اصلاح سیاست های نظام مالی و پولی چین: درمان مستقل برای توسعه سرمایه گذاری آغاز شده به صورت محلی ؟

This paper studies the efficacy of China's financial reforms in helping the central monetary authority to achieve its goals of macroeconomic stabilization. A local–local monetary game is presented which examines the investment competition between local governments in different hypothetical financial settings. It is shown that direct means of credit control and indirect instruments of monetary policy have both strengths and weaknesses, suggesting that their combination would be desirable in macroeconomic management under the new financial arrangement.

In 1994 the Chinese government initiated further restructuring of the financial sector. The four key features of this program are as follows. First, the central bank's powers were to be greatly strengthened by various measures. This aims to lessen the influence and interference of local governments in its macro-financial control. Second, the state-specialized banks began the transformation into state commercial banks (SCBs). Third, state policy banks (SPBs) were to be created to provide finance for policy-based activities. The fourth feature is the gradual shift to the use of indirect monetary instruments from that of the traditional credit quotas in macroeconomic management. Macroeconomic instability was believed to have been caused by chronic locally initiated investment expansion. So the changes to the Chinese financial sector and monetary policy were intended to reduce this instability. Prior studies of China's financial reforms have concentrated on a few issues. These include the manner of the institutional restructuring of the banking sector, the disadvantages of the old means of control such as the credit quota, the relationship between banks and enterprises, central–local relations under the old financial arrangement and so on.1 However, the following questions have not yet been properly addressed: What would be the effect of the reforms on local government interactions when there is a shift to the use of new instruments of monetary policy and to the new mix of financing avenues? How might alternative policy instruments be compared to each other in terms of their regulatory power? These two questions are especially important given that the reforms are aimed at restraining the activities of local governments and helping maintain macroeconomic stability. Regarding the first question, the emphasis of this paper is placed on the local–local relations, contrary to Ma, 1995a, Ma, 1995b and Ma, 1996. A central–local monetary game can be used to explain how local governments force the central bank to change and increase the predetermined credit lines thus creating inflation (Ma, 1996), but not why. If local governments were all happy with pre-announced policies by the center in the first place, then it would not matter that much whether the center lacks its commitment to them. So the root cause of inflation may be further tracked down in the local–local relations to find out why local governments are not happy. Another justification for this lies in the following observed facts: (a) the new central bank system is becoming increasingly independent of governments at various levels (e.g., the central government's deficits can no longer be covered by borrowing from the central bank); and (b) the central government is able to resist demands from localities, such as rescuing state-owned enterprises (SOEs) etc., with recent massive labor shedding by SOEs being a good example. These imply that the central bank is more and more likely to commit itself to prudent monetary policies. Therefore, a theory of local–local monetary game is an appropriate framework. It is intriguing to find out the way this game is unfolded in the new financial environment where both credit lines and indirect monetary instruments are being independently used, and, as prompted by the second question, how effective they are. A pioneering attempt to formally model the local–local relations in addressing the above two questions was made in Li and Ma (1996). However, several deficiencies of that study still remain. First, the objective functions of local governments specified there did not take into account the presence of monetary constraints. Second, the authors intended no further inquiries into how reserve requirements affect investment expenditures of local governments and thus inflation under various circumstances. Finally, the roles of open market operations and interest rates, and their interactions with other policy instruments, in stabilising the economy were not investigated, leaving a black box in the understanding of China's public finance and monetary policy reshaped by the new reform package. This paper seeks to fill the gaps embodied in the aforementioned two questions in general and three deficiencies of Li and Ma (1996) in particular. Section 2 attempts to show that the ongoing financial reforms will not remove the fundamental contradiction in the allocation of financial/physical resources. This is done by embedding the credit bargaining mechanism in an investment competition model. In Section 3, we ask whether the new financial arrangement, as compared with the old one, would be better in macroeconomic stabilisation, if facing the same investment “hunger” of local governments as before, but more diverse financial sources available than before. The efficacy of some typical instruments of monetary policy corresponding to each financing avenue is studied in a rigorous manner. Finally, Section 4 summarizes the findings of this paper.

This paper analyzes the effects of the 1994 financial reforms upon inter-regional investment competition in China. The purpose of our analysis is to compare alternative monetary instruments in terms of their regulatory powers. In contrast with previous studies, it has been established that the root cause of investment expansion is local government rivalry. Local governments are characterized by a desire for incompatibly larger share of physical and financial resources. This rivalry, combined with the lack of central bank's commitments to pre-announced policies prevalent in the old system, generated inflation. In the new financial system, even though local government rivalry is likely to persist, independence of the whole state banking system from, especially, local governments has been progressively established (It is in fact one of the objectives for the on-going financial reforms to achieve). Given this fact, the theory of a central–local monetary game is no longer a useful framework. Hence, it is appropriate to assume that the central bank has an exogenous role in the economy (i.e., exogenously given policy variables). Using a local–local monetary game, therefore, this paper shows how an independent central bank can effectively realize its objectives when the approach to monetary policy evolves from a reliance on direct controls to a mix of direct and indirect regulations. Of the results which may have general relevance, the following would seem to be most pertinent. The ongoing financial reforms are quite successful, because a broader menu of monetary instruments is becoming available and more or less efficacious in terms of macroeconomic stabilization. If local governments' excess investment expenditures are financed by credit from SCBs, only administrative means can be applied. If financed by inflation tax (such as credit from SPBs), then administrative means plus reserve requirements can be combined in regulation. Finally if financed by bonds sold to the non-bank public, then open market operations, interest rates as well as reserve requirements begin to take effect. However, administrative means and indirect instruments have differing merits and weaknesses. For this point to be fully appreciated, let us recall our findings in the previous sections: Due to the existence of investment competition in the state sector, reserve requirements alone are not so satisfactorily competent in preventing the economy from being overheated (Proposition 1), and need to be combined with open market operations in controlling inflation (Proposition 2). Open market operations may strengthen the role of reserve requirements, but will trigger a potential trade-off between inflation and fiscal deficits, and possibly lead to a huge stock of internal and/or external debts of local governments (Proposition 3). The interest rate may simultaneously curtail local deficits and curb inflation (Proposition 4), but its use is limited by the interest-repayment capabilities of local governments. Administrative controls over credit expansion can effectively check both excess investment and inflation, but this is applicable only to the cases of credit and inflation-tax financing. Accordingly, an optimal combination of administrative means with indirect instruments of monetary policy would be, with little doubt, desirable for the central monetary authority in macroeconomic management under the new financial arrangement.