FT Alphaville mentions the Chinese penchant for using tools other than interest rates to tighten monetary policy.
By using reserve ratios and open-market operations, the Chinese authorities are acting to change the supply, rather than the price, of credit. It struck me that this way of doing things should be worse for the economy, in theory at least. If you raise interest rates, then some borrowers will find that their projects become unattractive relative to their funding costs; thus people will borrow for more productive projects, and less productive projects will be shelved. If, however, the supply of credit is restricted, all the projects that were previously profitable will remain profitable, and there will have to be some kind of rationing. In China, this would presumably be on the basis of gaunxi (“connections”).
Can anybody add anything here?
Update: (Via Alphaville) Michael Pettis argues that raising interest rates might not reduce inflation in China.