Exchange Rate, Asset Price And Optimal Monetary Policy Rule

Monetary policy rules are the guidelines of central bank’s monetary policy decision-making and operation. Among them, Taylor rule is a widely used and effective rule, and it plays an important role to stabilize the economy in developed countries. With the development of China’s market-oriented reform of interest rate, Taylor rule will be ablc to better describe the stance of China’s monetary policy, and it can provide guidelines for the design and implementation of China’s monetary policy. In addition, we can see the intermediate target of monetary policy of the United States, the European Union, Britain, Canada and other countries and regions has experienced the process from the interest rate to money supply and then to interest rates. The Taylor rule has increasingly become the mainstream of theory and practice. It can be predicted that in the future China’s central bank will mainly improve the Taylor rule for China’s monetary policy operations.Along with Chinese economy’s opening, in order to realize stable economic growth, how to implement effective monetary policy in open economy condition is a main task which cannot be evasive currently. It also reflects research significance of this thesis. In the context of economic globalization, appreciation of the Renminbi and volatility of asset prices, it is very significant to conduct thorough research on monetary policy rules for better monetary policy design and monetary policy effectiveness improvement.In this paper, we conduct theoretical analysis and empirical analysis based on the optimal monetary policy rule theory. Firstly, we extend the classic Taylor rules in the context of open economy. Specifically, we add the exchange rate and asset price into the extended Taylor rules in the new Keynesian model. Secondly, based on theoretical deduction, we construct GMM model to make static estimation on the optimal interest rate rules by using monthly data after the exchange rate reform in July21,2005. At the same time, we conduct dynamic analysis by utilizing the impulse response function and variance decomposition analysis of SVAR model to investigate the applicability and dynamic characteristics of the extended Taylor rule. The empirical results indicate that extended optimal interest rate rule incorporated with exchange rate and asset price has higher goodness-of-fit and is more suitable for China’s monetary policy than original Taylor rule as a guideline. The interest rate is more sensitive to inflation rate than output gap. In a certain degree, inflation is the most important factor when considering the monetary policy. On the other hand, the importance of the output gap is not significant. In addition, some response coefficients in the optimal interest rule are not significant. The main reasons are that interest rate marketization reform has not been completed and China’s exchange rate system is special. Therefore, interest rate marketization reform should be further promoted and the role of optimal interest rate rule in the macro economy should be well played.