Instruments I: Sterilisation and Interest Rate Controls

This is the first of a pair of chapters discussing how Chinese monetary policymakers deployed the instruments they had in the 2000s, and how their strategy evolved. It builds on earlier chapters, which established both how a potential transmission mechanism from interbank market through bank balance sheets might work, and why it was limited in practice. Here we discuss the difficulties posed by a large net foreign currency inflow, and the relationship between administered and market rates. The central bank’s large-scale foreign exchange purchases left the banking system with a persistent structural liquidity surplus, which the central bank struggled to absorb. It first introduced central bank bills and then turned to intensive use of a variable reserve-deposit ratio to quarantine reserves. We discuss the extent to which policy-set and regulated bank rates influenced those rates left to be determined in the interbank market.