The Sovereign Yield Curve and the Macroeconomy in China

Abstract

AbstractA dynamic Nelson–Siegel model is adopted to estimate three time‐varying factors of yield curves, the level, the slope and the curvature, and a vector autoregressive model is built to study interactions between macro variables and the yield curve. Results show that, first, money supply growth is a more effective instrument to curb inflation than the monetary policy interest rate; however, the central bank also adjusts the interest rate to stabilize money supply. Second, investment is an important measure to stimulate the Chinese economy, but it also pushes up money supply growth, which results in higher inflation. Third, the yield curve reacts significantly to innovations to investment growth and money supply growth. The segmentation of China's bond market hinders the efficient implementation of monetary policy, and the monetary policy transmission mechanism is still weak in China. Finally, interactions between the yield curve and the macroeconomy in China are nearly unidirectional. Macroeconomic variables reshape the yield curve, but direct adjustments of the yield curve do not significantly change macroeconomic variables. Due to the incomplete liberalization of financial markets, there exists a wide disjunction between the real economy and financial markets in China.