An Empirical Analysis On The Effect Of China's Monetary Policy

With the transition from socialist planned economy to socialist market economy, China's fiscal policy changing from active into steady, the monetary policy becomes more and more important in macro-economic adjustment in China. Combined with contemporary situation in China, how to analyze and evaluate the effect caused by the monetary policy in adjusting macro economy, keeping price steady, and promoting economic development, which plays a crucial role both in theory and practice for China in its transition. The paper starts from a macro point of view, using methods like Time-varying Parameter Model, Simultaneous Equation Model and Structural Vector Autoregressive, etc, set up an empirical model to measure the effect of Chinese monetary policy, thus provides reference for Chinese monetary policy-making.The first chapter of the paper introduces the reforms in monetary policy since 1980s in China, analyzes the three compositions of the targets of Chinese monetary policy: Final target, Intermediate target and Operation target, with emphasis on the changes in currency supply and demand during transition, and provides a detailed theoretical and empirical background for the analysis of the effects of Chinese monetary policy. The survey on the effectiveness of monetary policy home and abroad provides enough references for the empirical test on the effectiveness of Chinese monetary policy, which ensures that the paper can carry out systematic study on the basis of present results.IS—LM model provides a theory framework of analyzing the operation mechanism of macroeconomic under the market economy, and explaining the functionary principle of fiscal policy and monetary policy. It inspects the combination of interest rates and output when commodity market and money market both are in equilibrium, and expresses the relationship between the major macroeconomic variables, and can be use as the valid evidence for the effectiveness analysis and constitution of macroeconomic policies. By the varying-time parameter model, the second chapter sets up a dynamic IS-LM model of China, analyzes the effect on output and currency supply caused by variation of interest rate, construct China's dynamic multiplicator of monetary policy using estimated output, and gets the result that the effects of Chinese monetary policy has been increasing since 2000. The aggregate demand curve based on multiplicator of monetary policy is the innovation of the chapter. The empirical tests shows that the slope of China's aggregate demand curve is becoming smaller, which means that China's aggregate demand curve is becoming flatter, thus analyzes the cause of China's"high development, low inflation"phenomenon from empirical point of view.The persistent"double surplus"situation since 2003 has aroused fierce disputation among domestic scholars on whether the value of RMB is underestimated and whether China's monetary policy is effective under open economy. Under the background of unity of world economy and finance, more frequent communication with foreign countries and the expedition of international capital flux lead to more sophisticated implementation and transmission mechanisms of China's monetary policy, and the evaluation of its effects also becomes more difficult. The paper analyzes the difference between nominal exchange rate and real effective exchange rate in China, points out the variation of real effective exchange rate is the main reason that affects imports and exports, and analyzes the variation of China's real effective exchange rate in recent years, especially after the reform in exchange rate formation mechanism of China in July.2005. The third chapter analyzes the effectiveness of Chinese monetary policy in dealing with surplus of balance payments with IS—LM—BP model and estimates the dynamic slope of Chinese IS curve, LM curve and BP curve since 2000. The conclusion is: the sensitive degree of Chinese GDP to exchange rates is falling gradually, illustrating that appreciation of exchange rates has little negative effects on output; the sensitive degree of money demand to interest rate is falling, which means that the steady growth of money supply guarantees the fast development of national economic; the marginal import inclination has been in relative low period since 2003, which explains the reason for the surplus in the constant accounts in China recently. So we has the conclusion that the appreciation of RMB does not has large negative effect on Chinese output growth, but can restrain the overinflowing of hot money, lowering the surplus in the balance of payments. So the current monetary policy of China can deal with the surplus of balance payments.Monetary policy exert its power through transmission mechanisms. From initial interest transmission mechanism, credit transmission mechanism, till asset price transmission mechanism under modern financial system and exchange rate transmission mechanism under open economy, different transmission mechanism becomes different bridge of monetary policy. Combination of transmission mechanisms can depicts the degree of tightness of one country's actual currency situation, and this is the MCI indices computed and published by most central banks and financial institutes nowadays. Because the interest rates channel and exchange channel are the major transmission channel of monetary policy in western countries, so these countries construct the MCI by the weighted summation of interest rates and exchange rates. But because China is in the transition period, the credit channel is the major channel of monetary policy. The fourth chapter sets up a dynamic index on China's currency conditions, which is composed of three elements (interest rate, exchange rate and increase rate of credit), and one innovation of the paper is the substitute of fixed weight used by western MCI indices into dynamic time-varying weight. The estimated results shows that the monetary condition of China since 2003 has experienced the process from tight to loosen and then tight, and the fall in real interest rates is the reason for monetary condition becoming tighter during 2001-2002, and the faster growth of credit leads to the monetary condition becoming fluffing during 2003-2005, and the faster improving in real interest rates and appreciation of RMB since 2005 is the major reason that the monetary condition in China becomes tight since 2005.Through retrospect on several reforms on China's monetary policy since 1980s, combined with the fluctuation of the increase rate of GDP, we find China's monetary policy plays a more and more powerful role in adjusting fluctuation of macro economy and weakening excess in economic cycle. The fifth chapter firstly introduces the major monetary policy operations since reform opening, and sets up small simultaneous equations of macro economy of China, and separates China's economy into city, country, investment and finance modules combining western economic theory and Chinese current characteristics of monetary transmission channel. Using Chinese 1978-2005 yearly data, estimates the influential relationship and size of economic variables of Chinese macroeconomic system quantitatively. The outcome shows that the constrictive monetary policy indeed could constrain the economy from overheat by increasing interest rate and reduce currency supply, and the especially in lowering the increasing rate of fixed assets investment and credit, which means that the monetary policy carried out by People's Bank of China is quite useful in macro economy adjustment。Compared with tens, even hundreds years of operation practice of western country's monetary policy, China has so little experience in monetary policy. As a good reference, western country's experience is important for China in transition. The six chapter of the paper uses developed and mature American economy as a reference, analyzes and compares the difference between Chinese and American transmission mechanisms of monetary policy. The paper discusses the evolution trail of American monetary policy both on dominant ideas and implementation outcome firstly. In the empirical analysis which compares Chinese and American monetary policy practice, sets up a 4-variable model of Chinese and American interest rate, exchange rate, currency supply in narrow sense M1 and aggregate output GDP, and finds the impulse response functions of Chinese and American GDP to interest rates, exchanger and M1. The estimated outcome shows that a positive shock to interest rates and exchange rates can bring out a negative effects in GDP both in China and U.S., and a unit positive shock to M1 can both lead to the increases in the GDP. But viewing in the time lag of monetary policy effect, the impulse response function of Chinese GDP to interest rates and exchange rates shows a apparent change from the first period, but the time lag of U.S. monetary policy is relative longer, which is three period, illustrating that because China carryes out managed floating exchange system, the effect of the change in Chinese exchange rates has a relative longer time lag than U.S.. Lastly, from the size of the effect of these variables, because the financial system in China is not so right, the size of the effects of the changes in Chinese monetary policy variables on the GDP are smaller than the influences of U.S. monetary policy variables on GDP.