Has the Chinese economy become more sensitive to interest rates? Studying credit demand in China

Abstract

Chinese authorities have traditionally relied mainly on administrative and quantitative measures in conducting monetary policy, with interest rates playing a less prominent role. Additional support for this view resides in a number of earlier studies that have found that the impact of interest rates on the real economy has been miniscule. However, taking into account numerous reforms in the financial sector and more widely in the Chinese economy, interest rates may have gained some influence in the last few years. It is important to study the effectiveness of interest rates also in light of future reforms of the monetary policy tools in China. Whereas administrative policy measures were effective in guiding the behaviour of state-owned enterprises, the authorities may need to increase the use of more market-oriented monetary policy tools as the share of the economy in private and foreign ownership grows. We use a vector error correction model to study, within a credit demand framework, whether the impact of interest rates in China has become stronger over the last decade. Our results suggest that loan demand has indeed become more dependent on interest rates, albeit the channel from interest rate to the real economy is still weak.

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).…”

U.S. monetary policy and China's exchange rate policy during the great recession

“…Koivu (2009) points out that China's monetary policy has relied on a fixed exchange rate, capital controls and a selection of administrative and quantitative policy tools. Koivu (2009) points out that many features of China's monetary policy have changed in recent years. Cheung, Tam, & Yiu (2008) find that U.S. interest rates have a weak effect on China.…”

“…Ma and McCauley (2008) find that capital controls have proved effective. Second, since the summer of 2003, growing capital inflows have increased liquidity in China's financial markets and have complicated the conduct of monetary policy (Koivu, 2009). They argue that even with the dollar peg, China employs measures to retain its monetary policy independence.…”

Reforming China's Monetary Policy Framework to Meet Domestic Objectives

“…In a VAR-based analysis, Laurens and Maino (2007) also find that changes in short-term interest rates have had a minimal and statistically insignificant impact on GDP. In another VAR study, Koivu (2008) reports that the transmission of interest rate changes to the real economy is weak over the sample period 1998 to mid-2007mid- . Qin et al (2005 paradoxically find that a rise in interest rates leads to an increase in investment, with a lag of about one year.…”