Monetary Policy Rules and Business Cycle in China: Bayesian DSGE Model Simulation

Abstract

In this paper, using a benchmark Bayesian Dynamic Stochastic General Equilibrium (Bayesian DSGE) model (Smets-Wouters Model) with Taylor’s rule and a modified Smets-Wouters model with a money growth rule, we have simulated China’s monetary policy transmission process and the roles of monetary variables and non monetary variables in China’s business cycle by incorporating many so-called New Keynesian Macroeconomic (NKM) approaches such as nominal stickiness and market imperfections in the model. The estimated values of the parameters in the model by Bayesian approach based on China’s quarterly time series data feature the unique characters of China’s economy compared with that in the US and the Euro area. The simulation results in terms of the Taylor’s rule and money growth rule (MacCullum Rule) highlight the monetary transmission mechanisms of China’s monetary policy and the diverse contributions of monetary shocks and non-monetary shocks to China’s business cycle.