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Central Bank of the Republic of China


Opening Remark for the Taipei International Conference on Modeling Monetary and Financial Sectors

Opening Remarks by Fai-nan Perng
Governor of the Central Bank of China
Delivered at the Taipei International Conference on Modeling Monetary
and Financial Sectors, Taipei, December 18, 2000

Director Hu, Distinguished Guests, Ladies and Gentlemen:

Let me begin by welcoming all the economists and fellow central bankers who have come from afar to join us here. The Taipei International Conference on Modeling Monetary and Financial Sectors is organized jointly by the Institute of Economics, Academia Sinica, the Directorate-General of Budget, Accounting and Statistics, and the Central Bank of China to allow the exchange of ideas regarding the monetary and financial sectors. Allow me to extend my appreciation to the Institute of Economics especially for their thoughtful arrangement of the conference. 

I will keep my opening remarks brief, as I know there are many interesting issues to be discussed in the next few hours.
Now, I would like to take this opportunity to share with you a few basic thoughts on some current and future challenges facing monetary policy makers. I will focus on three major developments.

The first challenge is the apparent change in the inflation process in recent years. From the beginning of this decade onwards, low inflation has been prevailing in the world economy. More surprisingly, this low inflation has been achieved without significant impediments to economic growth. The absence of a trade-off between low inflation and economic growth seems to be a great relief for most central bankers. But it is premature to declare right now that inflation is dead. Monetary economists and central bankers alike are still striving to understand the story behind this low inflation phenomenon. Is it a permanent change in economic structures, mainly due to the revolution in information technology? Or, is it simply caused by a positive shock in productivity that cannot last forever? Much uncertainty still remains as to whether this favorable inflation performance can continue indefinitely in the future.

The second challenge I would like to address refers to the adjustment of monetary policy frameworks. Over the last few years, a new policy framework, called inflation targeting, has been adopted by many central banks around the world. At the same time, we also observed the diminishing role of monetary targeting in those central banks.

Why has there been less of a reliance on monetary aggregates as targets? One reason that has been mentioned most frequently is that, the short-run relationship between money and inflation appears to have become unstable in recent years. Whether this statement is true or not may be still debatable. And that is why the stability of money demand functions still draws a lot of interest from researchers. As you might have noticed, four excellent papers discussing money demand functions will be presented today.

The third challenge facing modern central banks is the increasing importance of financial markets. More specifically, following an upgrade in the industrial structure, IT firms tend to raise funds from financial markets instead of banks. The shift in the sources of financing could be viewed as a transition from a bank-based to a market-based financial system. What contributes to this evolution? One important cause is that a bank-based system is more efficient in financing traditional industries, whose technology and business strategies are well known to banks, while a market-based system is more desirable when the technology is new and constantly evolving. Therefore, we have all seen a rapid expansion in the financial markets during recent years. More and more firms raise their investment funds through the financial markets. As a result, the importance of bank credit as a source of corporate finance has decreased. The most important implication for monetary authorities is that, the effectiveness of the credit channel of monetary policy transmission mechanism would be affected.

In conclusion, our economic structure has changed at a rapid pace over the past decade. In our country, the IT industry has been the engine of economic growth. The change in the economic structure has affected the financial structure, and this may bring about a potential change in the transmission mechanism of monetary policy. Under a rapidly changing economic and financial environment, to what extent should we rely on econometric modeling? We should bear in mind that the statistical relationships embodied in our econometric models are only loose approximations of the underlying reality. Therefore, we should be more careful when interpreting the results derived from econometric models.

Simply put, we have experienced drastic structural changes in both the real and financial sectors over the past couple of years. In addition, monetary policy makers face new challenges in the period ahead. Much has been learnt in the last ten years about what lies behind these changes, but many questions still remain. I hope the discussions in this conference will shed some light on these important issues.
Finally, I wish the conference every success. Thank you.