Study On The Effectiveness Of China's Monetary Policy Rule Base On Dsge Models

In recent years, the People's Bank of China (PBoC) has raised benchmark interest rates several times to curb excess liquidity, asset price inflation, and the RMB appreciation frequently, which indicates that the PBoC's monetary policy rule is discretion. The monetary policy rule with discretion affects the stability of China's macro economy. In monetary economics, the monetary policy regimes can be divided into two systems with rule and discretion. The general debate over rule versus discretion is continuing for a long time. In terms of the monetary policy main instrument, monetary policy rule consists of both money supply rule and interest rate rule.The PBoC abolished the quantity limit of credit after Asian financial crisis in1997, since then the money supply has been supposed to be a dominant policy instrument in China. Meanwhile, with the liberalization of Chinese interest rate market, the PBoC is inclined to make an active use of the interest rate rule. Thus, the effectiveness of money supply rule and interest rate rule has attracted the attention of academics. There are three views about the effectiveness of the money supply rule:(1) the money supply rule is still effective and the PBoC can continue to employ the money supply instrument;(2) the quantity rule seems to be less operable as China's money velocity and multiplier have increased significantly in the past years and the tie between money growth and output, inflation has loosened in the past years, so that the PBoC should turn to other monetary policy rule, e.g. the interest rate rule and the inflation targeting rule;(3) the money supply rule is ineffective and the PBoC should combine both interest rate and quantity of money for monetary policy operations.There are two opposite views about the effectiveness of interest rate rule:(1) the interest rate rule can provide a benchmark for measuring the stance of China's monetary policy;(2) the interest rate rule is unstable in China and the interest rate instrument may not be suitable for the PBoC to conduct the monetary policy.This paper is meant to answer the following questions:whether the monetary policy rule is more effective than discretion? How about the effectiveness of the money supply rule and interest rate rule in China? Is the policy framework employing both quantity and price instruments more effective than one that uses a single instrument?Considering the loss of welfare and the economy stabilization, this paper extends the model of Kai Leitemoa&Ulf Soderstromb (2007) to analyze the selection between the monetary policy rule and discretion in China. After adopting Dennis's (2005) algorithms to solve for minimizing the loss function of social welfare, we find that in the discretionary equilibrium, output is over-stabilized while inflation is too volatile, leading to lower welfare than under rules. Therefore, the welfare gain from precommitment is surprisingly large, especial our center bank preferring the output stabilization. Furthermore, under rule the impacts of three shocks on the economy stabilization are smaller than the impact under discretion. Thus, it is reasonable for the PBoC to justify institutional reforms adopting rules in Chinese economies. It is necessary for us to discuss the effectiveness of money supply rule and interest rate rule.The gaps between actual and targeted money growth have been relatively large, so the effectiveness of the money supply rule in China has been questioned. This paper adopts Schorfheide (2000)'s dynamic stochastic general equilibrium model to analyses the effective of money supply rule in China. The most striking result is that the liquidity effect is weak for the interest rate channel is blocked up, which indicates that the money supply rule is ineffective in China.This paper adopts an open-economy dynamic stochastic general equilibrium model to study the effectiveness of the interest rate rule and the likely behavior of the Chinese macroeconomy by the RMB appreciation shock. The results indicate that the PBoC follows an anti-inflationary policy and reacts strongly to the output, while the PBoC does not directly change the interest rate path due to exchange rate movements. Our model simulations do show that the RMB appreciation shock induces a reduction in nominal interest rate, and an increase in the output and inflation, and the interest rate shock leads to negative reaction of output and deflation. The interest rate shock induces the reduction in both the output and inflation, which indicate that the interest rate rule is effective. So the PBoC can make a more active use of the interest rate rule.In China a hybrid rule that uses both interest rate and quantity of money as instruments outperforms the rules using one instrument alone at the current stage of economic and financial market development. There are two reasons for this conclusion. On the one hand, structural impediments such as the underdeveloped banking system and market segmentations have made the interest rate rule alone inadequate. On the other hand, the inflation targeting rule is not suitable for the PBoC to operate the monetary policy.