NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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The Nexus of Monetary Policy and Shadow Banking in China

Kaiji Chen, Jue Ren, Tao Zha

NBER Working Paper No. 23377
Issued in May 2017, Revised in May 2018
NBER Program(s):Asset Pricing, Development Economics, Economic Fluctuations and Growth, Monetary Economics

We estimate the quantity-based monetary policy system in China. We argue that China's rising shadow banking was inextricably linked to banks' balance-sheet risk and hampered the effectiveness of monetary policy on the banking system during the 2009-2015 period of monetary policy contractions. By constructing two micro datasets at the individual bank level, we substantiate this argument with three empirical findings: (1) in response to monetary policy tightening, nonstate banks actively engaged in intermediating shadow banking products; (2) these banks, in sharp contrast to state banks, brought shadow banking products onto the balance sheet via risky investments; (3) bank loans and risky investment assets in the banking system respond in opposite directions to monetary policy tightening, which makes monetary policy less effective. We build a theoretical framework to derive the above testable hypotheses and explore implications of the interaction between monetary and regulatory policies.

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Document Object Identifier (DOI): 10.3386/w23377

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