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What Prompts the People's Bank of China to Change Its Monetary Policy Stance? Evidence from a Discrete Choice Model

  • Dong He
  • Laurent L. Pauwels

In the present paper, we model the policy stance of the People's Bank of China (PBC) as a latent variable, and the discrete changes in the reserve requirement ratio, policy interest rates, and the scale of open market operations are taken as signals of movement of this latent variable. We run a discrete choice regression that relates these observed indicators of policy stance to major trends of macroeconomic and financial developments, which are represented by common factors extracted from a large number of variables. The predicted value of the estimated model can then be interpreted as the implicit policy stance of the PBC. In a second step, we estimate how much of the variation in the PBC's implicit stance can be explained by measures of its policy objectives on inflation, growth and financial stability. We find that deviations of CPI inflation from an implicit target and deviations of broad money growth from the announced targets, but not output gaps, figure significantly in the PBC's policy changes. Copyright (c) 2008 The Hong Kong Monetary Authority Journal compilation (c) 2008 Institute of World Economics and Politics, Chinese Academy of Social Sciences.

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Article provided by Institute of World Economics and Politics, Chinese Academy of Social Sciences in its journal China & World Economy.

Volume (Year): 16 (2008)
Issue (Month): 6 ()
Pages: 1-21

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Handle: RePEc:bla:chinae:v:16:y:2008:i:6:p:1-21
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  1. Michael Dueker, 1999. "Measuring monetary policy inertia in target Fed funds rate changes," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 3-10.
  2. Jushan Bai & Serena Ng, 2000. "Determining the Number of Factors in Approximate Factor Models," Boston College Working Papers in Economics 440, Boston College Department of Economics.
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  9. Geiger, Michael, 2006. "Monetary Policy in China (1994-2004) : Targets, Instruments and their Effectiveness," W.E.P. - Würzburg Economic Papers 68, University of Würzburg, Chair for Monetary Policy and International Economics.
  10. Marvin Goodfriend & Eswar Prasad, 2006. "A Framework for Independent Monetary Policy in China," IMF Working Papers 06/111, International Monetary Fund.
  11. Ling Hu & Peter C.B. Phillips, 2002. "Dynamics of the Federal Funds Target Rate: A Nonstationary Discrete Choice Approach," Cowles Foundation Discussion Papers 1365, Cowles Foundation for Research in Economics, Yale University.
  12. Bernard Laurens & Rodolfo Maino, 2007. "China; Strengthening Monetary Policy Implementation," IMF Working Papers 07/14, International Monetary Fund.
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