Dual-Track Interest Rates and the Conduct of Monetary Policy in China

Hong Kong Institute for Monetary Research (HKIMR) Working Paper No. 21/2011

56 Pages Posted: 30 Jul 2011 Last revised: 29 Mar 2012

See all articles by Dong He

Dong He

Hong Kong Monetary Authority; Hong Kong Institute for Monetary Research (HKIMR)

Honglin Wang

Hong Kong Monetary Authority - Hong Kong Institute for Monetary Research (HKIMR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 27, 2011

Abstract

China has a dual-track interest-rate system: bank deposit and lending rates are regulated, but money and bond market rates are market-determined. At the same time, the central bank also imposes an indicative target, which may not be binding at all times, on total credit in the banking system. We develop and calibrate a theoretical model to illustrate the conduct of monetary policy within the framework of dual-track interest rates and a juxtaposition of both price- and quantity-based policy instruments. We model the transmission of monetary policy instruments to market interest rates, which, together with the quantitative credit target in the banking system, ultimately serve as the lever by which monetary policy affects the real economy. The model shows that market interest rates are most sensitive to changes in the benchmark deposit interest rates, significantly responsive to changes in the reserve requirements, but not particularly reactive to open market operations. These theoretical predictions are verified and supported by both linear and GARCH models using daily money and bond market data. Overall, the results of this study help us understand why the central bank conducts monetary policy in China the way it does: a combination of price and quantitative instruments, with various degrees of potency in terms of their influence on the cost of credit.

Keywords: Monetary Policy, People’s Bank of China, Dual-Track Interest Rates, Interest Rate Liberalization

JEL Classification: E52, E58, C25, C32

Suggested Citation

He, Dong and Wang, Honglin, Dual-Track Interest Rates and the Conduct of Monetary Policy in China (July 27, 2011). Hong Kong Institute for Monetary Research (HKIMR) Working Paper No. 21/2011. Available at SSRN: https://ssrn.com/abstract=1895941 or http://dx.doi.org/10.2139/ssrn.1895941

Dong He

Hong Kong Monetary Authority

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

Hong Kong Institute for Monetary Research (HKIMR)

3 Garden Road, 8th Floor
Hong Kong
China

Honglin Wang (Contact Author)

Hong Kong Monetary Authority - Hong Kong Institute for Monetary Research (HKIMR) ( email )

3 Garden Road, 8th Floor
Hong Kong
China

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