THE ability of the People's Bank of China (PBOC) - China's central bank - to develop a proper set of monetary tools to influence the economy must be one of its more pressing tasks. For a bank used to resorting to administrative orders and credit quotas to influence money supply, this is no mean task. How well it sets up these tools - together with the success of the state enterprise and banking reforms - will be a crucial measure of China's dexterity in steering the planned economy towards a market-oriented one. Administrative orders and credit quotas are heavy-handed, easy to implement, but highly inefficient. State banks tend to implement orders and quotas across-the-board, with little regard to borrowers' ability to pay. Any credit squeeze tends to translate into rigid control over wage bills and operational expenses. To a great degree, a similar impact could be attained - but more efficiently - by monetary tools. When the Federal Reserve Board raises interest rates, for instance, it sufficiently affects commercial banks and influences decisively the money they have to lend through the higher cost of lending. That reduces spending and thus aggregate demand in the economy. Experiences in capitalist economies have shown that open market operations, interest rates and reserve requirements have been effective in affecting money supply. The crucial difference between them and administrative orders and credit quotas is that the latter tend to be based on political directives. Which is why the statement by PBOC deputy-president Dai Xianglong that the bank had started compiling indexes of money supply must be welcomed. China is still far from having a proper monetary framework, but a start has to be made. It is too much to expect the PBOC to develop the influence of the Fed within a few years. But if it is to be a true central bank, it must demonstrate a steely resolve to ensure the evolution of a proper monetary framework. And a hallmark of that framework is the ability to turn to interest rates or open market operations instead of administrative orders to influence the economy.
