The Dependence of China’s Monetary Policy Rules on Interest Rate Regimes: Empirical Analysis Based on a Pseudo Output Gap

Xiaoyu Zhang,Fanghui Pan

doi:10.3390/su11092557

Xiaoyu Zhang, Fanghui Pan

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https://doi.org/10.3390/su11092557

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Although a large number of scholars have studied the policy preferences and monetary policy rules of China’s central bank, most have found no evidence that China’s central bank has adjusted the nominal interest rates against the output gap. By constructing the pseudo output gap defined by the deviation of the real output growth rate and the target growth rate, this paper finds that China’s central bank prefers to adjust the nominal interest rates against the pseudo output gap. The monetary policy preferences and rules of China’s central bank in different interest rate regimes are investigated based on the threshold Taylor rule model. It is found that, in the high-interest-rate regime, the central bank adjusts the nominal interest against the inflation gap and the pseudo output gap, while in the low-interest-rate regime, there is no evidence that the central bank adjusts the nominal interest rates against the pseudo output gap. The lower bound of interest rate reduction and the weakening of interest rate policy effects caused by the liquidity trap of the interest rate are the possible reasons for China’s central bank not to adjust the nominal interest rates against the pseudo output gap.

Highlights

The purposes of monetary policy are to keep the price, output, and finance stable [1] and to promote sustainable economic growth [2], so the government needs to adjust the monetary policy in accordance with economic development to achieve the above policy targets
The estimated results of the linear Taylor rule model based on the pseudo output gap indicate that China’s central bank significantly adjusts nominal interest rates against both the inflation gap and the pseudo output gap
This shows that the pseudo output gap calculated by the deviation between the real gross domestic production (GDP) growth rate and the target growth rate can better identify the monetary policy preferences of China’s central bank

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Introduction

The purposes of monetary policy are to keep the price, output, and finance stable [1] and to promote sustainable economic growth [2], so the government needs to adjust the monetary policy in accordance with economic development to achieve the above policy targets. In response to the US subprime mortgage crisis, the central bank of Japan implemented an expansionary monetary policy that caused the call rate on overnight loans to fall to 0%. In the presence of zero lower bound on nominal interest rates, the price-based monetary policy aimed at lowering interest rates and stimulating the economy seems to be ineffective; the central bank of Japan has pinned its hopes of economic recovery on a quantity-based monetary policy that increases the base currency or other ways to conduct quantitative easing [3]. In response to the crisis, the Federal Reserve implemented a more aggressive expansionary monetary policy than the central bank of Japan did. The federal funds rate had remained below 0.5% from 2009 to 2015, which means that the Federal Reserve Bank was facing the zero lower bound of the nominal interest rates

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