In order to help the overheated US economy make a "soft landing," the Federal Reserve raised the interest rate by 50 more basis points on May 17. The move begged the question as to whether the Central Bank of China (CBC,
The US' GDP grew by an average of 4.3 percent between 1996 and 1999. This speedy economic growth and the boom in the stock market had the Fed worried that private consumption might fan inflation.
From one perspective, the increase in production offsets the increase in salaries and raw material prices, and, therefore, helps relieve inflationary pressure. However, although the increase in production expands total output, the price of shares may be driven up by stock investors who expect a resultant increase in revenues.
Such an increase in stock prices may further induce investors to increase consumption spending. One effect of an increase in wealth is that a rise in demand may be greater than the increase in supply. Thus, the increase in production may increase inflationary pressures.
In terms of business financing, firms can either borrow money from banks or issue stocks and debentures to get capital from financial markets.
This emerging phenomenon poses a challenge for Taiwan's CBC. Their interest rate policy works because savings and investment within our economic system go mainly through indirect financing. However, when financing gradually shifts toward direct financing, the CBC's utility in interest rate adjustments will be weakened, and that may lead to unfair financing.
Traditional business firms mainly rely on indirect financing. However, it is easier for high-tech industries to raise funds through direct financing. If the CBC raises the interest rate in order to cool the overheated economy, it will affect traditional industries but will only indirectly and temporarily affect high-tech industries.
The annual growth rates of M1B and M2 in March were 19.88 percent and 8.23 percent, respectively. Furthermore, Taiwan had an international trade surplus of around US$8.5 billion in the first quarter, with the short-term in-flow of foreign funds being the major cause of the surplus.
By March, foreign funds had reached a high of US$29 billion, but the CBC refused to allow the NT dollar to go up in order to avoid impacting Taiwan's export competitiveness. All these reasons caused Taiwan's money supply to increase.
During a recent seminar in Geneva, several well-known scholars suggested central banks worldwide should not be afraid of their interest rate policies affecting stock and currency markets. Instead, the banks should go the opposite way to prevent assets from bubbling and to control inflation when asset prices are off the mark.
The financial and monetary authorities should watch the "bubble-ization" of assets. If necessary, the CBC should raise interest rates in order to prevent economic bubbles from ruining the wider economy. In the meantime, the CBC should propose complementary measures to avoid the impact of an interest rate hike on traditional industries.
Hong Chi-chang is a DPP legislator.
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