, management of the banking sector liquidity has become an important part in the pbc ’ s monetary policy conduct. instruments such as open market operations and reserve requirement ratio have been adopted to sterilize the growth of rmb supply as a result of foreign exchange purchase, and to absorb excessive liquidity in the banking system. nevertheless, the root cause of the liquidity problem has not been solved. the rmb equivalent to foreign exchange purchase has become the major source of base money supply while central bank lending to financial institutions accounts for a smaller share. this undermines the independence of monetary policy and makes money supply a more endogenous factor. in recent years, though cpi has remained basically stable at a fairly low level, broad price levels such as ppi and asset prices such as housing prices have increased significantly. moreover, the issuance of central bank bills and the frequent adjustments of reserve requirement ratio in the banking system have also affected the operational behaviour of commercial banks and even the efficiency of the financial system. the sterilization cost for the central bank has also been on a rise. iii. a more flexible exchange regime helps enhance the effectiveness of monetary policy according to the argument of impossible trinity, capital and financial account convertibility, independent monetary policy and exchange rate stability cannot be achieved at the same time. it is feasible for a small and open economy to pursue exchange rate objectives at the expense of monetary policy independence. the hong kong sar is such an example by adopting a currency board system, where the hong kong dollar is strictly pegged to the u. s. dollar and the hong kong monetary authority follows the federal reserve in its adjustment of hong kong dollar interest rates. as for singapore, exchange rate instruments, rather than interest rates, are used more frequently in macroeconomic management, as exchange rate is taken as the intermediate monetary policy target. china is not a small economy. with a population of 1. 3 billion, china cannot afford to lose monetary policy independence and subject itself to economic policies of other countries. adopting a more flexible exchange rate regime serves china ’ s long - term interests as the benefits of long - term price stability and economic restructuring far exceed the cost in reorganizing certain industries and removing outdated capacities. at present, a more flexible exchange rate regime will help curb inflation and asset bubbles. when domestic inflationary pressures are heightened, a stronger domestic currency will help bring down the price of imports. the role played by exchange rate in easing imported inflationary pressures is particularly important for

hu xiaolian : exchange rate regime reform and monetary policy effectiveness article by ms hu xiaolian, deputy governor of the people ’ s bank of china, beijing, 26 july 2010. * * * the chinese economy is growing rapidly, and is becoming increasingly market - based and more open. as a result, china needs to deal with a much more complicated economic situation. in this context, the ability to conduct macroeconomic management is critical for ensuring sound, rapid and sustainable growth, and the effectiveness of monetary policy has also taken on greater importance. at the current stage of development, china needs to employ monetary policy to accommodate four broad objectives, i. e., price stability, growth, full employment and balanced bop account. exchange rate policy has played a role in achieving these macroeconomic objectives. it also has an impact on china ’ s competitiveness, trade relations and resources allocation. therefore, improving the managed floating exchange rate regime and gradually enhancing exchange rate flexibility will help make monetary policy more flexible and effective, and strengthen the ability to conduct macroeconomic management. i. monetary policy is an important means of macroeconomic management in china monetary policy is one of the important means through which china manages the economy. its effect is transmitted through the financial system, the core of a modern economy. the effect of monetary policy is not limited to one sector or one area. more broadly, it is felt in every part of the economy and affects individual economic behaviors at the micro - level. in this sense, monetary policy carries more system - wide implications and is more systemically important than exchange rate target. monetary policy flexibility and effectiveness are particularly important under china ’ s unique circumstances. as a big developing country undergoing reform and transition, china has to deal with complicated and rapidly changing economic situation, and its macroeconomic policies are therefore designed to meet multiple objectives, such as reform and development. more specifically, monetary policy also has various objectives, including managing inflation, supporting growth, promoting a balanced bop account, boosting employment and facilitating financial reform. this fact highlights the importance of making flexible and effective monetary policies. the chinese economy was put under critical test since the global financial crisis began to unfold in the second half of 2008. to deal with the extremely complicated situation both at home and abroad, the chinese government implemented a proactive fiscal policy and relatively easy monetary policy, and adopted a comprehensive policy package. the economy was among the first to recover in the world. in response to the rapidly changing situation, the chinese government decided