Monetary Policy Reaction Function in China: Evolution Through Economic and Institutional Changes
Posted: 22 Feb 2018 Last revised: 3 Oct 2018
Date Written: February 14, 2018
This paper investigates the reaction function of the Chinese central bank, focusing on the variation in money supply as the main instrument for monetary policy. Monthly series are used for the 01/2000-12/2016 timeframe. Results show that the Chinese monetary policy displayed countercyclical reactions to prices and economic activity. On the contrary, it has been accommodative regarding equity prices, while fluctuations in the nominal effective exchange rate are found to be non-significant. A rolling window approach reveals that this has not been constant over time. Attention to growth was lower at the beginning and the end of the timeframe, while prices always remained at the foreground. Amongst major reforms, we show that the Shanghai-Hong Kong Stock Connect has had a significant impact on the conduct of monetary policy in China. We also empirically evaluate the effects of monetary policy through a vector autoregressive model. Impulse responses show that a monetary shock has a positive impact on prices and output. The effect on equity prices and the nominal exchange rate is not significant.
Keywords: China, reaction function, monetary policy, money base, McCallum rule
JEL Classification: C22, F31, G15E3, E4, E5, C3
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