Macroprudential Policy, Central Banks and Financial Stability: Evidence from China

This paper studies the Chinese case to show that a central bank can use macroprudential policies to play an active role in safeguarding financial stability. The narrative approach is used to disentangle macropudential policy actions from those monetary. We show that many monetary policy tools, such as the reserve requirement, window guidance, supervisory pressure and housing-market policies, can be used for macroprudential purposes. Time series are constructed to measure macroprudential tightness/ease. The VAR estimates suggest that macroprudential policy has immediate and persistent impact on the credit cycle, but no significant effect on output. Macroprudential policy can be used either alone to retain financial stability, without harming the real economy; or as a complement to monetary policy to offset the buildup of financial vulnerabilities resulted from a monetary easing. Our analysis suggests that it is the multi-instrument framework that enables a central bank to achieve both macroeconomic and financial stability objectives. This finding has implications for the current debates on the post-crisis central bank’s operating regime.