Combating crises and deflation in China’s central bank : Modeling post-pandemic monetary policymaking
Burdekin, Richard C. K.; Siklos, Pierre L. (10.04.2025)
Numero
2/2025Julkaisija
Bank of Finland
2025
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi-fe2025041025516Tiivistelmä
The monetary policy of the People’s Bank of China (PBoC) during 2001–2023 is assessed in terms of Taylor and McCallum rules, as well as a proposed composite monetary policy rule. PBoC policy is found to be responsive to the gap between target and actual nominal GDP in the McCallum rule, as well as the output and inflation gaps in the Taylor rule. We find a relatively close fit between actual and predicted monetary policy moves under both rules, and a superior fit with our composite rule incorporating monetary and interest-rate factors. The policy reactions persist across a series of transitions between high- and low-volatility regimes identified via Markov-switching regressions. The results are shown to be robust using several techniques.
Julkaisuhuomautus
NON-TECHNICAL SUMMARY
FOCUS
How best to model the monetary policy of China’s central bank in terms of a policy rule that describes how People’s Bank of China (PBoC) sets its monetary policy stance? We create a composite rule drawn from existing policy rules to evaluate monetary policy in advanced economies. Our hybrid rule fits the data especially well. A variety of econometric techniques are used to test the robustness of the main findings. Our proposed PBoC monetary policy rule is relatively complex compared to most monetary policy rules discussed in the literature.
CONTRIBUTION
John Taylor (1992) originally proposed a policy rule describing how the US Federal Reserve sets monetary policy based on the behavior of the central bank’s policy rate. Bennett McCallum (1999) followed up with a competing rule that evaluates monetary policy in terms of the money supply’s growth rate. Investigating the case of China, Burdekin and Siklos (2008) find McCallum’s rule superior in describing how the PBoC sets its monetary policy stance. Since the global financial crisis, however, China has made significant changes in how it conducts monetary policy and its financial markets have developed. Accordingly, we derive a hybrid model that provides for changes in interest rates and the money supply that is relevant to the current post-pandemic environment. We argue that our approach gives a better description of how the PBoC sets monetary policy today.
FINDINGS
Monetary policy setting in China is a much more nuance process than in the past thanks to a broad array of policy tools available to PBoC. While the McCallum rule captures the broad trajectory of Chinese money growth over the 2001–2023 period, the relationship is subject to a series of shifts that can be captured econometrically. We then compare these results against those generated with the more widely used Taylor rule. Both policy rules are found wanting relative to our proposed composite rule, which combines elements from both McCallum and Taylor rules. Our composite rule generates a monetary conditions index based on interest rates, money supply growth, as well as changes in the required reserve ratio, currency depreciation against the US dollar, and changes in the ratio of total private non-financial credit to GDP. The closest fit between actual and predicted monetary policy is seen under our composite index.
FOCUS
How best to model the monetary policy of China’s central bank in terms of a policy rule that describes how People’s Bank of China (PBoC) sets its monetary policy stance? We create a composite rule drawn from existing policy rules to evaluate monetary policy in advanced economies. Our hybrid rule fits the data especially well. A variety of econometric techniques are used to test the robustness of the main findings. Our proposed PBoC monetary policy rule is relatively complex compared to most monetary policy rules discussed in the literature.
CONTRIBUTION
John Taylor (1992) originally proposed a policy rule describing how the US Federal Reserve sets monetary policy based on the behavior of the central bank’s policy rate. Bennett McCallum (1999) followed up with a competing rule that evaluates monetary policy in terms of the money supply’s growth rate. Investigating the case of China, Burdekin and Siklos (2008) find McCallum’s rule superior in describing how the PBoC sets its monetary policy stance. Since the global financial crisis, however, China has made significant changes in how it conducts monetary policy and its financial markets have developed. Accordingly, we derive a hybrid model that provides for changes in interest rates and the money supply that is relevant to the current post-pandemic environment. We argue that our approach gives a better description of how the PBoC sets monetary policy today.
FINDINGS
Monetary policy setting in China is a much more nuance process than in the past thanks to a broad array of policy tools available to PBoC. While the McCallum rule captures the broad trajectory of Chinese money growth over the 2001–2023 period, the relationship is subject to a series of shifts that can be captured econometrically. We then compare these results against those generated with the more widely used Taylor rule. Both policy rules are found wanting relative to our proposed composite rule, which combines elements from both McCallum and Taylor rules. Our composite rule generates a monetary conditions index based on interest rates, money supply growth, as well as changes in the required reserve ratio, currency depreciation against the US dollar, and changes in the ratio of total private non-financial credit to GDP. The closest fit between actual and predicted monetary policy is seen under our composite index.