Deflation and Monetary Policy in Taiwan

Abstract

From 1999 to 2003, Taiwan faced a deflationary situation. The reasons for this deflation can be attributed to both domestic and global factors. Domestic changes including local political unrest, tensions with China, outbound investment to China, a weakened financial system, and a deteriorating government financial situation, provided the backdrop for the economic slowdown and corresponding deflation. A number of global factors, especially the bursting of the Internet and IT bubbles in late 2000 and the rise of China's economy, also heavily influenced both global and Taiwanese prices. This paper adopts a simplified aggregate demand and aggregate supply model to derive a deterministic equation of the GDP deflator (PGDP), and then applies quarterly data covering the period from 1982 to 2003 to estimate the PGDP equation using 2SLS. The empirical results are used to identify the sources of PGDP deflation in Taiwan. In addition, the phenomenon of price divergence appears since 2002 where the WPI increased and the CPI decreased. The causes of the WPI-CPI divergence are also investigated in this paper.

Global liquidity and monetary policy autonomy: an examination of open-economy policy constraints

“…While monetary policy in East Asia used to rely primarily on standing credit facilities, the accumulation of foreign exchange reserves within the last several years has shifted the focus towards the liability side of central bank balance sheets. All of the economies under consideration issued central bank securities in large amounts (LCS), which, in Taiwan's case, were complemented by so-called "re-deposits", reserves financial institutions are obliged to hold with the central bank (Yang and Shea, 2006). In China, central bank bills played an important role up to…”