China’s Monetary Policy and the Exchange Rate
Aaron N. Mehrotra
Bank for International Settlements (BIS)
José R. Sánchez-Fung
Kingston University - School of Economics
July 19, 2010
BOFIT Discussion Paper No. 10/2010
The paper models monetary policy in China using a hybrid McCallum-Taylor empirical reaction function. The feedback rule allows for reactions to inflation and output gaps, and to developments in a trade-weighted exchange rate gap measure. The investigation finds that monetary policy in China has, on average, accommodated inflationary developments. But exchange rate shocks do not significantly affect monetary policy behavior, and there is no evidence of a structural break in the estimated reaction function at the end of the strict dollar peg in July 2005. The paper also runs an exercise incorporating survey-based inflation expectations into the policy reaction function and meets with some success.
Number of Pages in PDF File: 27
Keywords: exchange rate, hybrid McCallum-Taylor monetary policy reaction function, SVAR, survey-based inflation expectations, China
JEL Classification: E42, E52working papers series
Date posted: August 4, 2010
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