Research On Credit Channel Of Monetary Policy: Empirical Test, Optimal Monetary Policy And Expansion Of Bond Market

The sub-prime crisis poses challenge to the ”New Consensus” view of monetary policy,reached during the Great Moderation since the 1980 s, that monetary policy should maintain an inflation target using short-term interest-rate instruments. First, the desirability of inflation targeting is doubted, with targets such as employment and GDP explicitly appearing on the list of central banks. Second, most of the post-crisis innovations of monetary policy instruments have quantitative characteristics, showing the inclination of the resurrection of quantitative monetary policies. Moreover, the relationship between monetary policy and financial stability needs to be reconsidered.Since credit-linked innovations are universally regarded as the primary impetus driving the post-crisis transformation of monetary policy, the credit transmission channel has become the focus of monetary theory and policy. Based on the credit channel theory of monetary policy transmission, this thesis looks into the following three questions: First, to what extent do financial frictions affect economic fluctuations in our country? Second, how to improve the target and instruments of monetary policy under the credit transmission channel? Third,given the ever-increasing impact of the bond market on monetary policymaking, how to extend the model of credit transmission channel in order to accommodate optimal monetary policy analysis?The thesis first reviews the theory of money and credit under the general equilibrium framework, with emphasis on the modeling techniques of money and credit as well as the design of optimal monetary policy in the New Monetarist and New Keynesian theories. By comparing the two theoretical systems, the thesis chooses the latter as an appropriate analytical framework for discussing post-crisis monetary policies.The thesis then measures the intensity of the impact of financial risk shocks on economic fluctuations, based on the financial accelerator model which integrates the credit transmission channel into the Dynamic New Keynesian framework. After estimating shock parameters using economic and financial data of China and the US respectively, variance decomposition results show that the impact of financial risk shocks on our economy is much smaller than that of the US. Since the estimation uses credit spread data from the bond markets of the two countries to match external finance premium in the model, the above-mentioned result at least indicates that the pricing mechanism of our corporate bond market does not fully reflects credit risks.The thesis puts special emphasis on the optimal monetary policy under the credit transmission channel. I first review the solving method of optimal monetary policy, the pattern of stabilizing inflation and relative price of capital goods, and the robustness of the Taylor rule,under the basic Dynamic New Keynesian model with only consumption demand and the model with capital accumulation and investment demand. The thesis then solves the Ramsey optimal monetary policy in a model with credit transmission channel. Preliminary findings show that,aside from stabilizing inflation and relative price of capital goods, entrepreneurial net worth has higher responses to shocks under the optimal policy than under the Taylor rule, partly because boosting net worth can mitigate financial frictions by lowering external finance premium. The thesis also compares several extensions of the basic Taylor rule, i.e., spread-adjusted Taylor rule and credit-scale-adjusted Taylor rule, to the optimal policy. Results show that these extensions to the interest rate rule, which only take into account variables in partial equilibria, cannot deliver desired policy effects.Last, the thesis attempts to extend the financial accelerator model with differentiated risk preferences and term factors in order for the model to be suited to the analyses of the credit transmission channel of monetary policy in the bond market. I use the extended models to study the macroeconomic effect of the risk retention regulatory requirement on securitization products and the impact of the term factor on the optimal monetary policy, respectively. As for the former problem, the thesis shows that economic fluctuations can be smoothed with a moderate retention ratio, but can also be amplified when the retention ratio is too high. As for the latter problem, the thesis shows that under the Taylor rule, the introduction of long-term bonds into the model drives down the responses of all variables to external shocks. However,under the Ramsey optimal monetary policy, the responses of most variables do not decrease monotonically with the extension of the average term of bonds. Optimal responses of variables such as inflation, long-term nominal interest rate, bond price, and quantity of debt significantly diminish as a result of the extension of the average term of bonds. This shows that as the term of debt in the economy grows longer, the stability of the price and the quantity of bonds becomes more important for investment and capital accumulation.