However, several problems that are responsible for the excessive monetary growth in the past is still left unaddressed. These problems include central bank independence, structural distortions and indirect monetary measures. First, the central bank is still under the strictly control of the State Council. It is often the case that due to various poliical reasons, the State Council is more "radical" (in the sense that it favors rapid economic growth than inflation fighting) than the central bank, if the central bank is given the authority to express its own view. This distincdon is confirmed from my interviews with several PBC officials. Under the State Council, the central bank is not likely to be able to comniit to a prudent money supply (either credit ceiling, or reserve ratio, or others) since the State Council is often unable to resst the demands such as rescuing SOEs, maintairing 'political stability, or solving bottleneck problems. Without such a commitment, the fundamental source of the monetary game still exists and excessive money growth may reoccur in other forms udder the new system.

Under the pressures from local governments and/or entuprises, however, a central bank that is more conservative than the central government is less likely to be tempted to grant additional loans or increase cash issuance targets. This suggests a central bank that is independent from the central government. A number of cross-country studies have presented empirical evidence suggesting that a more independent central bank is usually associated with a lower inflation rate (Alesina and Summers, 1992) than a less independent central bank. We recommend that China places the central bank under the Congress, and grants the central bank independence in the following sense: its decisions are not reviewed by other bodies except the Congress or its standing committee; its governor is appointed for extended periods and cannot be removed without cause; it does not have to seek approval for its budget; and it is not subject to an external auditor. Unlike the govemment proposed "central bank independence"independence from other ministries-which is only an administrative order and can be easily revoled by the cental government itself, the independence that we propose must be written in the constiution and be protected by the legal system.

Second, although the separation of policy lending from commercia **l** ending will eliminate the localities' major instrument in the monetary game-distorting the investment structure, how the policy lending projects will be financed is a big problem. It is claimed by the central government that the liabilities of the policy lending banks will include mainly social insurance, postal and investment funds. This is rather unrealistic. China does not have a social insurance system yet (check source), and the establishment of such a system is a long lasting task. Depositors in the postal deposit system and investors in investment funds require retums not lower than the deposit rates offered by the commercial banks. Therefore, if the sources are limited to the ones mentioned, no policy lending-which yields a return lower than commercial lending-can be actually made. No matter whether the central government is willing or not, the policy lending banlks must be supported by fiscal resources, forms of such support being either interest subsidies or direct subsidies to the banks. Although in the medium to long run the tax assignment may increase the central fiscal capacity, given the current fiscal imbalance, whether the center can afford the creation of three policy lending banks immediately is still a question.

Third, the fundamental source of the problem of excessive money growth-structural 44