Study On The Applicability Of Taylor Rules In China Based On An Open Economy Condition And Asset Price Movements

The responsibilities of central banks around the world become increasingly complicated after 1970s. The reality shows that discretionary monetary policy has many obvious flaws. Thus, the economists begin to find more effective monetary policies and pay more attention to the study of monetary policy rules. Therefore, this paper focuses on the Taylor rule, a monetary policy rule of great significance. The article will conduct an empirical test on the applicability of the Taylor Rule in China and attempt to find out a specific Taylor rule model which is suitable for China.First of all, the paper reviews theories and existing empirical results of Taylor rules in some main foreign countries. Secondly, we emphasize on the situation in China, and determine the selection of variables in Taylor formula for the following empirical research. After that we use the OLS method to estimate the equation with distinct Chinese characteristics and test if the inter-bank borrowing rate is significantly influenced by the inflation rate, GDP gap, exchange rate, monetary supply (M1 or M2) and asset prices. In conclusion, the statistical results show that all of the variables mentioned above except GDP gap are significant. To some extent, this implies that central bank has paid more attention to inflation stabilization than GDP objective when making monetary policies. In addition, we find that the forward-looking Taylor Rule model with interest rate smoothing mechanism is more accurate than the original model. After we keep on bringing exchange rate, monetary factor and factors of CGG model into the fundamental model, the R2 increases a lot and the explaining variables themselves show great significance.The main contributions of thesis are that we use the latest data, conduct a distinction test on money supply growth rate separately based on M1and M2 and test exchange rate data by a two-stage method in accordance with China’s exchange rate reform for the first time. The result reveals that with the further improvement of degrees of exchange rate freedom under an open economy, the impact of the exchange rate on monetary policy will be further strengthened. On the whole, the results of the article have a certain reference value for both investors and government.