| 財金（研）091-042號 |
中華民國九十一年七月二十九日 July 29.2002 |
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The Role of Economic Policy in Recent Recession and Recovery: Taiwan Experience |
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Chen-Min Hsu Department of Economics National Taiwan University |
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I.
Introduction
Following
two years of economic recovery from the shock of the Asian
financial crisis (the economic growth rates in 1999 and 2000 are
5.42% and 6.26% respectively), the downturn in the Taiwan
economy has been sharp and notable for the speed with which it
occurred. After still expanding in the first three quarters in
2000, the economy slowed down in the fourth quarter. In 2001,
except the positive growth rate of 0.91% in the first quarter,
the economy has been pushed into recession, with output falling
in the second quarter of the year. In fact, economic situation
in Taiwan is severe, with a recession manifest in a deflationary
pressure in goods and asset markets. This has never been
happened in Taiwan since 1952. Policy makers have not been able
to prevent private-sector confidence from plunging and spending
from being deferred. In addition, the weakness in export markets
and a continuing credit crunch have led to production cutbacks
and a further downward adjustment in medium-term expectations. Although recovery sign in the US export market and the appearance of the expansionary monetary policy effects in 2001 stabilize economic activity in the second half of 2002, there still remains some degree of risks about this rebound of the economy. To restore confidence and bring about a vigorous and sustained recovery, there is still some needs for coherent and credible policy measures that directly address the structural and balance-sheet weakness of the financial and corporate sectors. In addition, how to deal with capital outflow problem is still uncertain. And further reform in the fiscal structure in the public sector is needed.
The purpose of
this paper tries to explore the role of government policies in
the recent economic recession and recovery, also tries to
compare those is the 1998 recession. This paper is organized as
follows. Secton one is an introduction. Section two describes
recent trends of recovery and adjustment in the Taiwan economy.
Section three shows that fiscal and financial restrictions in
2000 caused the economic downturn, while section four shows the
slow reaction of monetary policy during the downturn. Section
five points out that the foreign exchange intervention policy
further restrict the growth of monetary supply. In section six,
we will show that the recent economic trend of recovery becomes
clear. However, whether the Taiwan ecomony has started a
full-scale recovery is still with uncertainty, since some
structural reforms are needed to be implemented. Finally, we set
up an econometric model based on a small open economy like
Taiwan to explain the interaction between monetary policy and
the macroeconomic behavior. And we do a Granger causality test
to explore the relation between monetary aggregates and main
macroeconomic variables, especially the nominal national income,
the exchange rate and interest rates. II.
Recent Trends of Recovery and Adjustment
During the last five years, Taiwan had been experienced two economic down-turns. One started in 1998, and picked up through the second quarter of 1999. The second one in recent times started in the fourth quarter of 2000. The recent recession was not simply a cyclical phenomena, although one determined by a world-wide technology cycle. Rather, it was a combination of cyclical and structural factors with the latter not only serving to keep the underlying economic growth weak but also making the economy vulnerable to shocks. Moreover, these structural factors have also acted to severely constrain the tendency over time for the Taiwan economy to experience periods of above average growth rate of, i.e. 5%. The shock to the economy had been primarily the sharp turnover of economic policy in 2000. GDP growth fell in the second quarter, slowing to 5.1% from 7.94% in the first quarter. The weakness was precipitated by a pull-back in household spending and a reduction in public investment spending, since net exports and private investment spending stayed robust and anchored growth over the second quarter of 2000. On the one hand, government spending was scaled back after the presidential elections, which partially neutralized robust growth in private investment spending. On the other hand, the weakness in the stock market and lack of policy clarity had damaged consumer confidence. As shown in Table 1, the real private consumption in 2000 went down all the way from the growth rate of 7.54% in the first quarter to 5.32%, 4.25% and 2.5% in the second , third and fourth quarters respectively. Drop in private consumption was mainly due to shrinkage in household wealth. The decrease in net worth in the second half of 2000 was concentrated in corporate equities, which suffered from large capital loss. The equity price index dropped from about 9000 point in May 2000 to 5000 at the end of 2000. The depression in the equity market was triggered by the political uncertainty and policy vacuum. A policy vacuum was deepened as a new administration with a shortage of experienced ministers remains hamstrung by an opposition-controlled legislature and an opposition-appointed government bureaucracy. The problem became more serious after the resignation of Premier Tang Fei and Finance Minister Shea Jia-dong in September 2000, since the new cabinet did not improve the stalemate between the executive and the legislative wings of government. As the new Premier Chang Chun-hsiung announced to hold out for no nuclear power station, the policy issue and political conflict between the executive administration and the legislature turn out to be a total deadlock. Table 1 also showed that the growth rate of real public investment slowed down, since the new government promise to crack down on so called “black gold”（or so-called Maffia and crony capitalism） politics and to give the people a clean political environment. Although the new government claimed no delay in the reconstruction of disaster areas, including industrial and spiritual recovery, however, the reconstruction work from the government had lagged behind for at least three quarters. As a result, the public investment grew negatively at – 4.28% in 2000. The slump in external demand that began in the fourth quarter of 2000, combined with concern over domestic problems of low growth rate of real private consumption and public investment resulted in a slowdown in most sectors of the Taiwan economy. Consequently, the growth rate of real GDP fell from 6.25% in the first half of 2000 down to 5.28%. The external shock to the economy had been primarily the sharp downturn in the production and export of information and communication technology goods (ICT) that underpinned the moderation of the economic slowdown. The growth buffer from this source of ICT export however turned out to be weakened in 2001, since the negatively external shock became permanent. The profitability of a significant number of firms that cater to domestic demand remained poor even during first half of 2000 when the economy was still upturn. The sharp weakening of investment activity in the first half of 2001 had been led by falling exports of ICT products, which had resulted in an unusually rapid decline of industrial production. As shown in Table 1, the private investment growth rates in the first and second quarters were –7.6% and –13.66% respectively. These caused the contraction of the second-quarter real GDP by 2.35% year on year, the first time in 26 years. Moreover, in the third quarter both domestic and external demand had been hit by one-off factors such us the terrorist attacks in the United States and typhoon “Nari” assaulted Taiwan. Keynesian approach to fiscal policy to expand public investment was expected when the supplementary budget passed in June of 2001. However, due to the lag effect, the real economic growth in the third and fourth quarters were negative. And the Taiwan economy experienced a severe recession in 2001, recording negative growth rates in three successive quarters to the fourth quarter of 2001, with annual real GDP growth rates reaching a level of –1.9% lower than any year during the past 50 years. Table 2 shows that even in 1998 when the economy was shocked by a combination of the effects of Asian economic turbulence, an enfeebled banking system and the balance-sheet problems of corporates, the real GDP growth rate still remained at 4.57%. This may be due to the favorable effects of various stimulative policy measures from the summer of 1998, leading to a jump in the second quarter of 1999. The slump in the Taiwan economy throughout the second half of 1998 and the spring of 1999 resulted from a combination of negative foreign and financial shocks ended at the second quarter of 1999. The economic recovery has been prompted by policy measures in the monetary and fiscal sphere. III.
Fiscal and Financial Tightening in 2000
Fiscal and financial policy tightened in 2000, when new government announced to eliminate “ black gold” and investigated into illegal practices linked to financial gain such as insider trading and under-collateralized bank lending. The fiscal tightening was not expected and motivated by any thinking that it was necessary to undertake fiscal structural reform. This was a political and government reform to establish a government that is clean. However, the negative effect on the economy became clear as the crackdown on Taiwan’s “black gold” action was pursed to combat with corruption in the corporate and financial areas. Not only did a cutback in government expenditure weaken effective demand, but also the willingness of bank lending to traditional sectors became weak. The sluggish bank credit growth lied primarily with high non-performance-loans (NPLs) and investigations into illegal lending practices. This also caused lower growth in narrow money (M1B) and sell-off of equity market. The investigations into business fraud were the only factors responsible for the financial markets’ skittishness in the first three months of the new government regime. Lack public confidence in the new cabinet of Tang Fei added to the uncertainty. In particular, some companies affiliated with or at least friendly to the former ruling Kuomintang (KMT) had lost their special access to financing from state-owned banks and privileged treatment from the Finance Ministry for bailout packages. All this cases were related to list companies and thus hurt investor confidence in finance and real estate. Table 3 shows that the stock price index in 2000 went down since June, even though the government funds tried to stabilize equity market. It also shows that the growth of bank loan and investment declined sharply since June 2000. In the meantime, the NPLs rate accelerated. The depressed asset market thus brought to the fore the problems of the financial sector. The weakest link in the financial system were the community-based financial institutions, i.e. the credit co-operatives and fishermans, which accounted for about 14% of domestic deposits, had accumulated nearly three times the bad-loan ratios of commercial banks. Equity market sell-off had brought financial-sector fragility to the fore. The financial market was shocked further since September 2000 by conflicting views of supporting the building of a fourth nuclear power plant, which most business believed to be essential to meet the future energy needs of Taiwan’s fast-growing high-technology industries. Since the nuclear plant was already one-third completed and major contracts had been signed for equipment, the costs of stopping were large. However, because president Chen Shui-bian and his party oppose the plant, arguing that there’s nowhere to store nuclear waste and that safe and more environmentally friendly energy sources are preferable, while Premier Tang Fei and the KMT supported the building, the tension and emotional debate over nuclear power triggered Tang’s resignation on October 3, followed by that of the entire cabinet. The new appointment of Premier Chang Chun-hsiung was not accepted and welcomed by the KMT, since this meant that President Chen had returned to old-fashioned party politics and abandoned his bid to build an “all people’s government,” a populist slogan blurring party affiliations. The political uncertainty had further depressed public confidence in the government’s ability to manage the economy, and therefore the stock prices went down even further. Although the fiscal and financial tightening in 2000 appeared to be justified by the relatively good growth in industrial production and private investment spending in the second and third quarter in 2000, however, policy makers and most economic forecasting research institutions seemed to have overestimated the underlying strength of the economic situation. In fact, the policy uncertainty with financial sector fragility had pulled down private investment spending and the economic growth in 2001. The private investment contracted in the fourth quarter of 2000 and its growth rate became negative, i.e. –1.28%. In 2001, the growth rate of private investment declined ever further to –22.66%. These and lower private consumption caused serious recession and the negative growth, starting from the second quarter of 2001, lasted for three quarters. The weak household expenditures combined with the negative growth of bank credit in the second half of 2001 had shown sign of deflation. IV.
Inflexible Reaction of Monetary Policy With the domestic-oriented traditional industries faced with a credit freeze and low inflation pressures in 2000, the Central Bank was expected to shift to an accommodative monetary stance. However, the monetary authority did not respond either quickly or actively to mitigate asset deflationary pressures and did not provide fully support to the economy and the financial system in the face of fiscal and credit tightening as well policy uncertainty in 2000. Instead, the Central Bank raised rediscount rate twice on March 24 and June 27 in 2000 in the face of high interest rate in the international market and high oil price inflation pressure since 1999（see Table 4）. In addition, to prevent individuals and firms to transfer domestic deposit account to foreign currency deposit account in December of 2000, the Central Bank imposed the required reserve on the foreign currency deposit account by 10%（see Table 5）. Although this action aimed at fighting against the exchange rate depreciation and keeping domestic deposits from capital outflows, the NT dollar still depreciated although with temporary stable in the first quarter of 2001. The main problem of monetary policy as the economy slipped into recession in the second half of 2000 and 2001 was that the monetary authority reduced the target zone of monetary aggregate M2 from (6%, 11%) to (5%, 10%) in 2001, and then even further to (3.5%, 8.5%) in 2002 as shown in Figure 1. The historical pattern showed that the Central Bank reacted to a weakening economy with a lower target for its monetary policy instrument, the monetary aggregate M2 growth rate. This suggests that if a typical recession does unfold in the coming months, the target for money growth rate will much lower. But there is an important difference this time compared with the last recession in 1998-99, which ended in the second quarter of 1999. The difference is that this time the Central Bank was essentially on hold as the recession began and indeed until it was well underway in 2000, whereas in the 1998-99 episode, the Central Bank began to lower the required reserve ratios in August 1998 and the rediscount rate in September 1998 before the onset of recession. Although the Central Bank lowered the rediscount rate for 12 times and started in December 2000 before the Federal Reserve of U.S. lowered the federal funds rate in January 2001, it seemed to be too late to do so comparing with that of the Federal Reserves（see Table 4 and 5）. The passive and inflexible response of monetary policy caused money growth rates to slide down from 8.2% in the first quarter to 6.7% in the fourth quarter of 2000. In contrast with this time, the money growth rate in 1998 did not contract too seriously as shown in Table 3. In fact, the money growth rate was raised from 8.1% in the first quarter to 9% in the fourth quarter of 1998. Its is worth mentioning that the time pattern of monetary base or high-powered money shows that monetary policy was more contractive recently than that in 1998-99 period. In face of low velocity and money growth rate as well as bank credit crunch since 2000 as shown in Table 6 and Figures 2-4, according to the monetarist view, it is no wonder that the Taiwan economy became weaker and weaker. And the unemployment rate increased from 2.74% in January 2000 to 5.22% in December 2001. The passive reaction of monetary policy could be found easily from the money supply targeting process. The Central Bank set the target zone according to its estimation of the money demand in the coming year, with the money demand function of government forecast values of economic growth rate and other financial variables (including interest rates and foreign exchange rate). If the forecasting value of economic growth rate is lower, then that money demand and therefore the target money supply will be also reduced. That is, with recession ahead, the Central Bank will react with tight monetary policy. This sounds irrational, however, this is what the monetary policy targeting process has truly been made. That is, the pattern of monetary policy had been following the rule of leaning with the wind instead of leaning against the wind. As mentioned above after a brief economic recovery from 1999 that peaked in the first quarter of 2000, the Taiwan economy had been shocked by equity price volatility due to the sharp downturn in the public investment (including government and public enterprise investments) as well as the credit squeeze to traditional business. The economy had experienced capital outflow since the second quarter of 2000. The painful experience of asset-price deflation, that had triggered the balance-sheet problems of list companies in the fall of 1998, had reminded the new government to intervene in equity market by using government funds as well as asking state-owned banks to buy stocks. However, due to liquidity problem caused by banks unwilling to lend to traditional sectors and low growth in narrow money (M1A and M1B) starting from July of 2000, the equity market sell-off and banking sector fragility interacted with a vicious circle. The balance-sheet problem of corporations affected the cost of credit and caused credit contraction further. As
Federal Reserve Chairman Greenspan had emphasized the increasing
importance of the role of asset prices in monetary policy and
suggested that central bankers should have a better
understanding of how asset prices were determined and how
changes in asset prices affected economic activity. In
particular, Greenspan called for further research into the
channels by which asset prices affect macroeconomic activity
(Greenspan (1999)). However, the Central Bank of China seemed to
forget the drag on the Taiwan economy of equity-price deflation
in 1998, and therefore did not implement an expansionary
monetary policy earlier in the second quarter (at least in the
third quarter) of 2000 as it had been done in 1998. The wrong
and lagging reaction of monetary policy to the equity price
deflation and capital outflows had caused the economy to be in
serious downturn situation. In fact, as the NT dollar exchange
rate started to depreciate in the third quarter of 2000, the
Central Bank feared for inflation and therefore intervened in
the foreign exchange market by selling foreign exchange reserve.
This exchange rate intervention combined with capital outflows
had made monetary base（or
reserve money）and
therefore money supply reduced further as shown in Table 6 and
Figure 2. V.Foreign
Exchange Intervention Policy
Buying foreign currency through unsterilised intervention is a theoretical option mainly because foreign-exchange market operations treat the various flows of funds as homogenous. In addition, it is always difficult to decide whether the level of a currency is inappropriate. Even the long-term equilibrium value of the NT dollar in US dollar terms has not been estimated sufficiently. Exchange rate policy, like monetary and fiscal policy, is potentially vulnerable to populist pressures and other political considerations. Sometimes policymakers will refuse to devalue a currency that needs to be devalued out of a stubborn unwillingness to admit publicly that their past policies have failed. Other time they will seek to devalue a currency that should not be in order to gain the short-term advantage of higher output and employment, figuring that the costs in terms of higher inflation will not show up until after the next election. For such reasons, it is preferred to see an independent authority having technical expertise and insulation from politics to have responsibility for intervention in the foreign exchange market（see Dominguez and Frankel（1993））. The Central Bank in Taiwan has primary responsibility for foreign exchange intervention policy as well as for monetary policy. Over the past two years the exchange rate has depreciated from 30.73 (NT/USD) in May 2000 to 35.06 in March 2002, by about 16%, and then appreciated to 34.46 in May 2002. Driving the depreciation of the exchange rate has been the high level of capital outflow since the second quarter of 2000. Recently, since the March of 2002 when the Japanese Yen started to appreciate, the NT dollar also appreciated against US dollar, despite repeated interventions. In
comparison with the depreciation rate of the Japanese Yen over
the period from May 2000 to February 2002 as shown in Table 7,
the NT dollar was over-depreciated. The intervention of the
Central Bank exerted deflationary pressures and caused money
supply growth rates to decline all the way down. The exchange
rate intervention policy had made the contractive monetary
policy even worse. This partially contributed to the low rates
of money supply in the past two years. VI.
Economic Recovery and Structural Reforms
6.1 Economic Recovery in 2002 Recent economic indicators have generally provided encouraging signs about the prospects for recovery. The Taiwan economy returned to growth in the first quarter of 2002, lifted by rebounding exports of computer chips and mobile phones. Increases in semiconductor prices, orders, and shipments over the first quarter of 2002, together with the broader strengthening of activity appearing in the United States and other advanced economies, support export performance and industrial production in Taiwan. The real gross domestic product (GDP) rose 0.89% in the first quarter from a year earlier. As Taiwan’s two main export markets (i.e. China and the US) had been recovering, Taiwan’s exports and industrial output rose in April 2002 faster than expected. Export orders in April and May rose 11.45% and 8.97% from a year earlier respectively, for the continuing increases for two months after the lasting negative growth for 14 months since February 2001. Indeed, production has already picked up, as has consumer or business confidence. The Taiwan’s unemployment rate dropped to a nine-month low of 4.98% in April from 5.16% in March 2002. The decline in unemployment came as more high-tech jobs opened up and more people became self-employed, particularly in the retail and wholesale sectors. According to criteria released by the Council for Economic Planning and Development (CEPD), the composite indicator of economic business cycle turned to a “green light” level that pointed to steady economic growth in April 2002. This maked the first green light since October 2000, after which the indicator moved to a “yellow blue” light for economic showdown in November 2000. The economy is expected to perform stronger in the second half of 2002. However, whether the Taiwan economy has started a full-scale recovery is not without any uncertainty. Among these are the magnitude of the recovery and weak dollar in the US economy due to recent corporate scandals and possible terrorist attacks, and other Taiwanese economic and financial structure problems. As the rapid growth of investment and exports associated with the information technology in that period of 1990s appears unlikely to be repeated, domestic sources of growth as well as broadening the manufacturing and export base have become more important. These include structural reforms, trade and investment relations with China, as well as both easing of monetary policy and public investment expansion of fiscal policy. In normal circumstances, the recovery indicators would lead to a relatively optimistic view of the economy by most observers. However, in the case of Taiwan at this moment, the economy still adjusting to massive imbalances, not only from the asset price bubble of the late 1980s but also from the past policy of heavy regulation of deliberately slowed adjustment. It is the interaction between cyclical processes and structural adjustments, with the latter not only serving to keep the underlying recovering growth rate weak but also making the economy particularly vulnerable to shocks. In fact, these structural factors have also acted to severely constrain the tendency over time for a market economy to experience periods of above average growth. The shock to the Taiwan economy in 2000-2001 had been primarily the sharp downturn in the production and export of information and communication technology goods (ICT), as well as the mismatch of deflationary monetary and restrictive fiscal policy. Although the external demand for ICT goods have underpinned the recent recovery, it is still not so strong. The rest of the economy has remained sluggish. The profitability of a significant number of firms that cater to domestic demand will remain poor, masked by the increase in profits earned by internationally competitive firms. It is in this domestic sector where bad loans are concentrated, with firms being allowed to survive thanks to low interest rates and debt forgiveness on the part of banks. The vulnerable banking sector that is due to the delay in dealing with non-performing loans and other balance sheet problems might again drag the recovery of the economy. Moreover, as show in Figure 5, due to the downward rigid adjustment of bank loan rates, the interest rate spread has been enlarged. This will discourage private consumption and investment, since the real interest rate is high while CPI inflation rate is low（see Table 8）. The policy implication is that the interest rate structure reform is needed. 6.2
Restructuring of the Banking Sector Reform priorities include the interwined issues of restructuring the banking sector and foreign exchange market, reforming the fiscal structure, and redesigning the pension system. As shown in Table 3, the non-performing loan has been recorded at 8.04% in April 2002. However, this does not include those debt forgiveness and extension followed by the loan agreement, which is about 4% of bank loans. The government has placed great emphasis on the need for the banking sector to finally dispose of bad loans with the purpose of improving the supply of capital to the private sector of the economy. However, the volume of non-performing loans is much greater than NT$ 1,147 billions (about US$ 33.73 billions), and the balance sheet of the banking sector remains weak. Thus, more ambitious measures need to be considered. A clearer timetable for bad loan disposal and balance sheet restructuring should be drawn up. There is widespread concern that the self-assessment of loan quality by banks is too optimistic and that the residual value of collateral is also significantly over-estimated. As shown above, non-performing loans are officially underestimated. At the same time, reserves for potential loan losses are much lower. The most important reason for the evident under-provisioning for bad and doubtful loans is the low profitability of the banking sector. In addition to non-performing loans, the banking sector is also saddled with large holdings of equity as collateral, which makes their balance sheet vulnerable to changing stock prices. A key to restoring the banking sector is for the authorities to enforce via regulatory means accurate timely disclosure of non-performing loans and especially those which must be regarded as bad. But there were aspects of moral hazard on the part of banks, management, since banks concern about low profitability and capital. Therefore, the financial inspections should be made annually rather bi-annually, and loans to large clients which have suffered a worsening in their market conditions such as their credit rating and relative share price, should be checked semi-annually. One reason for the low profitability is the over-capacity in the banking sector. One manifestation of this is the presence of weak government financial institutions, including state-owned banks, which are not subject to the same cost structure (for instance, not paying taxes and deposit insurance premiums). The other reason is uncertain about the actual residual value of the collateral and difficulty in enforcing claims. The government is planning to reinvigorate the real estate market and enhance the capacity of the new asset manage companies to dispose of assets effectively. However, due to the financial technology difficulty and lacking transparency of bank’s balance sheets, the financial innovation proceeded very slowly. To resolve the over-capacity problem in the banking sector, the Financial Holding Company Act was passed in June 2001, while the Acquisition and Mergence Law was enacting in December 2000. However, up to the second quarter of 2002, only one case of full banking mergence came out, which occurred in May 2002, although there were 13 cases of consolidation among financial institution to form joint financial holding companies. To aid the resolution of bad loans, especially for regional banks including credit co-operatives and farmers and fishermens associations, it is planned to widen the operations of the Resolution and Trust Funds (RTF) which established in August 2001. Although details are still to be decided, it is intended that banks should either sell those bad loans that have not been cleared within the three years time limit to RTF or transfer them for collection against a fee. The RTF has been granted an asset management license which will allow the RTF to repackage assets, shares, and loans it has received as new financial assets for resale, as long as a new law of Loan Securitization Act is passed. The other structural problem of the banking sector is the large bank equity holdings. The cross-shareholdings had been resulted from the policy of stock market stabilization since 1996. Unless bank acquisition and mergence come out, it is an unstable factor to the banking sector. In sum, the government’s intention to resolve the balance sheet problems of the banking sector is appropriate and progress is being made. Important legislation has already been submitted to the Legislative Yuan（i.e. the Congress）. The key question is whether it is enough to deal with the true scale pf non-performing loans. Banks need to be kept under pressure and tighter inspections by the finance authorities to deal with non-performing loans and to continue restructuring with the objective to raise profitability. In the absence of further capital injections, proper provisioning for non-performing loans at some banks might be so high as to wipe out their capital base, in which case the authorities should not hesitate to take them into ownership. If such a step were to prove necessary, the government should replace the top management and demand more extensive restructuring. In addition, more rigorous guideline covering private work-outs and loan forgiveness should be implemented since they avoid restructuring commitments. And the role of RTF remains unclear, especially its policy towards pricing loans, the financing and its governance. Whether it will be used as a transparent way of recapitalising banks is not so clear and remains a challenge work. 6.3
Liberalization in Foreign Exchange Market and
Establishment of an Efficient Real Estate Market To ensure that financial markets and institutions do not hinder the likelihood of economic recovery, the financial authorities have continued to pursue financial deregulation and restructuring, especially for corporate restructuring and consolidation among financial institutions. However, restrictions on entry into the foreign exchange market and lack of competition in foreign exchange services offered had caused an inactive foreign exchange market. To enhance the transaction in foreign exchange market and to set up an internationalization of Taiwan financial market, further liberalization of cross-border capital flows and financial services is needed. This will improve the profitability of banks, by removing the ban on over-the-counter sales of foreign investment trusts（mutual funds）and encouraging banks’ foreign investment. And banks and public retirement funds should be allowed to investment in foreign financial market. Real estate has an enormous importance in Taiwan and in the past has played a major role in the monetary transmission mechanism, the supply of credit being closely related to the value of real estate as collateral. It has also had a significant impact on resource allocation so that an efficiently functioning real estate market is important. Advances have been made in establishing a market for commercial mortagage-backed securities. In the future, after Real Estate Securitization Act is passed, investment companies should be allowed to hold real estate-backed securities. 6.4
Regional Integration between Cross-Strait Economy Due to geographical proximity,
shared cultural and language background, the economies of
Taiwan, Hong Kong and China together have formed one of the
fastest growing regions in the world since the start of China
economic reforms. The
so-called Cross-Strait Economy included the Regional Economic
Integration among these economies. As shown in Table 9 and 10,
the degree of the interdependence among these three economies
rose up over time. This can be found in the trade and FDI data.
Robust growth narrowed the gap in the development level among
the three economies and accelerated regional integration. This
fact is turned out to be crucial to the continuing growth of
Taiwan and Hong Kong. Table 9 illustrates the sources of China’s FDI in selected countries and regions. Foreign capital has flowed into China from more than 180 countries and regions in the world. Hong Kong rank the first, accounting for 52.73% of the total FDI inflows into China over the period 1990-2000, followed by the United States 8.49%, Japan 8.43% and Taiwan 8.23%. Hong Kong and Taiwan, accounted for about 60% of all FDI in China. Trade between China and Taiwan also rapidly increased (see Table 10). The share of exports to China relative to Taiwan’s total exports rose from 0.02% in 1993 to 2.84% in 2000 and the share of imports from China rose from 0.47% in 1991 to 4.44% in 2000. Similarly, between 1991 and 2000, the share of exports to Taiwan relative to China’s exports also rose from 0.83% to 2.02%, and the share of import from Taiwan relative to China’s imports rose from 5.70% to 11.33%. In 2000, Taiwan was the seventh largest trading partner of China. Despite that China reduced its trade with Hong Kong after 1993, she was still China’s fourth largest trading partner, comprising 11.4% of China’s total value of exports and imports in 2000. In 1989 this percentage reached 32.1%[1]. Hong Kong was also the second largest buyer of Taiwan’s exports since 1990, although some of Taiwan’s exports to Hong Kong were re-reported to China. Similarly, some of China’s exports to Taiwan were through Hong Kong. That is why Hong Kong plays an important role of intermediary in the trade between Taiwan and China (see Table 11). According to the Hong Kong Customs Statistics, among the US$1207 million that Taiwan exports to Hong Kong in 1979, US$21.5 million was re-exported to China, account for 1.8% of Taiwan exports to Hong Kong. However, the share reached to 60.3% in 2000. Likewise, the share of Taiwan imports from China via Hong Kong relative to Taiwan imports from Hong Kong rose from 16.3% in 1979 to 38.8% in 2000. In addition, the market share of China export goods in Japan and the United States were markedly increased from 6% and 3.89% in 1991 to 14.53% and 8.22% in 2000 respectively. However, over the same period, the marked share of Taiwan export goods in Japan and the United States were still in within the range 3.33% ~ 4.72% and 3.69% ~ 4.37%, respectively. The rapid pace of economic interaction between the two sides of the Taiwan Strait has increased the pressure on Taiwan to change the regulatory approach toward cross-strait exchanges. An easing of the restrictions on the flow of goods, people and investment between Taiwan and China should be an importance to facilitate global business plans, which often include market on the mainland China. Direct transportation between Taiwan and China is by far the most important to the business needs. Proximity
to and familiarity with the China market is Taiwan’s
comparative advantage. Aside from obvious cultural and
linguistic strengths, Taiwanness have extensive experience
operating in China. This makes Taiwan companies and
professionals attractive partners for foreign business wishing
to invest in Taiwan as well as use Taiwan as a platform for
China investment. Thus, in order for Taiwan-based business to
take full advantage of these opportunities, the government needs
to remove the bulk of the unilateral restrictions on
cross-strait business. VII.
Forecast Results for a Small Open Economy
In
this section, we will extend Walsh’s (1998) optimization model
to a small open economy like Taiwan (see Walsh (1998), section
5.4.1). The model consists of four equations. In addition to
policy-reaction function, aggregate demand, and aggregate supply
functions, we also incorporate an equation for the foreign
exchange market. Assume the Central Bank’s objective is to stablize
the internal and external values of the currency（i.e.
domestic prices and foreign exchange rate）and
promote economic
growth. And suppose that the Central Bank attempts to use
short-term interest rate rt as the short-run
operational target of monetary policy and sets rt
according to the following rule:
where
the subscript t refers to time; r
is the short-term nominal interest rate; ygdpt-1
is the output gap at t-1; ygdp is the difference
between the real GDP（y）and
its capacity or full-employment value y* ; p
is the inflation rate, p*
is the target inflation rate; e is the exchange rate
depreciation rate ( a higher e means currency
depreciation); and e* is the target exchange
rate depreciation rate. The policy feedback parameters a1,
a2 and a3 are expected to be
positive, so that the interest rate instrument rises in response
to output, inflation and exchange rate that are high relative to
their targets. We specify the open macroeconomics
model as follows:
Equation
(2) is the aggregate demand equation. Output depends on lagged
interest rate, its own lagged value, the current change in the
exchange rate, and a demand shock. Equation (3) is the aggregate
supply equation. The inflation rate depends on the lagged output
gap, its own lagged value, the lagged value of change in the
exchange rate, and a supply shock. Finally, equation (4) is
exchange rate equation. The change in the exchange rate depends
on the current interest rate, output, its own lagged value, and
the exchange rate shock.e1,
e2 and
e3 are
demand, supply and exchange rate shocks respectively. We will use quarterly data from 1983:1 – 2002:1 to estimate the
model. We use weighted averages of overnight interest rates in
inter-bank call loan market as short-term nominal interest rate
proxy. The short-term nominal interest rate is the instrument of
monetary policy. The data for the interest rate are from Financial
Statistics Monthly. The percentage change in the Consumer
Price Index (CPI) is the measure of inflation rate. The data for
CPI (1996=100) are from Commodity-Price Statistics Monthly.
The percentage change in the
New Taiwan dollar exchange rate against the US dollar is the
measure of exchange rate depreciation
rate.
Data
for the New Taiwan dollar exchange rate are from Financial
Statistics Monthly. We use the growth rate of real GDP as
the indicator of output growth rate. The quarterly real GDP data
are from the Quarterly National Economic Trend. The
output gap is the percentage deviation of output from a
quadratic trend. Since
variables may be endogenous, the OLS estimates are inconsistent.
To overcome the difficulty, we utilize the generalized method of
moments (GMM) to estimate our model, with one to five period
lagged dependent and independent variables serving as
instrumental variables. All estimates are consistent. Table 12
reports the GMM estimation results. It shows that all the
estimated coefficients for the monetary policy-reaction function
have the expected sign and statistically significant. In the
aggregate demand equation, all the estimated coefficients have
the expected sign except the exchange rate depreciation rate. In
the aggregate supply equation, all the estimated coefficients
have the expected sign and statistically significant except the
lagged value of the change in exchange rate. As for the exchange
rate equation, all the estimated coefficients have the expected
sign and statistically significant except that of the interest
rate. In
the following, we will use the estimated model to forecast. The
forecasting periods are December 2001, March 2002, and May 2002
respectively. Due to the
Central Bank of China has followed the United States by lowering
interest rates 12 times consecutively in 2001, the coefficient
of intercept term in the policy-reaction
function had been revised downward. The forecast results are
shown in table 13. Because the world economy continues to
expand, the Taiwan economy improves gradually in 2002. According
to our latest forecast results (May 2002), we find that real GDP
growth rates will reach 2.21%, 3.32% and 4.26% in the second,
third and fourth, respectively, and annual average growth will
reach 2.67%. The figure (2.67%) is consistent with the Chung-Hua
Institution for Economic Research’s prediction.
But the result is different from the prediction of the
Taiwan Institute of Economic Research (2.88%). For
the interest rates, although the economy will gradually recover,
the Central Bank will continue to maintain an expansionary
monetary policy, the overnight loan rate will continue to fall.
Our model forecasts of annual average overnight loan rate will
reach 2.28%. As for the exchange rate, the exchange rate of the
NT dollar will depreciate in the short
run. The annual average exchange rate depreciation rate will
reach 7.69% in 2002 without considering the recent increases in
foreign capital inflows due to the weakness of the US financial
market.. As for the prices, although the economy will gradually recover, the
consumer price index will slowly increase. The annual inflation
rate will decline to –0.01% in 2002.
VIII.
Block Causality Test of Money and Income
In this section, we try to investigate the role of monetary policy during the last seven years（from 1995 to 2002） by using a vector autoregressive（VAR）model to do block causality test of money and nominal income. The quarterly data are from 1995Q1 to 2002Q1. All variables are transformed by natural logarithm. The null hypothesis to be tested is the following: Lags of one variable does not Granger cause the remaining variables（Enders（1995）, Hamilton（1994））. Defining the variables used as follows: y : nominal national income（base on the price of 1996）, m: broad monetary aggregates, i.e. M2, r: interbank call loan rates, e: foreign exchange rate, The result is reported in the table below:
The results show that Model Ⅰ
rejects null hypothesis at 10% significant level, while Model Ⅱ
does not reject null hypothesis. This implies
that nominal income Granger causes money supply, while money
supply does not Granger cause nominal income. In other words, we
have shown that monetary policies were more passive in the past
7 years. The monetary policy authority did not actively use the
monetary policy instrument to enhance the national income. This
also proves our conjectures in Section Ⅳ
that monetary policy had been following the
rule of leaning with the wind instead of leaning against the
wind.
Table 2. Economic Growth Rate of Main Countries
Source ： IMF「IFS」、OECD、US、Japan、Korea、Singapore、Hong Kong Statistics Monthly Report、Internal Economy Dynamic Index. 2002 forecast data from DRI-WEFA.
Table 9. Source of China’s Foreign Direct Investment in Selected Countries and Regions
Table 10. The Share of Cross-Straits Trade in Taiwan and China Total Foreign Trade
Note: - Nil. Source: China Foreign Economic Statistical Yearbook, Monthly Statistics of Exports and Imports Taiwan Area.
Table 11. Trade between Taiwan and Hong Kong and Transit Trade to China Unit: US$ million, %
Source: Cross-Strait Economic Statistics Monthly, August 2001.
Table 13. Macroeconomic Forecasts Unit: %
Reference Dominguez, Kathryn M. and Jeffrey A. Frankel,
(1993), Does Foreign Exchange Intervention Work, Institute
for International Economics. Enders, Walter, (1995), Applied Econometric Time Series, John
Wiley & Sons, Inc. Greenspan, Alan, (1999), “Opening Remarks.” New
Challenges for Monetary Policy, 1-9, eds. By Gordon H. Sellon,
Jr. and Charmaine R. Buskas, Federal Reserve Bank of Kansas City,
pp.1-12. Hamilton, James D. (1994), Time Series Analysis, Princeton University Press. Walsh, Carl E. (1998), Monetary Theory and Policy, Cambridge:
The MIT Press. |
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