The Behaviors Of Interest Rate And Monetary Policy Effect Based On Learning:the Evidence From China

Expectations play the central role in modern macro economy. Expectations impact the investment’ and consume’ decisions, and are the factors that must be considered by firms, families and policy-makers. Just because of the central role of expectations, people have continuously forced attentions on the effect of the expectation formation on economy volatility, policy decisions and effects."Monetary policy is to a large extent the management of expectations (Svensson,2004),""because inflation expectations matter to the behavior of the households and firms, the critical aspect of monetary policy is how decisions of the central bank affect those expectations(King,2005)". So, investigating the market expectation formation process, concerning the change of market expectation, and analyzing the adjust speed of expectation have been the important issues in the related studies about monetary policy. Following the development of theory and empirical studies, dynamic expectation formation process has been the major channel to analyze the market expectation formation machine and dynamic changes. Learning, agent formatting expectation by estimating and updating forecasting model, offers a new view to probe into the dynamic expectation formation process.In the past few years, government in China always emphasized inflation expectation management, and central bank also wanted to guide inflation expectation by changing monetary policy. The State Council routine meeting in2009October first put forward ’manage inflation expectation’, Report on the Work of the Government in2010and2011also claims to manage inflation expectation. The Twelfth Five-Year Plan explicitly indicated that people need to well balance the relationship between economic growth, restructure and managing inflation expectancy. The people’s bank of China annual report in2009emphasized that taking multiple measures to well manage inflation expectation and to prevent the rapid increase of aggregate price level. The people’s bank of China annual report in2010emphasized that future exerting the impact of interest rate leverage on adjusting aggregate demand and managing inflation expectation. Inflation expectation management has been the core problem of macroeconomic policy in China.Under the background of above-mentioned theories and reality, market expectations and learning have central role in economic decisions and policy-making, and have effects on the process where monetary policy guides and controls inflation expectation. For the reason, this thesis used the data of interest rate system in China, analyzed the formation process and changes of market expectation in the view of learning, and discussed the learning processes of public and central bank. On the one hand, it is conducive to identify the dynamic character of market expectation, and to scientifically understand the learning processes of public for offering reference to expectation management. On the other hand, it is conducive to systematically analyze the implication of learning in monetary policy of China, and it has prominent reference values to further improve the effect of monetary policy.Different from the existing literatures on the dynamic relevance between inflation expectation and inflation, public expectation and its effect on monetary policy, this thesis major investigates expectation formation process and its learning effect implied in the information in financial market. Aiming at the learning processes of public and central bank in market, this thesis starts from market interest rate system to study the expectation formation process and learning dynamic of public, and starts from interest rate rule to study the preference of central bank and its learning effect. And more, the realistic basis for the expectation formation process and learning dynamic of public is also discussed from the views of monetary policy transparency and credibility.This thesis applies the learning into the formations and changes of expectations and monetary policy rules. The contents of this study are:The first chapter is the introduction, introducing the research backgrounds and significances, research ideas and framework, contents and methods of research, innovations and shortages.The second chapter is the theoretical basis and the literature review of market expectations and learning mechanism.The third chapter is interest rate expectations and error learning hypothesis under regime shift. While interest rate expectation plays an important role in investment indecision, using linear regression and Markov regime shift model, this paper inspects the error learning hypothesis in interest rate expectation, and analyzes relevance between different expectation errors of interest rate. And more, the role of risk premium is considered. The results show that one year period error learning hypothesis is demonstrated in interbank treasury market. The responds of interest rate expectations in different periods to expectation errors are independent, while expectation errors and risk premium have different effects on interest rate expectations in different states. Considering risk premium is conducive to explain the change of interest rate expectations.The fourth chapter discusses the expectations hypothesis of the term structure and the interpretation of learning mechanism. Taking into account that market expectation formation has a core role in the learning mechanism, this paper, based on the money market interest rate data, uses the model combined with time-varying nature of the structural break and time-varying term premium, to explore expectation formation of China’s short-term interest rates system. Our empirical results show that there are multiple structure breaks in interbank interest rates, and they have the same trend in a subinterval. The Expectations Hypothesis is mostly rejected in these subintervals, and time-varying term premium doesn’t have the dominative role, while the macroeconomic factors take different effects in different subintervals. The rejection of expectation hypothesis can be explained by the Bayes rule learning of public about structure change.The fifth chapter analyzes the market implied inflation expectations and the learning behavior based on the term structure of interest rates. Based on the term structure of the Treasury market, this paper uses three potential factors, the level, slope, and curvature, and inflation in the market, chooses BSVAR model to estimate and receive the inflation expectations implied in the market. The relationship between Inflation expectation implied in the tern structure of interest rate and realistic inflation satisfies adaptive process. Inflation expectations is a significant association with three potential variables and CPIFurther, the Kahnan filter for time-varying parameters is estimated to test the unbiasedness and efficiency of market expectations to actual inflation. The results are follows:In2005-2008, the inflation expectation has obvious adaptability. With the rise in inflation, inflation expectations continue to strengthen, and market has obvious learning effect. In2008-2012, the expectation and learning effect of public has been seriously affected by the volatility of realistic inflation and other information. When inflation is rising, the use of information by market expectation is not very efficient. When Market inflation continued to decline significantly from raising, the signal role of market information is clearer, the learning effect of market expectation has strengthen, and the use of information is even more effective.Chapter six based on the robustness of China’s monetary policy interest rate smoothing examines the asymmetric of central bank preferences and learning effect of central bank interest rate smoothing. First, in response to the interest rate smoothing problem, based on existing researches and the evidences of interest rate smoothing in Taylor Rule of China, this paper inspects the interest rate smoothing in actual actions of central bank, and analyzes the nonlinear smoothing of quarterly, monthly and weekly market interest rate using smooth transition regression (STR) model. And more, from the view of central bank’ preference, we use hyperbolic tangent function STR models to study asymmetry of central bank’s preference. The results show that there is significant interest rate smoothing in Taylor Rule of China, and also in actual actions of central bank, while serially correlated shocks are important but has no effect on the degree of interest rate smoothing. Logistic STR (LSTR) models testify there is forecast ability of market interest rates in different regimes. Central bank has asymmetric preference in interest rate smoothing and monetary policy inertia exhibits a striking nonlinear trait. Finally, the learning effect is studied for the existence of interest rate smoothing. Theory model analysis shows that the monetary policy with interest rate smoothing is conducive to realize of rational expectation equilibrium.Chapter Seven studies the learning behavior of the central bank and its effect based on market interest rates deviation from the interest rate rules. Standard Taylor rule and forward-looking Taylor rule with interest rate smoothing which have better robustness has been used as a benchmark.The analysis of Kalman filtering and Quantile estimation found that:In the situation of standard Taylor rule, center bank implements reverse adjusts on interest rate deviation when inflation deviation and interest rate deviation are large, while central bank has learning effect for interest rate deviation. The interest rate smoothing makes the respond of central bank on interest rate deviation to have intensive effect in the same direction, and then result in obvious negative interest rate deviation.Chapter Eight discusses the expectation management of central bank and reality basis of public learning. Market expectations and monetary policy expected effect are both the starting point of this study and the ultimate goal of the study. This paper explores the central bank’s expectation guide and expectation management from the monetary policy transparency and the credibility of monetary policy two aspects, and combined with the effect of monetary policy tools to discuss the reality basis of public learning. The results showed that:Monetary policy transparency has crucial effect on boosting the process of agent learning, steadying and guiding market inflation expectation, and improving monetary policy effectiveness. The adjustment of key lending and deposit rates has obvious inertia. It is useful for guiding market expectation. But, rapid and frequent adjustment pressure market to respond. The adjustments of deposit reserve ratio exists the time difference between Announcement Day and exercise day, which well guides public expectation. Liquidity management through open market operation by central bank has crucial effect on the formation of interest rate expectation and liquidity expectation in market. The total effect of central bank communication is weak, even has negative effect. The realization of monetary policy in China, not only guarantees the realization of economic target, but also builds good reputation of central bank. It is conductive to enhance the confidence of public in central bank and economic growth, and provides specific direction for the dynamic formation of public expectation and learning at the same time of guaranteeing the credibility of central bank. However, from the view of specific adjustment and short-term effect of monetary policy tools, monetary policy has some harmful effect, and then affects the learning effect of public expectation.Chapter Nine is conclusions and implications of the study.The result in this thesis which analyzes the expectation in market interest rate system brings some inspirations for expectation management and market institutions building. First, the non-rationality and structure change of public expectation should be considered in investment decision-making and policy decision-making. Second, the inertia operation of monetary policy not only reflects the preference of central bank, but also is conductive to guide public expectation and to promote learning of public. Third, central bank should promptly keep a watchful eye on interest rate deviation to improve policy operation, emphasize forward looking, flexibly set policy target, allow some interest rate deviation to exist, and so to achieve the effect of counter-cyclical adjustment in monetary policy. Fourth, central bank should enhance the conventional communication, reduce frequently excessive operations, and take steps to control the rapid increase of money supply.