Monetary policy and its transmission channels: Evidence from China

This paper examines the individual effect of the channels of monetary transmission (the asset price channel, the credit channel, the interest rate channel, and the exchange rate channel) in China using Impulse Response Separation Vector Auto Regression (IRSVAR) technique. The results are as follows: First, although China's market-oriented reform has been carried out for 40 years, the role of the neoclassical interest rate channel in the overall effect of monetary policy is still relatively low (31%). Second, although the relative role of the credit channel has declined, it remains, on average, the most important transmission channel (42%). It shows that there are still serious frictions in China's economy and that market-oriented reforms need to be further strengthened. Third, in general, the relative marginal role of asset price channels has risen significantly (20%), mainly because of the rapidly increasing wealth effect on households in China's stock and property markets. Since the exchange rate has been strictly controlled, the role of the exchange rate channel has always been unimportant (7%). These results have important policy implications: China has made progress to marketize the interest rate in the past years, however, it is necessary to further improve the comprehensive marketization mechanism, and the choice of the intermediate target of macro-prudential monetary policy should pay sufficient attention to the changes in asset prices.