The Empirical Study On The Confidence Channel Of Monetary Policy

The recent stagnation of economic growth and the decline of entrepreneurs’ confidence in China has led to an interest in the role that confidence plays in the transmission of monetary policy. Animal spirits, such like confidence, is not acknowledged as the main cause of economic fluctuations in traditional macroeconomics. Nevertheless, when confronting threaten of financial crisis, the monetary authority still puts great emphasis on the role of stable confidence. Although there is a widespread belief that confidence is a crucial factor in the transmission of policy shocks to economic activities, there is little evidence and agreement on whether and how confidence could have an impact on the real economy. This paper attempt to answer the following question: does the effectiveness of Chinese monetary policy depend on entrepreneurs’ confidence? If so, why the state of confidence, a psychological concept, could impact the transmission of monetary policy?In this study, I employ a structured auto-regression model to test the role of entrepreneurs’ confidence. The empirical results of the benchmark model show that a proactive monetary policy could inspire the confidence and stimulate real economic growth. To further identify and isolate the effect of entrepreneurs’ confidence, we construct a counterfactual situation that confidence does not react to a monetary policy shock. I construct structural vector autoregression(SVAR) models in the spirit of Bachmann and Sims(2012) for Chinese monetary policy analysis. The SVAR models incorporate both quantitative and price-based monetary policy indicators in China to provide a channel through which entrepreneurs’ confidence may affect the dynamic responses of the real output to monetary policy shocks. Based on the SVAR models, I carry out counterfactual simulations and isolate the effect of confidence in the underlying system to identify how entrepreneurs’ confidence influences the transmission of monetary policy. By simulating the condition that entrepreneurs are neither inspired nor depressed by monetary policy, I find that the response of real economic output to a positive monetary policy is much more weakened comparing to the actual responses. In 10-quarter horizon, the difference of accumulated growth rate between benchmark SVAR model and counter-factual SVAR model is up to 2.11%. This finding is robust for alternative measures for monetary policy in China. Further analysis also shows that entrepreneurs’ confidence affects their credit and pricing decisions.Next, this paper discusses the possible mechanism of confidence channel of monetary policy. Theoretical analysis shows that, if entrepreneurs form pessimistic expectations about future economic condition, they will probably neither pursue loan actively nor raise price. The empirical results shows that when the indirect effect of confidence channel is removed, both loan demand and PPI reduce significantly comparing to benchmark model.Finally, I check the robustness of the above results. After checking the stationary of time series, I use the first-difference of non-stationary variables to replace the original dataset. The empirical results of SVAR based on stationary variables are roughly the same with the previous ones, so the conclusion is robust for stationary. The impulses base on quarter-to-quarter data also show that different method of calculating the growth rate will not impact the robustness of results.Overall, the empirical results provide several important implications. First, entrepreneurs’ confidence plays an important role in Chinese monetary policy transmission mechanism. Second, center bank communication is always key for effective monetary policy-making. Third, when confronting the event that may affect the macroeconomic stability, the monetary authority should clearly states its position and takes effective measures to stabilize expectations. Finally, to enhance the effectiveness of monetary policy, the proactive policy should be sustainable and credible, and could effectively reduce the burden on enterprise.