Study On The Cost Channel Of Monetary Policy And Optimal Monetary Policy Of Central Bank

The monetary policy transmission mechanism has been an important issue ofmacroeconomic research. This paper studies aggregate supply effect or cost channelsof monetary policy, and its impact on optimal monetary policy. First, the paperdescribed the mechanism of the cost channel, and introduce the new Keynesiandynamic stochastic general equilibrium (DSGE) model to analyze the impact ofaggregate supply of monetary policy effect on inflation and output through the costchannel. Secondly, using the industrial enterprises as a sample and econometric modelto empirically test cost channel of monetary policy in China from themicro-level.Again, with the baseline model in the framework of the IS-Philips, andadaptive learning deviated from the rational expectations of the private sector as aprecondition, the pape analyzed rational expectations equilibrium uncertainty and itslearnable conditions of monetary policy, whereby also analyzing impact of the costchannel on effect of monetary policy to curb macroeconomic fluctuations.Finally,analyzing the role of the cost channel on optimal discretional and commitmentmonetary policy of the central bank.Through this research, the article drew the following main conclusions: First,there exists cost channel with China's monetary policy transmission, tighteningmonetary policy will increase the cost of corporate finance significantly, therebypushing up the inflation level. Accroding to traditional monetary policy theory,tightening monetary policy with raising interest rates to curb inflation, while as costchannel of monetary policy, raising interest rates in the short term may not be able tocurb inflation, may became the driver of persistent inflation. Second, whether thetraditional Taylor rule or forward-looking Taylor rule, the aggregate supply effects ofmonetary policy reduced the room for centural bank to output gap and inflationtrade-off. Third, whether the central bank choosing discretional policy or commitment rules, cost channel push inflation level endogenously, and thus, when the economy isfacing exogenous shocks, the central bank will be placed in a difficult position oninflation and output gap trade-off.The main innovations of this article are in following areas. First, this article paysattention to the cost channels of the monetary policy transmission earlier at home.From the perspective of dynamic stochastic general equilibrium (DSGE) models andNew Keynesian Phillips Curve with cost channels, as well as from micro perspectiveof industrial enterprises, the paper verifies the cost channel of monetary policytransmission theoretically and empirically, making the results more convincing.Second, the article is the earlier study which is based on adaptive learning expectationof the private sector and central bank. It introduces aggregate supply effect ofmonetary policy to the framework of New Keynesian IS-Philips curve, analyses theeffect of adaptive learning expectations on the economic expectation equilibriumconditions, and further valuates the effectiveness of China's monetary policy oncurbing macroeconomic volatility.Third, this article is also the earlier study ofintroducing the cost channel of monetary policy to the dynamic stochastic generalequilibrium (DSGE) model. It analyses the effect of cost channel on the monetarypolicy of central bank, and using the numerical simulation methods, it compares theinterest rate difference of the central bank's monetary policy between the output gapand inflation trade-off, which is under the two situations of with or without theexistence of cost channels, when economic productivity and fiscal policy exogenousshocks, as well as commitment policy rules and discretionary rules. It also comes tothe change path of the output gap and inflation under all kinds of equilibrium situation,together with its effects on welfare loss of the central bank.Before when the central bank makes and implements monetary policy, it onlyconsiders the total demand effect it conveys. The cost channel of the monetarypolicy is playing its part in real economy together with the interest rate channel, credit channel, wealth channel and the exchange rate channel of traditional theory.Therefore, when the central bank formulates optimal monetary policy, it should alsotake into account the aggregate demand and aggregate supply of monetary policy inorder to effectively control the level of inflation, to maintain stable economic growth.The central bank should pay more attention to inflation concerning monetary policy.Although the paper assumes that the adaptability of the central bank and the privatesector learning is expected to be homogeneous, as a professional institution, thecentral bank has its own information superiority to lead the public to adaptive learningso that it can better manage inflation expectation, making the economy reach a stableequilibrium level, preventing the emergence of multiple equilibriums and sharpfluctuations, and achieving the goal of suppressing fluctuations in the economy.Therefore, this paper is a practical reference to central bank to optimize monetarypolicy.