Monetary Policy Transmission In China: Evidence From FAVAR Approach

Post financial crisis era, an important innovation in the conduct of monetary policy in major central banks was the adoption of ‘forward guidance’, which try to bridge the gap between the central bank’s policy intentions and market expectation. So whether monetary policy effect will be affected by emotion factors and then have different effects on other macro-economic variables?Considering the availability and integrity of the data, this paper uses 84-months monthly data, the data set contains 151 series. Common factor was extracted from a dynamic factor model after the macroeconomic variables are classified. In order to explore whether the emotional factors have any effect in the monetary policy transmission, two FAVAR model was conducted which difference is contain or without emotional factor.Three results from the empirical research are worth highlighting. First, compare to the model without emotion factor, the model which contain emotional factor showed that, tight monetary policy is much more effective in cooling the economy. Second, the model with the emotional factor also shows that the inflation would be controlled well, the "price puzzle" doesn’t show in the model which contain the emotional factor. Third, the interpretation degree of monetary policy on the real economy factors, the RMB real effective exchange rate and the inflation increased in different degree.