Section 2 Reform and improvement of the monetary policy framework（1978—2012）

I.Monetary policy framework in the period when state planning and market readjustment co-existed：1978—1992

At the beginning of the reform and opening-up，with China's transition from the planned management system to the market economic system，the adjustment of monetary and financial policy framework under the original planning system gradually began，laying the foundation for future monetary policy framework under socialist market economy. It can be said that the transition was the primary feature of this period.

Transition was first reflected in the transformation of money creation mechanism. Since the People's Bank of China began to perform the functions of central bank in 1983，the division of work between central bank and commercial financial institutions such as professional banks has become clearer. People's Bank of China no longer handled banking business for the public，and professional banks and other financial institutions began to play a bigger role in money creation. The “double-layer” money creation mechanism was gradually consolidated—the central bank issues basic currency through lending to financial institutions，purchasing foreign exchange，gold and silver，and banking financial institutions create deposit currencies through loan derivation and other channels.

During this period，the ultimate objective of monetary policy was mainly reflected in two aspects. First，maintaining price stability remained the primary objective. The special stage of transition from a planned economy to a market economy is prone to inflation，so inflation management had always been the major difficulty and priority of monetary policy. Inflation management in 1979，1984 and 1988 was the most representative. Second，promoting industrial restructuring also became one of the objectives of monetary policy. Since there was only limited room for total quantity control，the government promoted the optimization of industrial structure through adjustments of the credit structure. Taking into account the characteristics of supply and demand in the early stage of reform and opening-up，the adjustment of credit structure mainly aims to satisfy the demand of enterprises in light industry such as production，purchase and processing of subsidiary agricultural products，textile，as well as state-owned large and medium-sized key enterprises，and to reduce unreasonable loans[15] of low-value projects，non-production projects，and self-financed fixed asset investment projects.

At the same time，with the gradual expansion of monetary credit monitoring scope，the system of market-oriented intermediate objective gradually took shape. With the development of commodity economy，the degree of economic monetization continuously improved，and the scope of application of cash and credit expanded significantly. Therefore，People's Bank of China set out to compile a “money supply plan”[16] in 1987 to incorporate deposits into monetary statistics，and started to develop a “nationwide credit plan” in 1989 to further enrich credit management from bank loans only to broader credit creation. These two initiatives marked the beginning of the “two-way” regulation model，i.e.，monitoring and regulating from both credit creation and money supply. The “two-way” regulation model was continuously enriched and improved since then，which to a large extent laid the foundation for China's system of monetary policy intermediate objective. It is also the origin of today's monetary statistics，financial institutions’ credit revenue and expenditure statistics，and social financing statistics issued regularly by the People's Bank of China. These elements still serve as an important basis for monetary and financial environment monitoring and monetary policy formulation. In addition，the money and credit monitoring during this period was continuously institutionalized，and the reporting mechanism shifted from the previous “one plan for one year” to regular monitoring and forecasting on a quarterly and monthly basis，and new indicator were also introduced.

This period was not only China's transition period from a planned economy to a market economy，but also People's Bank of China's transition period from a “centralized” national bank to a modern central bank. The intervention of local and departmental interests still existed to a large extent，which restricted the role of indirect control tools. Therefore，on the one hand，the control of original credit scale and cash issuance plan still played an important role as a monetary policy tool；on the other hand，due to the development of non-bank financial business，the credit plan management model created during the previous planned economy period was subject to some adjustments，and the two formed a multi-layered credit plan management system[17]. In addition，during this period，the People's Bank of China carried out a series of major reforms and innovations on monetary policy tools，and successively created a variety of indirect control tools，trying to create a combination of direct control tools and indirect control tools. Firstly，the central bank lending system was established. By increasing or decreasing central bank's loans to state-owned professional banks and other financial institutions，the People's Bank of China indirectly affected their amount of credit without directly interfering with professional banks’ operation，and this measure became an important tool for regulating the credit scale and money supply. Secondly，a deposit reserve system was established. The legal reserve system was introduced in 1984 and the payment reserve system later in 1988.Thirdly，the interest rate system was reformed to strengthen interest rate management on various financial institutions，adding extra levels to interest rate，introducing different interest rates，and adjusting the interest rate system. During this period，the central bank used interest rate adjustment tools to implement monetary policy for several times.

II.Establishing and improving the monetary policy framework during the period of socialist market economy：1993—2012

In 1992，the 14th National People's Congress of the Communist Party of China set the reform objective of establishing a socialist market economic system，which marked China's entry into the new stage of establishing and improving the socialist market economic system. During this period，optimization of the monetary policy framework was accelerated，which quickly moved towards maturity.

Firstly，the two-tiered money creation mechanism further evolved and currency and credit creation activities became more active. The money creation mechanism of the period presented two characteristics：

First，the diversification of the base currency issuance channels，especially the channel of funds outstanding for foreign exchange，which even once became the major channel for the central bank to issue base currency. With continuous expansion of the “double surplus” in current account and capital account，export enterprises and foreign businessmen exchanged their foreign currency for RMB at opening banks，which then exchanged foreign currency for RMB at the central bank. This process is also how “funds outstanding for foreign exchange” created base currency. Between China's accession to the WTO and 2009，the amount of base currency created through this channel once exceeded the net increase of base currency of the year. Moreover，from 2004 to 2006，funds outstanding for foreign exchange on the central bank's balance sheet increased by 1.6 trillion，1.6 trillion and 2.2 trillion yuan respectively，accounting for 268%，295% and 166% of the net increase of base currency of the year（Feng Ming，Yang He，2018）. The proportion was so significant that the central bank had to recall the excess base currency released via the funds outstanding for foreign exchange by issuing central bank bills.

Second，the money derivation capacity of commercial banks was continuously enhanced，playing an increasingly active and crucial role in the money creation mechanism. The growth rate of deposit currency was much higher than that of cash in circulation—during the two decades from 1993 to 2013，MO increased from 586.47 billion yuan to 5，857.44 billion yuan，only expanding by 9.0 times；and M2 increased from 3，487.98 billion yuan to 110，652.50 billion yuan，with an increase of 30.7 times. The proportion of M0 to M2 continued to drop from 16.8% in 1993 to 5.3% in 2013.

Secondly，during this period，the regulation of monetary policy transformed from direct regulation to indirect regulation，and China gradually established a monetary policy regulation system compatible with the socialist market economy. The State Council's Decision on Financial System Reform in 1993 was the first central government document explaining the ultimate objective and intermediate objective of monetary policy，pointing out that the ultimate objective of monetary policy is to “maintain the stability of currency and promote economic growth”，and the intermediate objective and operational objective are “money supply，total credit，interbank lending rate and bank reserve ratio” [18]. The Law of the People's Bank of China adopted in 1995 kept the phrase “the monetary policy objective is to maintain the stability of currency value and promote economic growth”，yet it did not distinguish between ultimate objective and intermediate objective. Put into historical context，the expression “maintaining the stability of currency（currency value）and promoting economic growth” at this time reinforced the objective of maintaining currency value stability，which to certain extent indicates the intention of reformers and legislators to transform the functions of the People's Bank of China and to simplify monetary policy objectives. As the financial reform deepened，the shortcomings brought by local or departmental interests intervention into monetary and credit policies were largely overcome near the end of this period. In terms of intermediate objective，money supply gradually received more attention. From 1994 onwards，the central bank began to release money supply data from three dimensions（M0，M1，M2）on a quarterly basis.

At the same time，the central bank began to pay more attention to the use of indirect tools and internationally accepted policy tools for macroeconomic regulation and control when implementing monetary policy. Firstly，in October 1994，the rediscount business was launched. Since then，rediscount gradually became a commonly-used monetary policy tool. Thereafter，the central bank can flexibly adjust money supply through various methods including increasing or decreasing the amount，raising or lowering the threshold of rediscount，adjusting the rediscount rate，and defining the beneficiary of rediscount. Secondly，the central bank began to conduct open market operations，control money supply and adjust interest rate by selling and purchasing securities. Specific measures include open market operations of foreign exchange started in April 1994，open market operations of government bonds started in April 1996，and the subsequent open market operations of securities such as policy financial bonds and central bank financing bonds. Thirdly，the existing central bank lending system and deposit reserve system was reformed. In 1995，central bank lending was put under the unified management of the head office，and loans were directly issued by the head office of the People's Bank of China to the legal person of each commercial bank. Branches of the People's Bank of China and branches of commercial banks no longer have direct participation in the central bank's refinancing operation. In 1998，the statutory reserve merged with the payment reserve，and the statutory deposit reserve ratio was lowered significantly. Accordingly，plan-based tools and direct directive tools were gradually weakened or terminated during this period. For example，in January 1998，the control over credit scale[19] on state-owned banks was repealed，so mandatory plan for state-owned banks was removed. Instead，directives were changed to guidelines，and the central bank's responsibility changed to asset-liability ratio management and risk management of commercial banks.