Abstract
We examine whether the effectiveness of the monetary policy rate transmission differs before and after interest rate liberalization in China using the autoregressive distributed lag (ARDL) bound test and an error correction model (ECM). The results show that after liberalization the mark-up is lower, and both the long-run and short-run interest rate pass-through has become faster and more complete. We attribute our findings to the ongoing reforms of China’s banking system, which has improved the competitiveness of Chinese commercial banks.
Highlights
The People’s Bank of China (PBOC) started to liberalize the interest rates of commercial banks at the end of the 1990s
We provide empirical evidence on the pass-through of the policy rate to lending rates set by commercial banks by testing whether the effectiveness of monetary policy transmission is hampered or enhanced after interest rate liberalization in China
We examine how interest rate liberalization influences the effectiveness of monetary policy transmission
Summary
The People’s Bank of China (PBOC) started to liberalize the interest rates of commercial banks at the end of the 1990s. Prior to interest rate liberalization, both the lending and deposit rates were set by PBOC. All commercial banks charged similar interest rates on bank loans, regardless of the credit risk of their borrowers. All banks offered similar deposit rates and almost all banks, big or small, enjoyed implicit guarantees from the Chinese government. Loans were often channeled to some inefficient and loss-making state-owned enterprises (SOEs) that enjoyed implicit government guarantees. Small- and medium-sized enterprises in the private sector had very limited access to bank loans
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