Forward-looking Monetary Policy Reaction Function In The Open Economy Under The Conditions Of Study

The ultimate effect of the monetary policy regulation depends on the mode of operation of monetary policy. More and more countries begin to use the monetary policy rules, of which the Taylor's Rule is the most popular. The Federal Reserve Commission uses the monetary policy rule with interest rates as intermediate targets. The success of the Fed's monetary policy also sets a good example for China. We try to conduct a monetary policy reaction function suitable for China on the basis of Taylor's rule.In the second chapter of this article we discuss the basic model of Taylor's rule (benchmark Taylor's rule) and its follow-up development (expanding Taylor's rules) in detail, then we give a brief historic review of China's interest rate policy.In the third chapter, we make a forward-looking monetary policy reaction function suitable for our country, in terms of inter-bank borrowing rate, and test its applicability in China's monetary policy. Then we expand the forward-looking monetary policy reaction function with exchange rate, test it with interval quarter data of real effective exchange rate from 1996 to 2007. According to the result from the empirical test, we find that the applicability of the forward-looking monetary policy reaction function is improved after introducing exchange rate into it, and we also find this monetary policy reaction function can provide a benchmark for measuring the stance of China's monetary policy.In the fourth chapter we give the conclusion: China should carry interest rate reform forward and set up the monetary policy regime with interest rates as intermediate target and use the monetary policy rules. The exchange rate should also not be neglected. But can the interest rate rules be used in our country? We analyze it. First, we discuss the limitations that China uses interest rates as intermediate target. We also analyze the view that our country should apply the inflation targeting. Finally, we put forward policy recommendations on how to reform China's interest rate formation mechanism and improve the performance of its monetary policy.