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Identifying the Interdependence Between Monetary Policy and Financial Stress: Evidence from China

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  • Rong Li
  • Xiaohui Tian

Abstract

We estimate the interdependence between Chinese monetary policy and financial stress using structural vector autoregression. To solve the simultaneity problem, we employ a strategy including both short‐run and long‐run restrictions that maintains the qualitative properties of monetary policy shocks derived from the literature. This method is applied to Chinese monthly data, together with a newly constructed index of financial stress in this paper. Our findings suggest there exists strong interdependence between monetary policy and financial stress. The financial stress index increases immediately by 0.4 of its standard deviation after a monetary policy shock that raises the M2 growth rate by 1 percentage point. An increase of financial stress by one standard deviation leads to a decline in the M2 growth rate by 2 percentage points.

Suggested Citation

  • Rong Li & Xiaohui Tian, 2018. "Identifying the Interdependence Between Monetary Policy and Financial Stress: Evidence from China," Pacific Economic Review, Wiley Blackwell, vol. 23(3), pages 411-425, August.
    • Handle: RePEc:bla:pacecr:v:23:y:2018:i:3:p:411-425
    DOI: 10.1111/1468-0106.12174
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    Cited by:

    1. Aleh Mazol, 2019. "The Influence of Financial Stress on Economic Activity and Monetary Policy in Belarus," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 44(2), pages 49-75, June.

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