NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Monetary Policy Effectiveness in China: Evidence from a FAVAR Model

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

NBER Working Paper No. 20518
Issued in September 2014
NBER Program(s):Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

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.

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Document Object Identifier (DOI): 10.3386/w20518

Published: Fernald, John G. & Spiegel, Mark M. & Swanson, Eric T., 2014. "Monetary policy effectiveness in China: Evidence from a FAVAR model," Journal of International Money and Finance, Elsevier, vol. 49(PA), pages 83-103. citation courtesy of

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