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Dual-Track Interest Rates and the Conduct of Monetary Policy in China

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  • Dong He

    (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research)

  • Honglin Wang

    (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research)

Abstract

China has a dual-track interest-rate system: bank deposit and lending rates are regulated, but money and bond market rates are market-determined. At the same time, the central bank also imposes an indicative target, which may not be binding at all times, on total credit in the banking system. We develop and calibrate a theoretical model to illustrate the conduct of monetary policy within the framework of dual-track interest rates and a juxtaposition of both price- and quantity-based policy instruments. We model the transmission of monetary policy instruments to market interest rates, which, together with the quantitative credit target in the banking system, ultimately serve as the lever by which monetary policy affects the real economy. The model shows that market interest rates are most sensitive to changes in the benchmark deposit interest rates, significantly responsive to changes in the reserve requirements, but not particularly reactive to open market operations. These theoretical predictions are verified and supported by both linear and GARCH models using daily money and bond market data. Overall, the results of this study help us understand why the central bank conducts monetary policy in China the way it does: a combination of price and quantitative instruments, with various degrees of potency in terms of their influence on the cost of credit.

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Bibliographic Info

Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 212011.

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Length: 57 pages
Date of creation: Jul 2011
Date of revision:
Handle: RePEc:hkm:wpaper:212011

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Keywords: Monetary Policy; People's Bank of China; Dual-Track Interest Rates; Interest Rate Liberalization;

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References

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Cited by:
  1. Dong He & Honglin Wang, 2013. "Monetary Policy and Bank Lending in China - Evidence from Loan-Level Data," Working Papers 162013, Hong Kong Institute for Monetary Research.
  2. Nguyen, Vu Hong Thai & Boateng, Agyenim, 2013. "The impact of excess reserves beyond precautionary levels on Bank Lending Channels in China," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 26(C), pages 358-377.
  3. Alicia Garcia-Herrero & Eric Girardin, 2013. "China's Monetary Policy Communication: Money Markets not only Listen, They also Understand," Working Papers 022013, Hong Kong Institute for Monetary Research.
  4. Jing Wu & Joseph Gyourko & Yongheng Deng, 2013. "Is There Evidence of a Real Estate Collateral Channel Effect on Listed Firm Investment in China?," NBER Working Papers 18762, National Bureau of Economic Research, Inc.
  5. Dong He & Honglin Wang, 2011. "Dual-Track Interest Rates and the Conduct of Monetary Policy in China," Working Papers 212011, Hong Kong Institute for Monetary Research.
  6. Fernald, John G. & Spiegel, Mark M. & Swanson, Eric T., 2014. "Monetary policy effectiveness in China: evidence from a FAVAR model," Working Paper Series 2014-7, Federal Reserve Bank of San Francisco.
  7. Dong He & Honglin Wang & Xiangrong Yu, 2014. "Interest Rate Determination in China: Past, Present, and Future," Working Papers 042014, Hong Kong Institute for Monetary Research.

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