The Effect Of Monetary Policy On The Interest Rate Term Structure Of Treasury Bonds

There have been discussions about interest and monetary for a long time, both in academia and in financial market. The interest rate term structure has been studied extensively in interest system, so the association between monetary policy and interest rate term structure was well established. The monetary policy conducted by the central bank affect short-term interest rate, and then spread to long-term interest rate because of the relationship between short-term and long-term interest rate. Therefore, the monetary policy can influence the overall level of interest rate.On October 23th,2015, People's Bank of China declared that there is no deposit interest rate floating ceiling for commercial banks and rural cooperative financial institution any more. It is the last and the most important step in the process of interest rate liberalization. Since then, China entered the era of market interest rate. At present, it is the critical period of comprehensively deepening reform. The monetary policy will gradually be shifted to the structurally imbalance-adjusted price type from the numeric type during the 13th five-year plan. In this context, the study about the effect of monetary policy on the interest rate term structure of treasury bonds is of great practical significance.This study will analyze the effect of monetary policy on the interest rate term structure of treasury bonds in China completely from theory to empirical study as well as from qualitative to quantitative analysis.In the theory study, first review the theory system about interest rate term structure and monetary policy. The theories of interest rate term structure include the pure expectations theory, the segmented market theory, the liquidity premium theory, the static and the dynamic interest rate term structure models. Besides, the study presents a widely-used principal components analysis (PCA) to describe the interest rate term structure. In previous studies, using PCA to describe both the foreign and domestic interest rate term structure can explain more than 95% of the total variance. It proves that this mothed above is reasonable. The theory of monetary policy includes the conduction mechanism of monetary policy. After reviewing these theory systems, this study introduces the studies associated with the effect of monetary policy on the interest rate term structure. Apart from that, the conduction mechanism and part of researches at home and abroad are also included. These researches generally suggested that the monetary policy did have influence on the interest rate term structure, but the way and the extent of effects were inconsistent because of different methodologies and data. Domestic related studies were mostly conducted between 2000 and 2012, and less researches in recent years. Moreover, they only focused on quantitative analysis rather than qualitative analysis.Then, introduce the monetary policy and the Treasury bond market in China briefly. The introduction about the monetary policy includes the monetary policy tools of People's Bank of China and how to execute in the past two years. The introduction about the Treasury bond market includes the development, the existing problems and the formation of the interest rate term structure of Treasure bonds. This part is background intrductition.For the empirical part, this study selects the yield of inter-bank fixed Treasury bond and uses qualitative and quantitative analyses simultaneously.In the qualitative analysis, the study analyses the effect of monetary policy on the interest rate term structure of Treasury bonds qualitatively. In this part, select the required reserve ratio (RRR) and the prime interest rate as the monetary policy, and consult Ma Jun etc.'s research. The study will analyze the effect of RRR and the prime interest rate to observe the changes of yield spread between the People's Bank of China's announcement date and the next, the 5th trading day and 1 month following. The study analyzes the recent observable adjustment in detail, and at the same time analyzes the adjustments in last 5 years to avoid coincidence. From the qualitative analysis, the adjustments of RRR and the prime interest rate do influence the interest rate term structure. Expansionary monetary policies will lower the interest rate and increase the slope of the Treasury bonds yield curve. Tight monetary policies will increase the interest rate and reduce the slope. The effects of expansionary and tight monetary policies are asymmetric. And the adjustments of RRR have more ideal effect. Besides, the adjustments of RRR will expert more impacts on the shorter-term interest than the longer-term. When raise the prime interest rate, the effect always lag; and when low, the effect often has shorter duration.In the quantitative analysis, the study uses PCA and VAR model. Litterman and Scheinkman found that extracting the level, slope and curvature factors of the yield of the US Treasury bonds based on PCA could explain the 98.4% of the total variance in 1991. The study follows this approach, and on this basis, contrasts the above factors and the actual data. From the contrast, the three factors cohere with the actual data. So this method is reasonable in both theory and empirical perspectives. In VAR model, select 7-day interbank rate as the price type monetary policy, select the broad money (M2) supply as the numeric type monetary policy, select the consumer price index (CPI) as the price level variable, and select the industrial production (IP) as the macroeconomic variable. These variables are monetary policy variables in VAR model. Before modeling, the study tests the causal relationship between these monetary policy variables and the level, slope and curvature factors through Granger causality tests. It is found that the selection of variables is reasonable in economics and statistics. Then test the stationarity of these time series based on ADF unit root test. These variables are stable except for the M2 supply, CPI and IP. But the 1st difference of these three variables are stable. So the model will use the 1st difference series of M2 supply, CPI and IP. Under the condition of reasonable causal relationship and stable time series, model these monetary policy variables with the level, slope and curvature factors separately, and use impulse responses and variance decompositions to analyze. From the quantitative analysis, monetary policy does effect the interest rate term structure of Treasury bonds. And among the level, slope and curvature factors, the most affected is the level factor, and the least affected is the curvature factor. Besides, price level and price type monetary policy will affect the level factor significantly, and only price type monetary policy will affect the slope and curvature factors significantly. Furthermore, no matter for which factor, price type monetary policy will have greater influence than numeric type.Based on above analyses, the study gives policy proposals about the development of Treasury bond market, interest rate market and monetary policy, combined with the background of interest rate liberalization. Considering the existing problems, Treasury bond market should enrich the bonds of different maturities and market participants. Also Treasury bond market should mature the central counterparties (CCP) mechanism gradually. As China has taken the last and the most important step in the process of interest rate liberalization, interest rate market should find the new benchmark interest rate in the reansition period, and build the interest rate corridor in the future. At the same time, provide a clear path for interest rates. Nowadays, major economies in the world develop differently, and China faces the pressure of the economic downturn. So monetary policy should be transformed, and the framework of monetary policy ought to be improved. At the same time, People's Bank of China should insist the monetary policy independence, and coordinate with international monetary policy.This study is established on the basis of the interest rate liberalization and the comprehensively deepening reform from the selected topic to the policy proposals. So it is of great practical significance. The study uses the latest data, and the observation is enough, so it is more timeliness. Quantitative analysis rather than qualitative analysis is the main focus of domestic related studies. But this study combines qualitative with quantitative analysis, so it is more persuasiveness. In the empirical study, the study extracts the level, slope and curvature factors of the yield of the Treasury bonds using PCA based on Litterman and Scheinkman's research. But unlike previous studies, the study contrasts the above factors and the actual data to verify the feasibility of the model.