China monetary policy - control of capital not money

There are two major directions for implementing monetary policy. The one that is talked about in all economic classes is the setting of interest rates. The monetary policy is effective through the credit channel by controlling the cost of funds. The central bank can raise or lower rates. It can change reserve requirements, and it can intervene in exchange rates. Open market purchases and sales of securities can also be done to affect rates and the supply of credit.

What is usually not discussed is the the control of capital through regulation. Some have started to call this the macro-prudential approach to monetary policy. By changing regulations and rules credit flows can be adjusted. The Fed has generally not used this approach but the central bank of China seems t be adopting this regulatory or rules-based approach to stem the rise in real estate. Instead of using the hammer of rate changes, the scalpel of targeted regulation is employed. This will be an interesting experiment. Th Chinese would prefer not to raise rates so the targeted approach may be more effective at dealing with specific asset bubbles.

Note that the Fed could have raised margin requirements to stop the sock bubbles and it could have asked for more regulation in the mortgage markets, it did not. The Chinese market may be overheating, but the central bank is trying to stop some of the excesses without cutting money and the economic growth rate. The markets should watch this nuanced approach closely.