translated into one trillion yuan in net purchases.

The move marked a concrete shift in the way the Chinese central bank executes monetary policy, towards practices more in line with the way the Federal Reserve has traditionally done business.

It also served, however, to fully embody the unified coordination of monetary and fiscal policy that sets China apart from other major economies.

The Chinese central bank’s injection of one trillion yuan via government bond purchases coincided with the issuance of one trillion yuan in ultra-long-term bonds by the Ministry of Finance (MOF) in 2024, as the forerunner to further stimulus-driven debt issues by Beijing.

Pan indicated in his Lujiazui Forum speech that the central bank would “strengthen coordination with the Ministry of Finance, and jointly drive implementation.”

The Joint Work Team established by the Chinese central bank and MOF also held its inaugural meeting in October 2024, just a month after the central bank launched its debut cycle of government bond purchases.

Domestic observers said the launch of government bond trading by the Chinese central bank was fully intended to provide a complementary financial environment for expanded debt issues by MOF, in anticipation of a new status quo of deficit spending by Beijing.

MOF was in turn paving the way for the Chinese central bank to alter its monetary policy practices, by providing it with the requisite supply of government bonds to serve as the fodder for open market transactions that adjust the money supply.

Why the central bank suspended government bond purchases

Since January of this year, the Chinese central bank has suspended the purchase of government bonds as part of its open market operations, relying instead on its old stand-bys of seven-day reverse repo and MLF operations.

This appears to run contrary to Pan Gongsheng’s explicitly stated reform goals, as well as Beijing’s clear plans for large-scale fiscal and monetary stimulus in 2025, to deal with the protectionist head winds of Trump’s second term in office.

Domestic analysts say the Chinese central bank suspended the purchases due to concerns over high bond prices, low long-term yields and the related implications for the yield curve.

Many have pointed to an “asset drought” in China that has driven up the price of government securities. This issue has been further exacerbated by Chinese households making an exodus from bank deposits in response to low interest rates, turning instead to wealth management products that are backed by bond investments that benefit from these same low rates.

The ongoing purchase of government bonds by the central bank would serve to exacerbate this issue, by creating additional demand that puts upwards pressure on their prices. It would simultaneously boost demand from institutional investors, who would be anticipating heavy purchasing by the central bank.

This would in turn further depress long-term interest rates, putting pressure on the yield curve, during a period when Chinese commercial banks have been struggling with the narrowing of net interest margins and its impacts on their profitability.

Observers have also expressed concern that the Chinese bond market could form expectations of a central bank “put” on government bonds - that the central bank will step in to support the bond market with purchases if prices were to decline too much in future.

Mainstreaming of monetary policy set to resume

As the final quarter fast approaches, expectations are now on the rise within China of the resumption of government bond purchases by the Chinese central bank.

The Joint Work Team held its second meeting in early September, reportedly discussing topics that include the management of government bond issues and how the central bank will executes related transactions.

Domestic analysts say the meeting points to the heightened likelihood of the Chinese central bank buying more government bonds before the end of the year, in order to provide liquidity and stability to financial markets.

Zhang Xu (张旭), chief fixed income analyst at Everbright Securities, said to the state-owned China Securities Journal that the central bank’s renewed trading of government bonds would be part of the “further expansion of counter-cyclical monetary policy adjustments” (“稳增长扩内需 财政货币政策协同性将继续增强.”)

“The focus will be on expansion of demand, invigorating confidence, and driving the ongoing improvement of the economy,” Zhang said.

While this development would put reforms for the mainstreaming of Chinese monetary policy back on track, it would also serve to further cement China’s distinctive brand of unified macroeconomic management.

Wang Qing (王青), chief macroeconomic analyst at Golden Credit Rating, said the resumption of government bond purchases by the Chinese central bank would be a part of the continued coordination of fiscal and monetary policy.

The purchases will serve as a means for the central bank to provide an “advanced convoy” of liquidity for upcoming issues of government bonds by Beijing.

“This year, the government has expanded the scale and stepped up the pace of bond issues, and each month has essentially been a peak for issuance,” Wang said.

“Since the start of the year, the central bank has reduced interest rates and the reserve ratio when necessary, and continued to undertake expansions and extensions of MLF and outright reverse repo operations, to keep liquidity in an ample state.

“This is providing a positive monetary and financial environment for the issuance of government bonds.”