The People's Bank of China (PBOC), the country's central bank, has been implementing a moderately loose monetary policy to support the Chinese economy. However, as the economy faces new challenges, the PBOC may be approaching its policy limits. This article explores the indicators, recent actions, and potential consequences of the PBOC reaching its policy limits.



Indicators of approaching policy limits

1. Leveraging a mix of monetary policy tools: The PBOC has been using a combination of tools, such as reducing the reserve requirement ratio and interest rates, to maintain reasonable and sufficient liquidity. This indicates that the central bank is trying to make the most of its available tools, which could suggest that it is approaching its policy limits (Source: PBOC's monetary policy priorities for 2025).
2. Keeping the exchange rate stable: The PBOC has emphasized keeping the exchange rate of the yuan basically stable at an adaptive and balanced level. This focus on exchange rate stability could indicate that the central bank is concerned about potential risks associated with further monetary easing, such as currency depreciation (Source: PBOC's monetary policy priorities for 2025).
3. Preventing exchange rate overshooting risks: The PBOC has expressed its intention to forestall exchange rate overshooting risks. This concern about exchange rate volatility could suggest that the central bank is approaching its policy limits and needs to be cautious about further monetary easing (Source: PBOC's monetary policy priorities for 2025).
4. Maintaining sufficient liquidity: The PBOC has stated that it will maintain sufficient liquidity and steadily increase financial supply to match the target for economic growth and overall price levels. This focus on maintaining liquidity could indicate that the central bank is trying to balance the need for economic growth with the risks associated with excessive liquidity (Source: PBOC's monetary policy priorities for 2025).
5. Improving the efficient use of funds: The PBOC has emphasized the importance of improving the efficient use of funds and increasing quality financial services for major strategies, key areas, and weak links. This focus on efficiency could suggest that the central bank is trying to make the most of its available resources, which could indicate that it is approaching its policy limits (Source: PBOC's monetary policy priorities for 2025).



Recent actions reflecting concern about policy limits

1. Moderately loose monetary policy: The PBOC has outlined its monetary policy for 2025, emphasizing a "moderately loose monetary policy" to create a sound monetary and financial environment for stable economic growth. This approach aims to balance the need for economic support with the risks of excessive stimulus (Source: PBOC's monetary policy priorities for 2025).
2. Leveraging a mix of monetary policy tools: The PBOC plans to use a combination of monetary policy tools, including reducing the reserve requirement ratio and interest rates when appropriate, to manage liquidity and financial supply. This strategy acknowledges the limits of relying solely on interest rate cuts and emphasizes the importance of a diversified toolkit (Source: PBOC's monetary policy priorities for 2025).
3. Keeping the exchange rate stable: The PBOC has expressed its commitment to maintaining the exchange rate of the yuan at an adaptive and balanced level, and forestalling exchange rate overshooting risks. This focus on exchange rate stability reflects the central bank's concern about the potential impact of currency fluctuations on economic stability and its limited ability to influence global currency markets (Source: PBOC's monetary policy priorities for 2025).
4. Improving the efficient use of funds: The PBOC has emphasized the importance of improving the efficient use of funds and increasing the quality of financial services for major strategies, key areas, and weak links. This focus on efficiency reflects the central bank's recognition of the limits of simply increasing liquidity and the need to target financial resources more effectively (Source: PBOC's financial work report).
5. Enriching the monetary policy toolbox: The PBOC has announced its intention to continue enriching its monetary policy toolbox, with the latest example being the inclusion of government bond operations. This move is designed to make short-, medium-, and long-term liquidity management more scientific and precise, acknowledging the limits of relying on traditional tools alone (Source: PBOC's press conference).

Potential consequences of reaching policy limits

1. Limited ability to stimulate growth: If the PBOC has already reduced interest rates and the reserve requirement ratio to their lower limits, it may have limited tools left to stimulate economic growth. This could hinder the government's efforts to expand domestic demand, stabilize expectations, and stimulate vitality in the economy (PBOC, 2025).
2. Increased financial risks: As the PBOC has been actively managing financial risks in key areas, reaching policy limits could make it more challenging to forestall and defuse these risks. This could lead to an increase in financial instability, which could negatively impact economic growth (Pan Gongsheng, 2022).
3. Potential currency devaluation: If the PBOC is unable to maintain sufficient liquidity or control the exchange rate, there could be a risk of exchange rate overshooting, which could lead to a devaluation of the yuan. This could have significant implications for international trade and investment, as well as for domestic prices and inflation (PBOC, 2025).
4. Reduced effectiveness of fiscal policy: If monetary policy is at its limits, fiscal policy may become relatively more important. However, if the PBOC cannot provide sufficient liquidity or lower financing costs, the effectiveness of fiscal policy may be reduced, as enterprises and households may face higher borrowing costs (Lu Lei, 2022).
5. Potential impact on inflation and economic growth: If the PBOC cannot maintain adequate liquidity or control the money supply, this could lead to either excessive inflation or deflation, which could negatively impact economic growth. The paper "Forecasting China's economic growth and inflation" (Higgins et al., 2016) highlights the importance of accurate inflation and economic growth forecasts for policy analysis and decision-making.

In conclusion, the PBOC's recent actions and the indicators discussed in this article suggest that the central bank is approaching its policy limits. If the PBOC reaches these limits, there could be significant consequences for the Chinese economy, including limited ability to stimulate growth, increased financial risks, potential currency devaluation, reduced effectiveness of fiscal policy, and potential impacts on inflation and economic growth. As the PBOC continues to navigate the challenges facing the Chinese economy, it will be crucial for the central bank to adapt its monetary policy tools and strategies to maintain a balanced and adaptive monetary environment.