Identifying the nonlinear correlation between business cycle and monetary policy rule: Evidence from China and the U.S.

Abstract

This paper conducts an empirical study on the interest rate behavior of monetary authorities in China and the United States. First, by using a multiple-threshold model, we find that monetary authorities in China and the US have obvious asymmetric preferences at different stages of business cycle. Nominal interest rate adjustments are more likely to be used to curb inflation during expansion and to stimulate output growth during contraction. Second, we re-examine monetary policy rules in the two countries by using a LT-TVP-VAR model within the New Keynesian rational expectation framework. We find that nominal interest rate adjustments are significantly gradual and barely regime-switching. Finally, we also provide empirical evidence that the federal funds rate, despite remaining near zero, can stabilize output and inflation during the post-recession period. As output growth and inflation continue to follow a downward trend, China is likely to enter a period of low interest rates.