Exchange and Interest Rate Channels During a Deflationary Era - Evidence from Japan, Hong Kong and China

Abstract

We examine the role of the exchange and interest rate channels during recent deflation episodes in Japan, Hong Kong and China. We estimate open-economy structural vector autoregressive (SVAR) models for the three economies with different monetary regimes and varying degrees of openness. In both Japan and Hong Kong, shocks to the nominal effective exchange rate have a statistically significant impact on prices, with a notably stronger effect in Hong Kong.Our results provide evidence about the role of external influences in the deflation episodes of these economies, and could also be seen to weakly support suggestions to depreciate the currency in order to escape from a liquidity trap. The importance of the interest rate channel is also found to be high in Japan and Hong Kong. In China, where interest rates have not been an important monetary policy tool, neither exchange nor interest rate shocks significantly influence price developments.

Monetary policy, asset prices and consumption in China

“…While the studies on the advanced economies typically use a policy interest rate as the monetary policy indicator, the role of interest rates in the Chinese economy is known to be very modest (see e.g. Koivu 2008;Laurens and Maino 2007;Mehrotra 2007).…”

Exchange and interest rate channels during a deflationary era—Evidence from Japan, Hong Kong and China

“…Moreover, when the Saikkonen-Lütkepohl cointegration test (Saikkonen and Lütkepohl, 2000) is used to test for common stochastic trends in China, the null hypothesis of no cointegration cannot be rejected. Detailed results from the unit root tests for the three economies as well as cointegration tests for China are reported in Mehrotra (2005). Taking these considerations into account, we choose to estimate an SVAR model with contemporaneous restrictions and ignore possible cointegration relations.…”

Examining Monetary Policy Transmission in the People's Republic of China–Structural Change Models with a Monetary Policy Index

“…Laurens and Maino (2007) argue that there is no significant link between the PRC's short-term interest rates and movements in GDP. Mehrotra (2007) examines the role of interest rate channels in the PRC; Hong Kong, China; and Japan using a structural vector autoregression model and finds that while there is strong evidence of the interest rate channel as a monetary policy tool for both Japan and Hong Kong, China, the same cannot be said for the PRC. The limited importance of the interest rate channel in the PRC is attributed to the implementation of interest rates by administrative measures rather than market-determined interest rates.…”