Professor of Economics
Measuring China's Economy; Dynamic Factor Model; Factor-Augmented VAR; Monetary Policy
The authors use a broad set of Chinese economic indicators and a dynamic factor model framework to estimate Chinese economic activity and inflation as latent variables. The authors incorporate these latent variables into a factor-augmented vector autoregression (FAVAR) to estimate the effects of Chinese monetary policy on the Chinese economy. A FAVAR approach is particularly well-suited to this analysis due to concerns about Chinese data quality, a lack of a long history for many series, and the rapid institutional and structural changes that China has undergone.The authors find that increases in bank reserve requirements reduce economic activity and inflation, consistent with previous studies. In contrast to much of the literature, however, they find that central-bank determined changes in Chinese interest rates also have substantial impacts on economic activity and inflation, while other measures of changes in credit conditions, such as shocks to M2 or lending levels, do not once other policy variables are taken into account.Overall, results indicate that the monetary policy transmission channels in China have moved closer to those of Western market economies.