The Direction and Intensity of China’s Monetary Policy: A Dynamic Factor Modelling Approach^*

Abstract

The recent update of the People’s Bank of China’s monetary policy framework establishes a corridor system of interest rates. We employ a dynamic factor modelling approach to derive an indicator of China’s monetary policy stance. The approach is based on the notion that co‐movements in several monetary policy instruments have a common element that can be captured by a single underlying, unobserved component. To clarify and interpret the derived index, we employ a baseline dynamic stochastic general equilibrium (DSGE) model that can be solved analytically and allows tracing of the expansionary and contractionary on‐and‐off phases of Chinese monetary policy.

China’s economic growth – selected financial aspects

“…The Standing Lending Facility (SLF) instrument introduced in 2013, which is the upper limit for fluctuations in interbank offered rates, allows to provide liquidity 24 M. Funke, A. Tsang [2019], The direction and intensity of China's monetary policy conduct: a dynamic factor modelling approach, "The Bank of Finland Institute for Economies in Transition. Discussion Papers", vol.…”

The Vanishing Interest Income of Chinese Banks

“…The rediscount rate used by the People's Bank of China (PBoC) remained constant after December 2010, while the monetary policy stance was steered through such measures as adjusting the size of open-market operations and the rate of the standing lending facility (see e.g. Funke and Tsang, 2019). Second, Ln(Balance sheet total / Consumer Price Index) measures the size of operations.…”

Uncovering Heterogeneous Regional Impacts of Chinese Monetary Policy

“…In recent decades, China has gradually changed its monetary policy framework from a repressive financial system to a more market-based system (Funke and Tsang, 2021). The existing literature has shown that China's monetary policy has been tracking the Chinese economy well (see Funke and Tsang, 2021;Kamber and Mohanty, 2018;Sun, 2018).…”

“…In recent decades, China has gradually changed its monetary policy framework from a repressive financial system to a more market-based system (Funke and Tsang, 2021). The existing literature has shown that China's monetary policy has been tracking the Chinese economy well (see Funke and Tsang, 2021;Kamber and Mohanty, 2018;Sun, 2018). In addition, Funke and Tsang (2020) have shown that China's swift and decisive monetary policy easing since the COVID-19 outbreak has supported the quick rebound of the economy.…”

“…Against this background, this paper will examine the heterogeneous regional impacts of the current Chinese monetary policy. Instead of using conventional monetary policy variables (mainly interest rates), this paper uses the newly developed dynamic factor model (DFM)-based monetary policy indicator (constructed in Funke and Tsang, 2021) and provin-cial-level data. 1 Specifically, this paper will answer the following: i) Does the current national monetary policy have heterogeneous regional impacts in China?…”