In 1996, China marked a significant shift in its monetary policy by designating the money supply as an intermediary targetThe early years of this policy saw a reliance on direct control mechanisms over bank lending, pronouncedly evident when these restrictions were lifted in 1998 for state-owned commercial banksBy adopting broad money (M2) as the key metric for indirect quantity-based regulation, China developed a distinct monetary policy framework that resonated with the demands of its economy at the timeAs the financial landscape evolved, particularly with the rapid expansion of off-balance-sheet financing and direct funding methods, the People's Bank of China (PBOC) began compiling and releasing statistics on the growth in the total social financing scale starting in 2011. This initiative aimed to provide a comprehensive view of financial support to the real economy.

The transition to a more market-driven monetary policy was further underscored in October 2015 when the PBOC eliminated the ceiling on deposit interest rates for commercial banks and rural cooperatives, marking another evolution toward interest rate liberalizationIn 2018, a noteworthy shift occurred when the central bank ceased to publish specific growth targets for M2, indicating a move toward a framework focused on monetary price mechanismsToday, China’s monetary policy operates through a dual approach that combines both quantity-based and price-based controls, reflecting its adaptive nature in the face of changing economic realities.

As China’s economy transitions from high-speed growth to a focus on quality, it becomes increasingly clear that traditional monetary policy tools, targets, and methods are insufficient to meet emerging challengesThe urgency for a refined and improved monetary policy framework tailored to Chinese characteristics has become more pressing, driven by several factorsFirstly, the controllability of monetary supply targets has diminishedRecent years have witnessed a notable surge in the monetary multiplier, with considerable volatility observed even when the legal reserve requirement remains unchanged

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A fluctuation close to 10% indicates that relying solely on quantitative controls to manage the scale of base money is becoming increasingly difficultThis challenge is exacerbated by a wide interest rate corridor, as it creates significant volatility in market funding rates.

Secondly, the correlation between quantitative intermediary targets and the underlying economy has weakenedAs structural transformations take place across China’s economy and financial markets evolve, the historical relationship between money supply and real economic activity has grown less predictableNotably, the correlation between total social financing scale and nominal GDP has weakened since 2020, although many market participants continue to rely on these indicators to gauge economic conditionsConsequently, any shortfall in social financing or financial data can rapidly undermine market confidence, leading to broader economic repercussions.

Furthermore, the market-oriented interest rate control mechanisms still require enhancementThe interplay between quantitative and price controls can sometimes lack cohesion, and the proliferation of policy interest rates hampers the interconnectedness of different market ratesAdditionally, the marketization level of the Loan Prime Rate (LPR) has yet to reach its full potentialAs of 2022, an increasing percentage of new loans were being issued at rates below the LPR for top-tier borrowers, reaching 43.33% by September of this yearThis indicates a pressing need for further reforms in the commercial lending landscape.

During the 15th Lujiazui Forum on June 19 this year, PBOC Governor Pan Gongsheng presented a clear vision for the future evolution of China’s monetary policy frameworkHis suggestions included gradually downplaying the focus on quantitative targets while considering the designation of a specific short-term operational rate from the central bank as the primary policy rateHe also proposed a collaborative narrowing of the interest rate corridor’s width

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Following this, the PBOC initiated a series of measures, such as implementing temporary reverse repurchase agreements and adjusting reverse repurchase operations, to actively promote the transition towards a price-based monetary policy framework.

Currently, a basic monetary policy framework has emerged, with the 7-day reverse repurchase operation rate serving as the main policy rate, DR007 (the weighted average rate of 7-day pledged repo transactions among interbank deposit-taking financial institutions) acting as the baseline for the money market, and government bond yields forming the foundation for the bond marketThe usage of various open market operations such as repos and treasury transactions is designed to solidify the monetary policy stance and stabilize fluctuations in short-term interest rates, ultimately enhancing the transmission effects from short-term to long-term rates.

To better facilitate the interest rate transmission mechanisms under the forthcoming price-based monetary policy framework, several measures need to be prioritizedFirstly, the volatility of the benchmark interest rate in the money market remains high, and greater utilization of open market operation tools is essential to mitigate this volatilitySince the 7-day reverse repurchase operation rate was established as the primary policy rate, the DR007 has not exhibited significant improvements in stability, which undermines the clarity of the monetary policy stance.

Recommendations include expanding reverse repurchase actions, deploying temporary repo tools, and employing precise short-term government bond transactions to control short-end rates effectivelySecondly, the government bond market requires expansion, and both the issuance pace and maturity structure of bonds should be optimizedGiven that government bonds are a primary asset for market participants and exhibit a wide range of maturities, they can play a pivotal role in creating linkages between short and long-term interest rates through investment decisions across various market actors

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