Abstract
The objective of this study is to determine the impact of monetary policy on real output in China and its provinces using the vector error correction (VEC) method for the 1980-2004 period. It compares and contrasts two alternative indicators of monetary policy - M2 and interest rates. Our findings indicate that the bank lending rate is a better indicator of the direction of monetary policy in China. Using VEC-generated impulse response functions, we find that coastal provinces respond more to shocks in monetary policy than inland provinces. We also determine that the differential provincial responses to monetary policy changes are positively related to the share of loans accounted by industrial firms and to the primary sector’s GDP share. Finally, the percentage of firms that are stateowned (a proxy for the soft budget constraint) has a negative, albeit statistically insignificant, relationship to a province’s response to monetary policy shocks.
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