CHINA’S OPEN MARKET OPERATION: PRACTICE AND REFLECTION[11]

Reflection on the objective of open market operations

Open market operations exert influence on the money market rate in two ways. Directly, the market rate is affected by the open market operation interest rate publicized by the central bank. In a more roundabout manner, the open market operation changes the liquidity of banking system, so as to affect the supply and demand of market funds, and consequently the market rate. However, these two effects are inseparable. If open market operation is to input base money, the interest rate should be lowered or the bond price should be raised, and vice versa.

In open market operation the relationship between base money adjustment and money market rate adjustment should be viewed dialectically. Firstly, the central bank should set the operation objective. If base money is set as the objective, the quantitative objective of base money is gained directly. If money market rate is set as the objective, the quantitative objective of inputting or withdrawing base money should be deduced on the basis of interest rate. Secondly, the means of the central bank to achieve the operation objective is by changing the base money supply. If base money is the operational objective, then the means directly brings about the objective. If interest rate is the operation object, adjusting base money by the central bank will affect the supply and demand of market funds, and consequently the interest rate. Thirdly, to change base money, the central bank should adjust the interest rate. If the central bank adopts fixed-rate volume bidding, it intends to input or withdraw base money by lowering or raising interest rate. In case of interest rate bidding, the rise or fall of the interest rate seems to be decided by bidding from primary traders, but in fact, it is accepted by the central bank. So the central bank still changes base money supply by adjusting the interest rate. Fourthly, the central bank needs to observe whether the operation objective has been achieved or not.

The following conclusions can be drawn from the above analysis:

Firstly, no matter whether the quantity-oriented or the price-oriented operation objective is chosen by the central bank, there is no necessary correspondence with the intermediate objective of monetary policy. The type of operation objective mainly is subject to such factors as the development of the money market, the forming mechanism of market interest rate and the structural distribution of commercial banks' funds.

Secondly, even if the central bank adopts the quantity-oriented base money objective, it should also observe in operation the change of money market interest rate.

The situation in China is somewhat different. In its current position, the influence of the central bank’s open market operation on the long-term interest rate is unavoidable. Since treasury bonds and financial bonds circulating in China's bond market are basically long-term bonds with a maturity above five years, the central bank should pay close attention to the long-term bond interest rate influenced by its open market operations. By doing so, it can avoid systematic risks in the market caused by violent fluctuations in the long-term bond interest rate.

(by Sun Guofemg)