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MonetaryPolicyInChina

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Information about MonetaryPolicyInChina
Education

Published on April 13, 2008

Author: Columbia

Source: authorstream.com

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Challenges for Monetary Policy in China::  Challenges for Monetary Policy in China: I. Overheating and Financial Depth, II. Adverse Selection and Credit Rating Error, III. Macro-economic Stability and Loan-Loss-Reserve Regulation I. Overheating:  I. Overheating Evidence of Overheating Inefficient Capital Allocation Informal Financial Intermediaries Excessive Money Supply Small Government Bond Market 1. Evidence of Overheating: Inflation Spike:  1. Evidence of Overheating: Inflation Spike Source: CIA Factbook, and June 2007 Figures Slide4:  Evidence: Real Estate Prices Slide5:  Evidence: Shanghai Engineers’ Salaries Higher than in Thailand, Indonesia, Philippines Source: METI - China and ASEAN4 2. Capital Allocation: State Banks to State-Owned Enterprises:  2. Capital Allocation: State Banks to State-Owned Enterprises Source: McKinsey Capital Allocation: Too Scarce in Inland Areas:  Capital Allocation: Too Scarce in Inland Areas Source: METI Capital Allocation: Can Heighten Regional Inequalities:  Capital Allocation: Can Heighten Regional Inequalities Source: METI 3. Money Supply: China’s M2/GDP out of proportion:  3. Money Supply: China’s M2/GDP out of proportion http://www.allcountries.org/china_statistics/index.html 4. Informal Finance::  4. Informal Finance: “ All small business start with loans from family and friends. I’m not aware of any business that was started with bank financing.” - Manager of one of Shanghai’s 10 largest Private Firms (McKinsey) Slide11:  Informal Financial Intermediaries Source: McKinsey 28% 5. Small Government Bond Market: Makes Central Bank’s Job More Difficult:  5. Small Government Bond Market: Makes Central Bank’s Job More Difficult Source: McKinsey II. Adverse Selection by Credit Rating Error:  II. Adverse Selection by Credit Rating Error Think of two firms which must go through a long difficult process – just to achieve the same credit rating. But say the 1st firm is a good risk, while the 2nd firm is a poor risk. (So there is Rating Error.) Which firm will be more determined to complete the rating process? Empirically Based Simulation of Credit Rating Effects::  Empirically Based Simulation of Credit Rating Effects: “Modeling the economic value of credit rating systems”, by Jankowitscha, Pichlera, and Schwaigerb Journal of Banking & Finance Volume 31, Issue 1, January 2007, Pages 181-198 Adverse Selection: History of 30,000 Austrian Corporate Loans:  Adverse Selection: History of 30,000 Austrian Corporate Loans Source: Jankowitsch et. al., Journal of Banking & Finance (2007) Adverse Selection: Basis Point Improvement in Change from Low Credit Rating Accuracy:  Adverse Selection: Basis Point Improvement in Change from Low Credit Rating Accuracy Source: Jankowitsch et. al. (2007) Adverse Selection:  Adverse Selection The study finds this improvement in return is mostly due to less adverse selection – not better loan pricing. As a very distinguished banker friend of mine once said: “If you lose the principle, it’s hard to make it up on interest payments.” III. Macro-economic Stability and Loan-Loss-Reserve Regulation:  III. Macro-economic Stability and Loan-Loss-Reserve Regulation “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way, along with his fellows, so that no one can really blame him.” J.M. Keynes (1931) Macro Stability: Keynes noted the “Paradox of Thrift”:  Macro Stability: Keynes noted the “Paradox of Thrift” Consumers cut back on their spending and save more during a recession. This only makes the recession worse. Similarly, Loan Loss Reserves (LLR) are often raised in a recession, just when banks can least afford them – often ensuring their collapse and worsening the recession. Macro Stability: Perverse Loan-Loss Regulation:  Macro Stability: Perverse Loan-Loss Regulation Laeven, Luc & Majnoni, Giovanni, 2003. "Loan loss provisioning and economic slowdowns: too much, too late?," Journal of Financial Intermediation, Vol. 12(2), April, pages 178-197. Can be downloaded from World Bank: http://ideas.repec.org/p/wbk/wbrwps/2749.html They argue that LLR should be ‘pro-cyclical’, built up in good times, so that it is available for bad times.:  They argue that LLR should be ‘pro-cyclical’, built up in good times, so that it is available for bad times. Instead, LLR growth ‘counter-cyclical’: Weak LLR in booms spurs inflation, Strong LLR in busts worsens recessions:  Instead, LLR growth ‘counter-cyclical’: Weak LLR in booms spurs inflation, Strong LLR in busts worsens recessions Tentative Conclusions::  Tentative Conclusions: China’s Monetary Policy challenge is very difficult, with few policy instruments A good Credit Rating System has great potential for improved financial returns from banking However, poor regulation based on credit rating has the potential to increase macro-economic instability

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