NOTE
Monetary Policy
English translation of the original VNote “Monetary Policy”, preserving its structure with only necessary small corrections.
This is a historical learning note and may contain outdated or incomplete understanding.
Note: This preserves the original VNote structure and wording as much as possible. Only clear errors or statistical/institutional definitions that have changed are corrected.
1. What Is Monetary Policy?
Measures issued by the central bank to adjust money supply or credit conditions.
1.1. Money-Supply and Money-Demand Balance
1.1.1. Money Supply
M=m*B, where M is the money supply, m is the money multiplier, and B is the monetary base.
1.1.2. Money Demand
2. Classification of Monetary Policy
2.1. Interest-Rate Policy
Lowering commercial-bank deposit and lending rates can encourage people to spend rather than save and can encourage firms to borrow and invest.
2.1.1. Tools
Expansion: lower interest rates, leading to an increase in B -> increase in M. Contraction: raise interest rates, leading to a decrease in B -> decrease in M.
2.1.1.1. Adjust Central-Bank Policy Rates
2.1.1.1.1. Relending Rate
The rate used when the central bank lends to commercial banks.
2.1.1.1.2. Rediscount Rate
The rate applied when a commercial bank takes an unmatured bill to the central bank and converts it to cash.
2.1.1.1.3. Required-Reserve Interest Rate
The interest rate the central bank pays commercial banks on required reserves.
2.1.1.1.4. Excess-Reserve Interest Rate
The interest rate the central bank pays commercial banks on reserves held above the required-reserve level.
2.1.1.2. Adjust Statutory Deposit and Lending Rates of Financial Institutions
2.2. Exchange-Rate Policy
Lowering the exchange value of the domestic currency can support exports.
2.2.1. Tools
2.2.1.1. Exchange-Rate Regime
Floating exchange rate. Fixed exchange rate.
Why Didn’t U.S. Stocks Keep Falling When the Federal Reserve Raised Rates?
Why did U.S. stocks rise after Fed rate hikes? - Zhihu The Federal Reserve raised rates to address inflation. Stocks did fall during parts of the tightening cycle and later recovered. How do Fed rate hikes affect global wealth? - Zhihu Transmission through interest rates -> bond market + stock market + exchange rates.
2.2.1.2. Foreign-Exchange Market
Establish foreign-exchange stabilization funds or similar mechanisms.
2.2.1.3. Foreign-Exchange Operations
Foreign-exchange transactions may be handled through designated state foreign-exchange authorities or banks.
2.3. Credit Policy
3. Common Monetary-Policy Tools
3.1. Reserve Requirements
Raising the reserve-requirement ratio reduces m and therefore reduces M in the simplified multiplier framework.
3.2. Rediscount Policy
Discounting: the public takes an unmatured bill to a commercial bank and converts it to cash. Rediscounting: a commercial bank takes an unmatured bill to the central bank and converts it to cash. This differs from repo and reverse-repo transactions in Bonds. Raising the rediscount rate reduces B in the simplified framework and therefore reduces M.
3.3. Open-Market Operations
The central bank buys and sells securities and, in some frameworks, foreign-exchange assets in the market. Selling securities or foreign exchange withdraws base money and reduces B in the simplified framework.
3.4. LPR (Loan Prime Rate)
MLF (Medium-term Lending Facility)
MLF, the Medium-term Lending Facility, was introduced by the People’s Bank of China in September 2014. The market nickname in Chinese is “malafen.” In simple terms, it is a monetary-policy tool through which the central bank provides medium-term base money to eligible commercial and policy banks. Historically, MLF terms have included three months, six months, or one year.
2026 update: MLF remains a medium-term liquidity tool. The PBOC has further clarified the main policy-rate role of the 7-day reverse-repo operation rate, while MLF has less of a policy-rate role.
4. M0, M1, and M2
4.1. What They Are
M0 is cash, roughly the money in your wallet. Starting with January 2025 data, M1 uses a revised definition: M0 + corporate demand deposits + personal demand deposits + provisions received by non-bank payment institutions. M2 is broad money. It includes M1 plus other less-liquid deposits and other quasi-money items. The exact statistical definition should follow the latest PBOC publication.
4.2. Use
M2 is one important indicator of broad money. Money growth may affect asset prices through credit, interest-rate, and portfolio-allocation channels, but M2 growth alone does not imply that housing or stock prices must rise.
4.3. M1-M2 Gap
- If M1 growth > M2 growth, the note historically interpreted this as demand deposits growing faster than time deposits. It can be used as one clue about how active money balances are, but it cannot by itself establish corporate profitability or the direction of the economy.
- If M1 growth < M2 growth, the note historically interpreted this as more money shifting toward time deposits. It can be used as one clue that money is becoming less transaction-oriented, but it cannot by itself establish profitability or the direction of the economy.