The Impact of Chinese Monetary Policy Shocks on East Asia

A recent working paper from the Bank of Finland (who write a surprisingly large amount of papers on China for a northern European central bank) looking at the impact of Chinese monetary policy on the rest of Asia.

The conclusions are unsurprising I am not not a fan of SVAR models myself but it might interest some.

The Impact of Chinese Monetary Policy Shocks on East Asia [SSRN]

TOMASZ J. KOZLUK
Organisation for Economic Co-operation and Development
AARON N. MEHROTRA
Bank of Finland - Institute for Economies in Transition (BOFIT); European University Institute - Economics Department (ECO) April 25, 2008

BOFIT Discussion Paper No. 5/2008

Abstract:
We study the effects of Chinese monetary policy shocks on China's major trading partners in East Asia by estimating structural vector autoregressive (SVAR) models for six economies in the region. We find that a monetary expansion in Mainland China leads to an increase in real GDP (temporary) and the price level (permanent) in a number of economies in our sample, most notably in Hong Kong and the Philippines. The impact could result from intertemporal substitution present in a general equilibrium framework which allows for positive domestic impacts of foreign monetary expansions. Our results emphasize the growing importance of China for its neighboring economies and the significance of Chinese shocks for the design of monetary policy in Asian economies.


Keywords: monetary policy shocks, Asian production chain, SVAR, East Asia, China

JEL Classifications: E52, F42

"Hot Money" in China: the noose tightens

Today the FT reports on China's continuing problem with "hot money". The flows are perceived to be hampering China's attempt to curtail the ever increasing inflationary pressures.

The policy of requiring exporters to park money is a backward development and is more red tape to trade. This is a dangerous move and could even have inflationary ramifications in the West if cheap Chinese goods prove harder to come by.

China to tighten capital controls in clampdown on 'hot money' [FT]

China announced a major strengthening of capital controls last night in an attempt to limit the amount of speculative "hot money" entering the economy and frustrating its efforts to contain inflationary pressures.

In an announcement on its website, the State Administration of Foreign Exchange, the country's foreign exchange regulator, said exporters would be required to park revenues in special accounts while the authorities verified the funds were the result of genuine trade.

The new system risks becoming a cumbersome burden for exporters such as suppliers of cheap goods to western retailers.

Exporters will now be required to provide documentary evidence that their invoices are based on genuine transactions if they wish to change dollars into renminbi. The regulator said the new computer system for checking invoices would be introduced from August 4. A trial period begins on July 14.

Recent leaked figures showed record inflows of capital entering China over the past two months. Officials believe some money came in illegally after companies exaggerated export revenues.

China has become an attractive country for investors and companies because interest rates are now above US levels and the renminbi is expected to appreciate.

According to Reuters, China's foreign exchange reserves increased by a record $114.8bn (£57.6bn) in April and May to $1,800bn. Although it is impossible to calculate how much of that inflow is short-term, speculative capital, the figures were substantially higher than the combined numbers for the trade surplus and foreign direct investment.

The capital inflows have made economic management more difficult because, even though domestic inflation has been high in recent months, the Chinese central bank has been reluctant to raise interest rates for fear of attracting more hot money.

Authorities have so far prevented the inflows from causing money supply to grow too sharply by issuing bonds and lifting bank reserve requirements.

There has been a growing discussion among private sector economists about whether the authorities should introduce a large, one-off appreciation of the currency in order to limit speculation. However, most economists believe that the government would be very reluctant to take such a step as parts of the export sector are already suffering badly because of higher costs, including the stronger renminbi.

.

On China's Monetary Trap and Inflation

A link to the always excellent "China Financial Markets" posts on China's Monetary Trap and the increasing problem of inflation.

The first article summarises Pettis' arguments as to why he believed China's monetary policy is out of control. He lists eight main arguments which are well made. The only issue is whether his envisaged "revaluation" will ever take place due to the political implications.

China's monetary trap [China Financial Markets]

This whole argument in favor of a maxi-revaluation depends crucially on the assumption that foreign exchange inflows will continue to accumulate at extraordinary levels until the adjustment is made. This is the bet I made four years ago – I argued that reserves would surge. Of course like everyone else I seriously underestimated just how much it would surge. The key argument against continued rapid appreciation is of course the incentive this creates for speculative inflows.

In a second post Pettis deconstructs Chinese inflation to reveal in simple terms just how bad things have got and how quickly.

Deconstructing Chinese inflation [China Financial Markets]

This gives a better idea than do the headline annual figures of how variable inflation has been and how it has accelerated. The first thing to note is that inflation really began to pick up at the end of 2006, but only began showing up in the annual numbers in the summer of 2007. A quick calculation (which is not included in the graph) indicates that from May 2007 to now China has suffered from double-digit inflation (11.1% annualized). The same calculation also suggests that if the next three months show price increases that on average equal the price increases of the past eight months (around 1% month-on-month) we will have double digit year-on-year inflation in China by May.

The second thing is that the February rate of increase in the CPI was very high (35% on an annualized basis), more than twice as high as the already-high January rate of increase. Because of the big jump in February prices, the numbers for March are likely to be distorted. In fact prices could decline significantly in March (by 1.8% on average) while still maintaining a continuation of January’s 7.1% year-on year CPI inflation. If prices do not decline this month, March 2007 year-on-year CPI inflation will reach 9.1% or more.

.