Empirical Test Of Taylor Rule In China

After the collapse of the Bretton Woods system in early 1970s, The responsibilities of central banks around the world become more complicated. The reality shows that discretion has much more flaws. The economists begin to try to find more effective decision-making style of monetary policy and pay more attention to the study of monetary policy rules. This paper will do research on Taylor Rule, a monetary policy rule of great significance. This paper will make empirical test of Taylor Rule in China and find Taylor rule model of China.First of all, the paper reviews theories and empirical results of Taylor rules. Secondly, we discuss the choices of variables in Taylor Rule for the following empirical test. After that we use the Johansen-cointegration Test and GMM Estimation to test if the inter-bank borrowing rate has long-run trend in the model of Taylor Rule and estimate the equation of Taylor Rule in China.The results show that there is long-run relationship between rate and inflation gap and output gap is insignificant in the model. To some extent, this implies that central bank paid more attention to inflation gap when it made monetary policies. Forward-looking Taylor Rule with interest rate smoothing mechanism is better than original CGG model and R2 increases a lot. After we bring the monetary factor, expected inflation rate and expected output gap are insignificant. The main reason is that expected inflation rate, expected output gap and monetary supply have high correlation. After we bring the exchange rate factor, every variable is insignificant and this decreases R2 of the monetary policy reaction function. The reaction coefficient for inflation is below 1, and this implies that Taylot rule in China is an instable monetary policy rule.