Much of the debate about NGDP targeting in the blogosphere is about what the Federal Reserve should do. However, I think it is equally important to discuss and focus on what monetary regimes are preferable for other countries. I hope I will be able to increase the focus among Market Monetarists on monetary policy in other countries than the US.

Given that China is the second largest economy is the world it is somewhat surprising how little interest their is in Chinese monetary policy and especially in what are the key drivers of Chinese monetary policy. A working paper – “McCallum rule and Chinese monetary policy” – by Tuuli Koivu, Aaron Mehrotra and Riikka Nuutilainen from 2008 sheds more light on this important topic and Market Monetarists should be very interested in the results.

Here is the abstract:

“This paper evaluates the usefulness of a McCallum monetary policy rule based on money supply for maintaining price stability in mainland China. We examine whether excess money relative to rule-based values provides information that improves the forecasting of price developments. The results suggest that our monetary variable helps in predicting both consumer and corporate goods price inflation, but the results for consumer prices depend on the forecasting period. Nevertheless, growth of the Chinese monetary base has tracked the McCallum rule quite closely. Moreover, results using a structural vector autoregression suggest that our measure of excess money supply could be used to identify monetary policy shocks in the Chinese economy.”

Hence, according to the authors the People’s Bank of China (PBoC) follow a McCallum rule whereby they use the money base to hit a given target for growth in nominal GDP (NGDP).

This in my view is a highly interesting result and it is somewhat of a surprise that these empirical results have not gotten more attention – especially given China’s impressive economic performance in recent years. Furthermore, it would be extremely interesting to see how the results would look if they where updated to include the Great Recession period. I am sure there is lot of aspiring Market Monetarists out there who are getting ready to update these results…

The PBoC is certainly not conducting monetary policy in a transparent way and the Chinese financial markets remain overly regulated, but at least it seems like the PBoC got their money base control more or less right.