Board of Governors of the Federal Reserve System

November 1987

Monetary Policy in Taiwan, China

Robert F. Emery

Abstract:

This paper examines how Taiwan, China, has used monetary policy to deal with the impact of the two oil shocks since 1973, as well as with the recent problem of a very large rise in foreign exchange holdings. In dealing with the inflationary pressures brought on by the two oil shocks, the central bank relied primarily on changes in its rediscount rate to reduce inflationary pressures. However, the changes were initially too small and too late to prevent a large rise in consumer prices in 1974 and 1980. Since 1985, the large gains in foreign exchange reserves, due to a rising trade surplus and capital inflows have sharply expanded the money supply. The burden of containing this inflationary threat has fallen on monetary policy, and the government has not been able to offset the build-up in reserves by prepayment of external debt since the amount of outstanding debt is relatively small. In addition, use by the central bank of its rediscount policy or changes in reserve requirements has not been appropriate as domestic credit expansion has been low and not a basic cause of the large rise in liquidity. Instead, the central bank has relied almost exclusively on open market operations. It has engaged in a massive sterilization operation, selling primarily central bank certificates of deposit to neutralize the potentially inflationary impact from the large rise in the money supply. So far the central bank has been successful in holding the inflation rate to a low level, but it is not yet clear whether the present strategy will continue to be successful. Some suggestions of new basic measures for restoring a sustainable equilibrium between the external and domestic sectors are discussed.

PDF: Full Paper