Optimal Monetary Policy Rules Based On Mixed Phillips Curve

Since 1984, People’s Bank of China fulfilled the functions of the central bank, and the operation of China’s monetary policy has discretionary features. From the mid-1990s, China’s money supply has begun to implement the intermediate target for monetary policy framework. However, the practice of monetary policy in recent years shows that the stability of the relationship between the money supply and the ultimate targets of monetary policy has declined. The money supply enhanced by the central bank to control the money supply in order to achieve the objectives of monetary policy effectiveness is declining; there is an urgent need for the current monetary policy framework adjustment and improvement.Based on these practical problems, this paper used the new Keynesian mixed Phillips curve to discuss how China should achieve forward-looking monetary policy rules in the double bind of inflation inertia and inflation expectations. First, we made a systematic description of the monetary policy and Phillips curve, and combed the theoretical relationship between these two concepts. Second, we proposed the framework of reference linear rational expectations model, with the integration of high-order lag inflation of new Keynesian Phillips curve, then build a linear rational expectations models and optimal form based on forward-looking monetary policy rules (the reaction rate rules). And last, according to the inflation (CPI), short-term nominal interest rate (7 days interbank offered rate) and nominal GDP of China from the first quarter of 2002 to the second quarter of 2014, based on the data analysis and processing and higher-order lag SVAR model hybrid Phillips curve measurement test and empirical analysis, we characterized quantitative of mixed expectations augmented Phillips curve dynamic characteristics and the specific form of inflation.The study found, as the Phillips curve of China has higher-order lag characteristics of hybrid Phillips curve, and the monetary policy rule based on CPI has obviously forward-looking and inertia characteristics, as well as time lag, so the monetary policy practice should pay more attention on two aspects:reduce inflation inertia and manage inflation expectations. Based on these theoretical models and empirical analysis, combined with monetary policy implementation experiences of other countries, we make the following recommendations on China’s monetary policy practice:maintaining price stability is the primary objective level of monetary policy; increase the transparency and the credibility of monetary policy implementation; flexibility to choose various monetary policy operation tool; and strengthen the independence on monetary policy formulation and implementation of the central bank.