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Monetary Policy Effectiveness in China: Evidence from a FAVAR Model

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  • John Fernald
  • Mark M. Spiegel
  • Eric T. Swanson

Abstract

We use a broad set of Chinese economic indicators and a dynamic factor model framework to estimate Chinese economic activity and inflation as latent variables. We incorporate these latent variables into a factor-augmented vector autoregression (FAVAR) to estimate the effects of Chinese monetary policy on the Chinese economy. A FAVAR approach is particularly well-suited to this analysis due to concerns about Chinese data quality, a lack of a long history for many series, and the rapid institutional and structural changes that China has undergone. We find that increases in bank reserve requirements reduce economic activity and inflation, consistent with previous studies. In contrast to much of the literature, however, we find that central-bank-determined changes in Chinese interest rates also have substantial impacts on economic activity and inflation, while other measures of changes in credit conditions, such as shocks to M2 or lending levels, do not once other policy variables are taken into account. Overall, our results indicate that the monetary policy transmission channels in China have moved closer to those of Western market economies.

Suggested Citation

  • John Fernald & Mark M. Spiegel & Eric T. Swanson, 2014. "Monetary Policy Effectiveness in China: Evidence from a FAVAR Model," NBER Working Papers 20518, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:20518
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    More about this item

    JEL classification:

    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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