BOFIT Discussion Papers, Institute for Economies in Transition, Bank of Finland
No 21/2011:
Dual-track interest rates and the conduct of monetary policy in China
Dong He ()
and Honglin Wang
Abstract: China has a dual-track interest-rate system: bank deposit
and lending rates are regulated while money and bond rates are
market-determined. The central bank also imposes an indicative target,
which may not be binding at all times, for 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 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 are the means 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 results are verified and
supported by both linear and GARCH models using daily money and bond market
data. Overall, the findings of this study help us to understand why the
central bank conducts monetary policy in China the way it does, using a
combination of price and quantitative instruments with differing degrees of
potency in terms of their influence on the cost of credit.
Keywords: monetary policy; People’s Bank of China; dual-track interest rates; interest rate liberalization; (follow links to similar papers)
JEL-Codes: C25; C32; E52; E58; (follow links to similar papers)
56 pages, August 22, 2011
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