We also stated that, in view of the economic situation and outlook, the current interest rate level appeared broadly appropriate for the next several months. In other words, significant new developments would be required for the MPC to raise interest rates – or lower them – at upcoming rate-setting meetings. I notice that the bond market seems to have realised the implications of this, as yields at the longer end of the market have not risen since the last interest rate announcement. But looking further ahead, it should be clear to everyone that if GDP growth forecasts materialise in coming  BIS central bankers’ speeches  3  years and the slack in the economy disappears, the monetary slack manifested in a negative real policy rate of over 1% must be removed over time. So where do we stand with respect to the monetary policy stance? Is monetary policy lax or tight? Chart 3 shows the Central Bank’s real interest rate measured by the effective policy rate and twelve-month inflation. The chart shows that, in spite of two recent rate hikes, the real interest rate will be lower in Q4/2011 (assuming unchanged interest rates in December) than at any time since the financial crisis struck, with the exception of Q1/2009, when inflation soared up above 18% and a dramatic disinflation episode was in the offing. Chart 3  Chart 4  But what about the Taylor rule, shown in Chart 4? There is a significant deviation at the moment – one that perhaps requires some explanation.
With the sustained budget surplus and accumulated surplus on the Exchange Fund and Land Fund assets, the actual amount of foreign reserves in Hong Kong amounted to $ billion at the end of September, the third largest in the world. This is more than seven times Hong Kong dollar cash in circulation or over three times $ M1. 30. The currency board system has an automatic adjustment mechanism to maintain exchange rate stability. When there are outflows of funds from the Hong Kong dollar, the Hong Kong Monetary Authority (HKMA) will sell US dollars to banks for Hong Kong dollar. On settlement day, the HKMA will debit the clearing accounts of the banks for the necessary amounts of Hong Kong dollars in return for the US dollar that will be credited to the New York accounts of the same banks. Since banks may have sold more Hong Kong dollars than they have in their clearing accounts with the HKMA, they can only obtain Hong Kong dollars by borrowing from other banks, by bidding up the interbank rates, or selling back the US dollars to the HKMA, that is, by reversing their short position. In fact, the banks do not hold excess Hong Kong dollars because they are generally long in foreign currency. The latest data at the end of July shows that the Hong Kong banking system is short roughly $ billion or $ billion. 31.