Empirical Study On The Construction And Application Of Monetary Conditions Index In China

Since first introduced in1994by the Bank of Canada, monetary conditions indexis causing widespread concern of the international community as an indicator reflectthe condition of monetary policy. Some countries use it as an operating target whenthey adjust the monetary policy. But more countries use it as an important referencewhen they draft monetary policy. As important tools adjusting the macro economy,interest rate and exchange rate are playing a more important role during the process ofChina’s monetary authority making monetary policy. According to the characteristicsof the Chinese economy, the paper use the real interest rate, the real exchange rate andthe real money supply three indicators to build China’s monetary conditions index andutilize it to measure the elastic change of China’s monetary policy. Combined withthe application of monetary conditions index in the economy, the paper make anempirical analysis on monetary conditions index’s application and forecast for theeconomic system. The empirical analysis shows that building the monetary conditionsindex can not only be used as an important reference when China’s monetaryauthorities make monetary policy, but also can be used as the policy indicator andleading Indicator of the monetary policy’s goal. Finally, the paper gives theconclusion and policy suggestions.The paper firstly introduces the generation of the monetary conditions index,researching significance and the present situation of researching. Then the paperintroduces the theoretical base of making the monetary conditions index–themonetary policy transmission mechanism. The paper also explains how to build themonetary conditions index and the function of it. When the paper selects the variables,on the premise of considering the interest rate and exchange rate, the paper also takethe money supply, which is also a primary channel of the monetary policytransmission mechanism, into consideration. In this way we can build a moremonetary conditions index suiting the condition of our country.In the empirical part, the paper firstly explains the way of selecting the variables.Then the paper use the real interest rate, the real effective exchange rate and the realmoney supply, the consumer price index and the gross domestic product (GDP) five variables from Q11997to Q22012to build vector autoregressive (VAR) model.Then make impulse response analysis base on the VAR model to calculate the eachweight of the interest rates, exchange rates and money supply when estimate themonetary conditions index. According to the weight of the three variables, we can seethe influential of these variables when they impact the economic and judge thecondition of monetary policy. Then analysis the relationship between MCI and GDPgrowth rate, inflation rate, make Granger causality test. Draw the monetary conditionsindex for the predicted relationship between the GDP growth rate, inflation rate, andto provide a basis for predicting the situation of monetary policy and economic trends.Finally, adjust and optimize the monetary policy to solve the problems reflected in themonetary conditions index based on the results of empirical analysis.