Chinese monetary policy remains a mystery for most. How is it conducted? What does monetary transmission look like in China?
Hong Kong Monetary Authority’s economists Chang Shu and Brian Ng have written a nice paper which tries to demystify Chinese monetary policy.
The paper is very interesting as it tracks Chinese monetary policy using the narrative approach. This means tracking the stance scanning statements, speeches, reviews of Chinese central bank officials. And then they make an index based on these reports to measure the monetary policy stance of the central bank.
The paper undertakes the first study to examine China’s monetary stance using a narrative approach in the tradition of Romer and Romer (1989). Already widely applied for other economies, the narrative approach is conceivably particularly useful for China. The PBoC uses a wide range of monetary tools, including market- or nonmarket-based, quantity and price-based measures, for some of which information is not available. Therefore, conventional measures, most notably the interest rate, may not fully capture the changes in monetary stance. Based on two key official PBoC reports, this study compiles a number of indices to reflect the direction and intensity of monetary stance.
These indices are shown to better gauge China’s monetary stance particularly in the early 2000s when market-based monetary tools were less used, but become increasingly correlated with the interest rate, a market-, price based tool, in recent years.The indices are then used to investigate the PBoC’s policy response to macroeconomic developments through estimation of monetary reaction functions using ordered probit and logit models.
The empirical analysis shows that the most important policy objectives are economic growth and inflation, which are in fact the which the Government also announces annual targets, do not have significant impact on the PBoC’s monetary stance. In meeting their mandate, the PBoC appears to follow a rule of thumb, using historical averages as targets rather than the officially announced annual targets, and trend growth derived from the Hodrick-Prescott offers little guidance on monetary stance.
Within growth and inflation, PBoC reacts more strongly to growth than inflation. THis is on expected lines.
In the end authors say:
This first study using the narrative approach to study monetary stance in China opens up a whole new perspective to macroeconomic and policy developments in China. Conceivably, many aspects of China’s monetary economics can be usefully studied afresh using this alternative way of measuring monetary stance. The most obvious aspects are to examine the impact of monetary stance on macroeconomic developments, tracing the transmission channels and effects on economic indicators using these alternative monetary stance indicators.