China Pro-Growth Monetary Policy and Its Asymmetric Transmission

Kaiji Chen, Patrick Higgins, Daniel F. Waggoner, and Tao Zha

Working Paper 2016-9
September 2016

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China monetary policy, as well as its transmission, is yet to be understood by researchers and policymakers. In the spirit of Taylor (1993, 2000), we develop a tractable framework that approximates practical monetary policy of China. The framework, grounded in relevant institutional elements, allows us to quantify the policy effects on output and prices. We find strong evidence that monetary policy is designed to support real GDP growth mandated by the central government while resisting inflation pressures and that contributions of monetary policy shocks to the GDP fluctuation are asymmetric across different states of the economy. These findings highlight the role of M2 growth as a primary instrument and the bank lending channel to investment as a key transmission mechanism for monetary policy. Our analysis sheds light on institutional constraints on a gradual transition from M2 growth to the nominal policy interest rate as a primary instrument for monetary policy.

JEL classification: E5, E02, C3, C13

Key words: monetary transmission, endogenous switching, central government, institutional rigidities, GDP growth target, lower growth bound, nonlinear VAR, systematic monetary policy, policy shocks, heavy industries, investment, bank loans, lending channel

Comments from Marty Eichenbaum and Shang-Jin Wei have helped improve earlier drafts. We thank the discussants Kevin Huang, Bing Li, and Kang Shi as well as seminar participants at the International Monetary Fund, the Hong Kong Monetary Authority, the ECB-Tsinghua Conference on China, and Chinese University of Hong Kong for helpful discussions. We are grateful to Yandong Jia at the People's Bank of China and Hongyi Chen at the Hong Kong Monetary Authority for discussions of institutional details of monetary policy practice in China. Tong Xu provided outstanding research assistance. This research is supported in part by the National Science Foundation Grant SES 1558486 through the National Bureau of Economic Research and the National Natural Science Foundation of China Research grant nos. 71473168 and 71473169. The views expressed herein are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or the National Bureau of Economic Research.
Please address questions regarding content to Kaiji Chen, Emory University, 1602 Fishburne Drive, Atlanta, GA 30322-2240 and Federal Reserve Bank of Atlanta,; Daniel F. Waggoner, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470,; Patrick Higgins, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470,; or Tao Zha, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, Emory University, and NBER,
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