Identifying the Interdependence between Monetary Policy and Financial Stress: Evidence from China

15 Pages Posted: 6 Aug 2018

See all articles by Rong Li

Rong Li

Renmin University of China

Xiaohui Tian

Renmin University of China

Date Written: August 2018

Abstract

We estimate the interdependence between Chinese monetary policy and financial stress using structural vector autoregression. To solve the simultaneity problem, we employ a strategy including both short‐run and long‐run restrictions that maintains the qualitative properties of monetary policy shocks derived from the literature. This method is applied to Chinese monthly data, together with a newly constructed index of financial stress in this paper. Our findings suggest there exists strong interdependence between monetary policy and financial stress. The financial stress index increases immediately by 0.4 of its standard deviation after a monetary policy shock that raises the M2 growth rate by 1 percentage point. An increase of financial stress by one standard deviation leads to a decline in the M2 growth rate by 2 percentage points.

Suggested Citation

Li, Rong and Tian, Xiaohui, Identifying the Interdependence between Monetary Policy and Financial Stress: Evidence from China (August 2018). Pacific Economic Review, Vol. 23, Issue 3, pp. 411-425, 2018. Available at SSRN: https://ssrn.com/abstract=3226038 or http://dx.doi.org/10.1111/1468-0106.12174

Rong Li (Contact Author)

Renmin University of China ( email )

Room B906
Xianjin Building
Beijing, Beijing 100872
China

Xiaohui Tian

Renmin University of China ( email )

Room B906
Xianjin Building
Beijing, Beijing 100872
China

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