Modeling monetary transmission and policy in China

doi:10.1016/j.jpolmod.2004.12.005

Journal of Policy Modeling

Volume 27, Issue 2, March 2005, Pages 157-175

https://doi.org/10.1016/j.jpolmod.2004.12.005 Get rights and content

Abstract

This is an empirical investigation of how monetary policy has been transmitted into the macro economy of China. It forms part of a work on building a macroeconometric model of China. Econometric modeling reveals that the Chinese monetary system follows basically the Polak model with three types of effective monetary policy instruments: interest rates, the required reserve ratio, and a direct quantity control rule of the base money supply. Model simulations show that these instruments are most effective in affecting monetary aggregates and prices but are least effective in affecting the real economy in the long run.

Introduction

The study aims at determining empirically how monetary policy has been transmitted into the macro economy of China. It is built on and also forms part of a quarterly macroeconometric model of China developed by the Economics and Research Department of Asian Development Bank jointly with the Institute of World Economics and Politics of the Chinese Academy of Social Sciences. The task requires us to search for the appropriate models for the key money aggregates to capture the essential characteristics of the banking system and to identify the monetary policy instruments that have been effective and the channels through which these instruments feed into the economy.

The paper is organized as follows. Section 2 provides a background overview of the Chinese banking system mainly for the period since 1990. Section 3 describes the results of our modeling search, i.e., the econometric equations that we have obtained to describe key money aggregates. Section 4 presents results of monetary policy simulations for the purpose of evaluating the effectiveness of policy interventions. The final section concludes with a summary of the results and their implications.

Section snippets

Overview of the Chinese banking system

The Chinese banking system has undergone considerable reforms over the past two decades. This section presents an overview of the banking sector development and a brief description of the evolving monetary policy instruments used by the central bank, i.e., the People's Bank of China (PBC), in order to pave way for the modeling search section. Since our data sample starts from 1992, we shall focus our description to the 1990s.

Modeling monetary transmission and policy

Two objectives guide the modeling search. The first is to find appropriate equations that will explain major money aggregates; the second is to identify which policy instruments exhibit significant roles in channeling monetary policies into the economy.

Previous empirical studies of money aggregates in China show that there exist fairly stable money demand equations since the reforms, e.g., see Qin (1994) and Girardin (1996). These results suggest that the essence of the Polak model is likely to

Policy simulation and economic implications

To investigate the effect of monetary policies, we incorporate the equations described in the previous section into the China model and run a number of model simulations. The simulations are designed to reflect the recent trend of tightening monetary policy in China. The simulation period is 2005Q1–2010Q4. Three scenarios are run to examine the effect of the three instruments, respectively, i.e., Rb, rRR and q_t. Before running the scenarios, we obtain the simulation base by making the last

Conclusions

Several features stand out from the estimated equations of the banking sector. First, the monetary system confirms basically the Polak model, i.e., money aggregates are fundamentally demand driven by the real economy. Second, monetary policies and base money supply have been cautious and accommodating to the demand of the economy, as shown from the relative constancy of the estimated equations, in spite of various banking reforms during the 1990s. Third, an interesting Chinese characteristic of

Acknowledgements

The first draft was presented at the EcoMod2004 International Conference on Policy Modeling in Paris. We would like to extend our thanks to our colleagues both at the ERD of ADB and IWEP of CASS for their help and comments on the PRC modeling project.

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¹: Duo Qin is also senior lecturer at the Economics Department, Queen Mary, University of London.

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Modeling monetary transmission and policy in China

Abstract

Introduction

Section snippets

Overview of the Chinese banking system

Modeling monetary transmission and policy

Policy simulation and economic implications

Conclusions

Acknowledgements

Journal of Asian Economics

Carnegie–Rochester Conference Series on Public Policy

Testing long-run monetary neutrality propositions: Lessons from the recent research

The Review of Federal Reserve Bank of St Louis

In search for a stable demand for money function for China

Economics of Planning

Aggregate investment in People's Republic of China: Some empirical evidence

Asian Development Review

Dynamic econometrics

Nobel lecture: Monetary neutrality

Journal of Political Economy