Analysis On The Intermediate Targets Selection In China’s Monetary Policy Operation

This paper analyzes the effectiveness of the monetary growth rate, the real China Interbank Offered Rate (Chibor), and real effective exchange rate (REER) of RMB as the intermediate targets in China’s monetary policy making. The effectiveness is judged by two criteria. The first criterion is their controllability by monetary policy instruments while the other is their relevance with price and output index. In order to achieving more accurate measurements, this paper combines smooth transition autoregression with the conventional vector autoregression model.Compared with previous research work, this paper deepens the current understanding with three contributions. First, this paper combines smooth transition autoregression with conventional vector autoregression model and vector error correction model for a better measurement of China’s dynamic economy. Second, the paper replaces the gross output with private demand while researching the relevance of intermediate variables to social output. Third, this paper employs a comprehensive inspection on the effectiveness of three intermediate variables from the perspective of controllability and relevance to price and output. Considering the current financial deepening and liberalization in China, I employ the real Chibor and REER as the index of interest rate and exchange rate, respectively.Chapter two reviews the theories on monetary policy transmission mechanism from the perspective of neoclassical channels and non-neoclassical channels. Based on corresponding theory, this chapter further reviews the empirical research work on both China and other countries. The last section denotes three innovations of this paper after pointing out the defects of domestic research in model and variable selection.Chapter three provides a comprehensive introduction on STAR models and the estimation methodology. This chapter begins with the introduction of the STAR model for a univariate time series and further illustrates the nonlinear test, the determination of transition function, and the estimation of parameters. Finally, this chapter proposes the estimation of vector STAR models based on the method of the basic STAR model.Chapter four focuses on the selection of variables and further provides the statistic description of all variables. In addition, this chapter compares the statistic characteristics of all variables and the pairwise correlations among them in three different periods throughout the whole sample range. Based on these comparisons, this chapter denotes the significance of the application of nonlinear models in China’s monetary policy research work.Chapter five analyzes the impacts of reserve requirement and one-year benchmark deposit rate change on the growth rate of broad monetary (M2), real China Interbank Offered Rate (Chibor), and real effective exchange rate (REER) of Renminbi through ST-VECM. The results indicate three conclusions. First, the application of STAR improves the goodness of fit of the whole model, especially for the regression of M2growth rate and real Chibor. Likewise, the REER model has the largest goodness of fit among three equations, which demonstrates that REER can be better controlled than money supply and interest rate through applying a STAR model. Second, the cointegration equations indicate that one-year benchmark deposit rate has leverage effect on all three intermediate variables as an efficient policy instrument while the reserve requirement does not have significant long-term impacts on them. In the short-term, adjusting one-year benchmark deposit rate with narrow ranges and a high frequency exerts larger influence on real Chibor than that of wide range and a relatively lower frequency. Finally, reserve requirement influences M2growth positively, which opposes to the policy maker’s intention.Chapter six analyzes the relevance of three intermediate variables to the growth rate of consumer price index (CPI), producer price index (PPI), and housing price index (HPI). The estimation of empirical models implies three points. First, the increasing REER of RMB leads to the decrease of all three price indexes. Thus the exchange rate liberalization contributes to domestic price stability in both consumer goods and real estate industry. Second, a growing broad money supply generates the inflation in housing price as little effects on CPI and PPI growth. This conclusion implies the rapid money growth contributes to the dramatically inflation in China’s real estate industry during past years. Third, both CPI growth pattern and HPI growth pattern follow a smooth transition process as the PPI growth pattern follows a linear autoregression model. Furthermore, the movement pattern of HPI changes in2009with an enhancing impact of money growth thereafter. This switch implies China’s monetary expansion has changed the HPI fluctuation pattern since2009.Chapter seven adopts social retail sales of consumer goods and private demand as output indexes. The Smooth Transition Autoregression models are applied to analyze the relevance of output indexes to money growth rate, China Interbank Offered Rate (Chibor), and Real Effective Exchange Rate (REER) of RMB. Empirical results reveal that none of these three intermediate variables holds a significant impact on the changes in the growth rate of social retail sales of consumer goods. An accelerating money growth drives private demand through investment channel but has no significant effect on private consumption. Hence, China’s monetary authority should smooth factors which hinder policy transmission from intermediate variables to private demand, especially to private consumption.Chapter eight summarizes the main conclusions of this dissertation and further proposes the following two research steps. The first is establishing theoretical models which explain the empirial conclusion of this research. The other is applying other non-linear models to analyze China’s macroeconomy.