Fifteen years ago,
Alan Blinder, a former vice chair of the US Federal Reserve and a professor of economics at Princeton, wrote a book titled
The Quiet Revolution, about changes in central banking. Chief among these was a move by some central banks towards open communication and transparency, and away from their long-held tradition of secrecy and surprise. A central bank “goes modern”, to borrow from the subtitle of Blinder’s book, when it starts talking.
The Fed was slowly heading in this direction by the turn of the century. It finally began announcing its interest-rate decisions in 1994, and issuing regular statements in 2000 (though it did not hold regular
press conferences until 2011). These changes reflected a new appreciation among central bankers of how changes in short-term policy rates work their way through the economy via expectations and market pricing.
Today, the People’s Bank of China is undergoing its own quiet revolution. Like the Fed before it, the Chinese central bank is becoming more
communicative. But the real revolution in Beijing concerns exchange rate policy, with the PBOC increasingly allowing market forces to determine the
renminbi’s value. Both developments are welcome.
The bank’s communication offensive has much to do with its new governor,
Yi Gang, who was appointed in March 2018. Last month, the PBOC hosted its first-ever briefing to explain the latest economic and monetary data. And Yi himself has taken the initiative to explain policy decisions, notably his “three arrows” to support funding for small and medium-sized enterprises. The governor also occasionally
weighs in on stock market volatility, even though such interventions may raise eyebrows among central banking traditionalists.
Another significant move came in January, when the PBOC unveiled a
new version of its English-language website. Previously, only about 2 per cent of the Chinese site’s content was available in English, prompting foreign investors to complain about an uneven playing field. But the bank’s new English site covers almost every major aspect of policy, from open-market operations and decisions to the governor’s speeches and activities. For example, it features Yi’s speech last December at Tsinghua University on China’s monetary policy framework, together with an English version of his original PowerPoint slides.
Although this open communication is certainly important, the PBOC’s increasingly flexible exchange rate policy is far more transformative. In 2015-2016, the PBOC spent about US$1 trillion of China’s
foreign exchange reserves to prop up the weakening renminbi. These days, the PBOC no longer intervenes regularly in the currency market, and does not have an exchange rate target.
This flexibility has been increasingly evident since the start of 2018. After peaking at 6.26 against the US dollar in February last year, the renminbi slid all the way to
6.97 by the end of October, a 10 per cent drop. (It has since risen again and currently stands at about 6.70.)
The renminbi’s peak-to-trough swing against the dollar in 2018 was comparable to that of the other Special Drawing Right (SDR) currencies: the euro (10 per cent), yen (9 per cent), and British pound (13 per cent). In a similar vein, the renminbi’s daily volatility last year reached 4.3 per cent – about 70 per cent of that of the four other SDR currencies (including the US dollar). And for the first time, the Chinese currency was more volatile than the Singapore dollar.
Despite – or because of – swings in bilateral exchange rates, the renminbi remained broadly stable against a mix of currencies. The index of the China Foreign Exchange Trade System, a 24-currency basket, started and ended the year at around 95. This happened with little central bank intervention. Even the
US Treasury Department said in an October 2018 report that direct intervention by the PBOC last year had been “limited” and that foreign exchange sales by state banks had been “modest”.
A flexible exchange rate acts as an automatic stabiliser in two ways. First, it serves as a safety valve that responds to, and relieves pressures from, capital flows and global demand. Indirectly, and more fundamentally, a market-driven exchange rate gives the PBOC more room to use interest rates and other monetary policy tools, such as the
reserve requirement ratio, to help stabilise the economy. This in turn stabilises the renminbi.
For evidence of this, look again at 2018. Whereas the Fed raised interest rates
four times during the year, the PBOC settled on a mere five-basis-point hike in March, and actually cut the reserve ratio four times as part of a policy of targeted countercyclical easing. Despite these cuts, the renminbi has not gone into free fall, as some might have expected: its current value against the US dollar is similar to that in mid-December 2017, when the PBOC last followed the Fed with a five-basis-point rate increase.
As the renminbi increasingly becomes a two-way floating currency, market expectations are adapting accordingly, and one-way bets against it seem far riskier than before. By contrast, a return to routine PBOC intervention in the foreign exchange market would breed instability. When policymakers do not allow exchange rates to adjust, they risk triggering a destabilising downward spiral of lower reserves, less confidence, and more panic.
The quiet revolution Blinder described in 2004 is under way in Beijing. True, the PBOC has plenty of room for further improvement in its communication and exchange rate policies. But its progress so far is good news for China and international policymakers alike.
Miao Yanliang is a member of the China Finance 40, a Beijing think tank. The views expressed here are the author’s own. Copyright: Project Syndicate
This article appeared in the South China Morning Post print edition as: China’s central bank is undergoing a quiet revolution
