A Narrative indicator of Monetary Conditions in China

This paper studies the Chinese monetary policy measurement problem. First, we construct a narrative index series to measure the PBC's policy stance in 2000-14, based on the information abstracted from the PBC's documents. Second, this narrative index is assessed in comparison with other composite indexes developed in the literature. Third, we study the nexus between the narrative index and individual quantitative policy variables such as policy instruments, operating targets, and intermediate targets. Our findings are twofold. First, the narrative-based and instrument-based indexes differ in the criteria for indicating what a policy shift is. Changes in the former reflect the PBC's responses to its perceptions of real economic growth and inflation, while the latter records all the changes in the instruments, driven by both these two objectives and regular liquidity management as a result of sterilization needs. The second finding is that the PBC relies mainly on interest rates and the required reserve ratio in realizing its policy shifts. Yet, they cannot be good policy indicators, as a substantial amount of variation in them reflects influences from factors other than monetary policy. Neither base money nor broad money can measure the PBC's policy stance, given that there is no clear link between them and policy shifts.