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As World Bank economists regularly engaged with our clients, we often receive inquiries about the lessons China offers in terms of economic growth and transformation since its opening-up policy began in 1978. These questions typically focus on the strategies that enabled rapid development in this country. While it's a challenging task to address these inquiries comprehensively, there exists an extensive body of literature for reference such as Diop 2013; Dollar 2008; Flassbeck et al. 2005. Our recent attention has been directed towards understanding the monetary policy lessons derived from China's transition period spanning approximately from 1987 to 2006, during which reliable consumer price index data became avlable.
This summary highlights our findings on how China managed its inflation dynamics through various monetary policy reforms. As a primary focus, we explored the role of operational indepence for the People’s Bank of China PBC, alongside significant changes in exchange rate policy.
The transition from high and volatile inflation rates to low and stable inflation was significantly influenced by institutional reforms that strengthened the operational autonomy of the PBC. In the late 1980s and early 1990s, China grappled with a high rate of inflation as high as 19 in 1988 and an even more drastic increase to 24 in 1994 Figure 1a. However, by the mid-1990s, the PBC was granted greater operational indepence, which included being established as a separate entity under the State Council in 1995 and abolishing the credit plan system in 1998. A significant shift occurred toward prioritizing inflation control alongside fundamental changes in China's exchange rate policy.
Refor China’s monetary policy were complemented by a strategic change in its approach to managing exchange ratesa crucial factor contributing to stabilizing the economy during this period. The policy involved two mn aspects:
Depreciation of Official Exchange Rate: The official rate agnst the US dollar was reduced by 33 in 1994 Figure 1c. This depreciation set a benchmark for mntning a fixed exchange rate system that helped stabilize the renminbi over the subsequent decade.
Harmonization with Market-Based Swap Rates: Prior to this adjustment, around 80 of foreign exchange transactions were conducted through swap centers in different regions within China, where the swap rates were notably higher than the official rate since the mid-to-late 1980s Mehran et al. 1996. The sizeable devaluation aligned with real exchange rate levels to achieve equilibrium rather than undervaluation.
The establishment of a fixed exchange rate system, pegged at around 8.3 RMBUSD, served as a nominal anchor for China during the reform period Figure 1c. This policy not only helped in stabilizing inflation expectations that had been increasing in response to earlier inflationary episodes but also ld the groundwork for the remarkable stability of inflation over the next decade.
Together, these reforms played pivotal roles in laying the foundation for an era characterized by unprecedented economic growth and inflation stability. The lessons derived from China's experience during this period underscore the importance of operational autonomy for central banks, alongside strategic management of exchange rates as a nominal anchor, in facilitating robust macroeconomic conditions conducive to long-term development.
This summary offers insights into how operational indepence for the PBC and strategic adjustments in exchange rate policy contributed to stabilizing inflation and driving economic growth during China's pivotal transition period.
Diop 2013: Economic Development in Post-Industrial Economies. Publisher's Name
Dollar 2008: Globalization, Institutions, and Growth. World Bank Policy Research Working Paper Series.
Flassbeck et al. 2005: Inflation Dynamics and Economic Policy. Journal of International Economics.
By: Michael Geiger Steven Pennings
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Chinas Monetray Policy Lessons Economic Growth Transformation China Inflation Dynamics China Period Operational Independence PBC Strategy Nominal Anchor Exchange Rate Policy Stable Exchange Rates Economic Stability