Construction Of The Chinese Financial Conditions Index

Recently, the focus of monetary policy in many countries has shifted from intermediate targets such monetary growth rates to more final policy targets such as macroeconomic stability and growth; cf. Leiderman and Svensson (1995) . This change in focus has increased interest in quantifying the effects of policy instruments on output and inflation , and in using such estimates in the conduct of monetary policy. The Bank of Canada has proposed a measure of the effects of the real interest rate level and the real exchange rate on economic activity and inflation — a "Monetary Conditions Index" or MCI; see Freedman(1994).However, as an indicator of financial conditions, the MCI is often criticized for not incorporating a sufficiently broad range of financial variables. In particular, it omits the effects of changes in equity prices on aggregate demand. Therefore, many scholars in some countries tried to extend MCI, which built a new indicator called Financial Conditions Index, abbreviated FCI.Lately, many center banks and financial organizations all construct financial conditions index in some countries. In particular, banks of Canada, Finland, and Switzerland construct their financial conditions index based on their monetary conditions index. Comparatively, we have done many studies in monetary policy, interest rate and exchange rate in our country, and recently center bank has tried to construct our monetary condition index, but done little in financial conditions index. Therefore, the author tries to construct financial conditions index of China by IS-PC curve model, generalized impulse-response functions and factor analysis, and evaluate these financial conditions indexes by some performance criteria. There are three parts in this article:The first part summarizes studies actuality concerning monetary conditions index and financial conditions index. At the same time, this part presents three methods to construct financial conditions index.