China Stock Market Bubble’s Changes And The Response Of Monetary Policy Based On Taylor Rule

Since1980s, all countries whether developed or developing countries all appear the stock and real estate asset price bubbles, the expansion and burst of the stock market bubble won’t cause the increase and reduce of wealth, but this process will lead the entity economy investment to reduce, hit the real economy, and cause economic imbalances. It results in the bank’s capital chain rupture, induce financial crisis, expand the gap between rich and poor to and induce economic and social problems. Since1990after China’s stock market’s birth, it has grow from small to large, from weak to strong, and its influence to the national economy is growing. But since its birth, the stock market has experiences huge ups and downs, and with its development, the potential threat of the stock market bubble to China’s financial security and financial development has been bigger and bigger.The traditional Chinese monetary policy transmission mechanism is based on the central bank control, commercial Banks is the main body of the financial system, the supply and demand fo fund and bank credit cost is the main channel of monetary policy to Implement. However, with the development and expansion of capital market, it constitutes a significant impact to the monetary policy implementation effect. As taylor rule can accurate and succinctly reflects the western countries’ recent years monetary policy practice, it has become monetary policy formulation and implementation basis of the federal reserve, the bank of England and other western countries’central bank. At present, money supply is our country’s control target of monetary policy, but our country has continuous reform the financial system, interest rate marketization is promoted steadily, so this paper use Taylor rule to explore monetary policy’s reaction to the stock market bubble change.This paper amends and develops the Taylor Rule by introducing expectation and bubble, then builds reaction mechanism of monetary policy including stock market bubble. This paper takes rigorous empirical analysis using ratio of bubble which is measured by dynamic residual income valuation model. It’s found that recent years the central bank’s monetary policy hasn’t considered the bubble no matter on Taylor Rule, Prospective Taylor Rule or monetary policy response function. So the central bank should consider bubble when it makes monetary policy. And the main contents of this paper are as follows:Chapter one, introduction, the theoretical and practical background of this paper is analyzed. The concept such as stock market bubbles and currency policy is expounded. And the organization of the whole paper is laid out.Chapter two, literature review, the deficiency of current research is pointed out through reviewing the foreign and domestic literature, and the basis thought of this paper is given.Chapter three, Taylor Rule’s theory, amendment and development, this part firstly introduces the development of the monetary policy rules’theory, raises the Taylor rule. Then this part provides a detailed introduction about Taylor rule theory, summarizes the Taylor rule’s amendment and development and summarizes the domestic and foreign scholars’related research achievements. Then this part introduces the perspectiveness to build the prospective Taylor rules, on this basis introduces interest rates’smooth to build the monetary policy response functions. At last, this part introduce stock market bubble to the Taylor Rule and the monetary policy response functions.Chapter four, the stock market bubble’s theory and measure, this part systematically sum up the stock market bubble theory and model, the stock market bubble judgment and measure method, focusing on the dynamic residual income valuation model, and get the measure method of stock market bubble. At last, based on Chinese stock market related data, this part obtains China’s stock market quarter degree of bubble from2002q1to2011q4. Based on the bubble degree, the stock market bubble can be divided into death negative bubble, malignant negative bubble, benign negative bubble, benign positive bubble, malignant positive bubble and death positive bubble, and then China’s stock market bubble is classified into these types.Chapter five, empirical analysis on affects of the stock market bubble change to China’s monetary policy, this part is the main empirical part of this paper, firstly the variables which the empirical analysis need should be determined and processed. And then data which we determine and the stock market bubble degree should be taken time series stationarity test to judge whether a co-integration examination should be carried. Then this part uses granger causality test to explore whether joining the stock market bubble to the Taylor rule is reasonable. Then the co-integration examination is carried based on the Taylor rule’s amendment and development and the prospective Taylor rules. A GMM is carried based on the expanded monetary policy response functions. By all of this, this part reveal the impact of the stock market bubble, inflation and the GDP gap to of the interest rates.Chapter six, conclusion and policy suggestions, this paper conclude that the bubble of China stock market which is not mature is obviously positive correlated with share price, in recent years interest rate is under reacted to inflation and output gap, the central bank’s monetary policy practice does not consider the stock market bubble. At last three policy suggestions are given, which is monetary policy responsing stock market bubble, promoting interest rate marketization, improving the stock market to reduce the stock market bubble.The innovation of this paper is that different from other literature using indirect index such as use p/e ratio, stock price index and so on, this paper uses dynamic residual income valuation model to measure Chinese stock market’s true bubble. Then this paper introduces Chinese stock market’s true bubble into Taylor rule to research monetary policy reaction mechanism including stock market’s true bubble as an endogenous factor. So it can more directly reflect stock market bubble and more accurately reflect the stock market bubbles’influence to monetary policy.