Empirical Research On China's Monetary Policy Response To Stock Price Volatility

Monetary policy's macro regulation and control on the economy is achieved mostly by interest rate measures. With the deepening of the marketization reform of China's interest rate, the regulatory power of interest rate on the economy is increasingly significant. At the runoff stage of building a moderately prosperous society, how to ascertain the reasonable interest rate to promote healthy economic growth is an important question yet to be answered in the monetary policy making process. Since the founding of China's stock market, the degree of the stock price fluctuation is hardly seen in the world, and the instability of the stock market is seriously impacting China's macro economy. Confronting the possible economic deterioration as a result of stock price fluctuation, whether China will adjust interest rate in an attempt to stabilize stock prices is the major research question of this paper.We use the Standard Taylor Rule as the basic model. First, we tested that the Taylor Rule applies to Chinese economy. We then introduced smooth factors of the interest rate in our model, in order to eliminate possible auto-correlations. After eliminating interference, we added stock price into the construction of the independent variable, in order to observe the responsiveness of monetary policy to stock price changes. To make the model better fit the realities, we introduced prospective thinking into the Taylor Rule to observe whether monetary policy responds to anticipated stock price fluctuations. Finally, by setting up auxiliary equations, we proved that stock price has indirect influence on the monetary policy. To ascertain the robustness of the findings, we used to two different regression methods, OLS and GMM, to reinforce the robustness.Empirical findings indicate that interest rate does not respond sufficiently to inflation gap and output gap, proving that China's monetary policy is not a stable one. China's interest rate is clearly smooth, indicating that the central leadership is inclined against adventures in monetary policies. Both static analysis and prospective-thinking-based one indicate that China's monetary policy does not directly respond to stock price fluctuation, however, stock price volatility could impact monetary policy in a indirect way.My findings have policy implications. China should continue with interest rate marketization reform, strengthening the responsiveness of interest rate to market changes. In practically making monetary policies in China, more attention should be paid to stock price changes in order to avoid stock market bubbles and high inflation. China should also make more efforts in gathering and organizing market information to gradually form monetary policies' responsive mechanisms to changes in inflation gap and output gap, so as to increase the effectiveness of monetary policies.