The Spillover Effect of US Monetary Policy on China’s Macroeconomy

Abstract

How to quantitatively measure the macro dynamic effect of monetary policy is one of the most critical issues in the mainstream macro research （Benanke and Gertler, 1995; Christiano, et al., 1999）. In the context of global financial integration, how will a country’s monetary policy affect the macroeconomy of other countries? This international spillover effect of monetary policy has been hotly debated in the academy, but it has not yet been conclusive. The reason is that, empirically, how to identify the impact of exogenous monetary policy has not been well resolved at the technical level; theoretically, mainstream macroeconomic models provide various transmission mechanisms, and no consensus has been reached.Due to the above difficulties, research on the international spillover effect of monetary policy is still in its early stage, and the impact of US monetary policy on China’s economy is seldom studied. From the empirical point of view, this article follows the latest literature Barakchian and Crowe （2013, hereinafter referred to as BC） to identify the impact of exogenous monetary policy in the United States, and studies the dynamic impact of US monetary policy on China’s macroeconomy and its underlying transmission mechanism. This article provides new evidence on the international spillover effect of monetary policy and also tests the existing theories in international economics from an empirical perspective.The primary issue to be addressed in monetary policy research is how to identify exogenous monetary policy shocks. However, macroeconomic regulation often relies on the current situation of aggregate economy. Since there is a strong endogenous relationship among economic variables, it is difficult to directly construct a system that includes policy variables and macroeconomic indicators to identify exogenous monetary policy shocks. To this end, BC （2013） solves the endogenous issue regarding the identification of monetary policy shocks. The exogenous shock constructed through their indicator not only avoids making ad hoc assumptions about the feedback rules of monetary policy, but also avoids the endogenous problems and the sample selection issue in traditional identification methods.Based on the US monetary policy shock constructed by BC （2013）, this article studies the spillover effect of US monetary policy on China’s macroeconomy and therefore solves the aforementioned endogenous problem of monetary policy shocks. The basic model of the empirical analysis is a three-variable structural vector autoregressive error correction model （SVECM） that includes China’s industrial output, price index, and US monetary policy shocks. Based on this model, we find that the opening-up policy of WTO accession at the end of 2001 has a significant structural impact on the spillover effect of US monetary policy and its transmission mechanism. Specifically, we divide the monthly data from 1996−2008 into two sub-samples before and after January 2002. Using the 2002−2008 subsample, we find that the impact of the US’s tightening monetary policy significantly causes China’s output to rise and prices to fall, thus performing as a positive supply shock to China’s economy. Based on the 1996−2001 subsample, US monetary policy will not have a significant impact on China’s economy. The above findings are largely different from the findings in Kim （1999, 2001）, Canova （2005）, and among others.In the analysis of the transmission mechanism, this article finds that the price channel can well explain the stylized facts in the data. Our theory proceeds as follows: The US tightening monetary policy will lead to the appreciation of the US dollar, which will cause US manufacturers to lower their export prices in US dollars （Exchange Rate Pass-Through）. Due to the yuan-dollar fixed exchange rate system, China’s import prices will decline, and the prices of domestic raw materials and CPI will decline. Lower production costs lead manufacturers to increase production, which is reflected by an increase in China’s output. Therefore, the price channel indicates that the US tightening monetary policy is equivalent to a positive supply shock, which will simultaneously increase China’s output and reduce the price level. Based on the extended SVECM system, we find that Chinese macro data can identify the price channels of imported goods. Further robustness analysis shows that our main findings are robust to different sample periods and different model settings. Besides, in order to better explain the identification of import price channels, we have conducted empirical tests on several standard theories in international economics. The results show that the standard theories fail to explain the Chinese data. Therefore, the price channel provides the primary transmission mechanism of the spillover effect of US monetary policy on China’s economy, and this channel also explains the empirical finding that WTO has a structural impact on the spillover effect.