Failure of Monetary Policy in China

Public Bank Of China tried many times to decrease the rapid growth of economy in china by using refined monetary policy. But these monetary policies remained ineffective like other new polices which were implemented to decrease the economic growth. The main reason of failure of these monetary polices was the devaluation of Yuan (China’s currency) which is the main reason of high rate of money supply.

China’s economy is stimulated by increased investments and exports which shifts the Aggregated demand (AD) to high level which depends on consumption, investment, government spending and net export. Dissimilar to U. S. economy China’s GDP is exports but it need to increase consumption and decrease the exports. China’s inflation hit an all time high of 6. 5% this year, and is threatening to go out of control as rapid increases in money supply because of low value of money and low intersect rate.

Because of this low interest investments increases which in turn in increases AD. China is implementing deflationary monetary policy aimed at reduction of money supply due failure of last ones. After the increase of five interest rate and nine reserve requirement ratio by selling government securities to a firm by central bank, there’s no affect on liquidity and looks to continue further tightening measures. But the undervalued Yawn is first reason of high growth of money supply which cause the failure of policies in china.

Second reason is the interest rate difference between China and U. S. which attract the foreign fund into Chinese economy, as everyone want high return rates. On the other hand, the central bank can also set a minimum amount of reserves that banks must hold; the reserve requirement ratio and bank are able to make loans which increase money supply. But when the central ban increase the RRR, which decreases the loans funds and which in turn decreases the money supply growth.

But the problem is that the central bank does not control the amount of money that households choose to hold as deposits in banks. So then people put their money in markets because of negative returns due to high inflammation which encourage stock market in china. China economy problem of money supply growth would curb with small appreciation of the Yuan. China is not appreciating Yuan despite of increasing international pressure.

The undervalued Yuan has created an imbalance in trade; with the U. S. accumulating a record balance of payment deficit and China with a balance of payments surplus. Economic theory shows that for fixed exchange rates, if the price is fixed below the equilibrium (undervalued), there will be excess demand for the currency, thus there will be a balance of payments surplus. So an appreciation of the Yuan would significantly decrease exports (NX), and because of AD=Consumtion+Investment+ Government spending +NX(import/export), aggregate demand will go down.

At the same time, the appreciation of the Yuan will also stop speculative foreign inflows (hot money), which will then also decrease investments (I). The undervalued Yuan is not only a big problem for world but also for china itself. With the time ahead it will be impossible for China to create independent monetary policy because of fixed exchange rate. This has allowed the increase of currency value, and unchecked inflation in the economy. If the problem is not dealt intelligibly it is going to burst out like a hallow ballon as the problem occurred in USA to some extent.