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

Author

Listed:
  • 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.

Suggested Citation

  • 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.
  • Handle: RePEc:hkm:wpaper:212011
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Monetary Policy; People's Bank of China; Dual-Track Interest Rates; Interest Rate Liberalization;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • C25 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions; Probabilities
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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