How do the dual effects of financial development change the transmission of monetary policy? – Evidence from China

Abstract

Based on the different driving factors of financial development, the paper divides the financial development of developing countries into dual effects, namely marketization effects (ME) and scale effects (SE). The former can reduce financial frictions, but the latter cannot. Using evidence from China, the paper investigates the dual effects of financial development on monetary policy effectiveness. Results show that China's financial development improves the effect of monetary policy on the whole, which is different from some research conclusions in developing countries only based on the credit channel, and also different from those of developed countries. This is because that ME and SE have different effects on the interest rate channel and the credit channel, and the total effect of monetary policy is the sum of the effects of these two channels.