Quantities and Prices in China’s Monetary Policy Transmission From Window Guidance to Interbank Rates

Whereas monetary policy in most major economies is conducted by an independent central bank manipulating the interbank overnight interest rate to achieve a price stability target, monetary policy in China is influenced by multiple actors and char- acterised by both quantity-based and price-based instruments and targets. Chinese monetary policy is further exercised through non-public practices such as “window guidance”, a policy by which authorities seek to guide commercial banks’ lending volumes by persuasion. The resulting complex interplay of these different factors is the subject of this study, which investigates the transmission mechanism of Chinese monetary policy for the period 2000–2015 in order to determine the effectiveness of different policy instruments and, subsequently, the effect of bank financing on the broader macroeconomy. Towards this end, a qualitative institutional analysis is con- ducted, followed by quantitative econometric analyses based on exogeneity tests and Structural Vector Autoregression models. The study explicitly accounts for the in- fluence of window guidance by incorporating information from a text-based analysis of People’s Bank of China reports in the tradition of Romer & Romer (1989). To trace the evolution of each instrument, estimations are also applied to subsamples as indicated by a Chow test for structural breaks. Results indicate that window guid- ance has played an important role in Chinese monetary policymaking in the period up to the Global Financial Crisis. Since then, the interbank overnight rate appears to have become more influential and exogenous. The study concludes by providing suggestions for further strengthening this interest rate channel, the stated goal of the People’s Bank of China.