Since Taylor's (1993)1 landmark contribution, researchers have made numerous attempts to devise simple decision rules to aid a central bank in gauging its policy actions. These rules assume that the central bank's policy interest rate depends on a few economic variables, eg the gaps between observed and targeted inflation rates and between potential and actual output. Although it is not possible to reduce central bank behaviour to such a simple equation, these rules can be quite useful in analysing policy and in communicating it to the general public. While many studies on monetary policy rules focus on the developed OECD countries, recent years have also witnessed some efforts at estimating various monetary policy rules for developing countries.
A number of research projects are under way at the BOFIT. In these projects monetary policy rules will be estimated for the major emerging economies. In a recent study, Tuuli Koivu, Aaron Mehrotra and Riikka Nuutilainen examine China's monetary policy using McCallum's (1988)2 monetary policy rule. The McCallum rule is based on control of the monetary base, which is set in accord with the gap between targeted and actual growth rates of nominal aggregate output. The rule is used to model central bank behaviour, especially where the money stock still plays a key role in the conduct of monetary policy.
China's central bank (People’s Bank of China, PBC) sets annual targets for the growth of two monetary aggregates and, in certain years, for credit growth. The PBC has controlled the money supply via reserve requirements and lending to commercial banks, as well as market liquidity via open market operations. In contrast, there has been a gradual freeing of interest rates, which have not had a significant influence on companies' investment decisions or commercial banks' behaviour. Officials have also tried to influence commercial bank lending by issuing specific rules.
The results of the study indicate that in China growth of the monetary base has behaved very much in line with McCallum's monetary policy rule. Toward the end of the 1990s monetary policy was somewhat tight compared to the rule, so that China experienced a brief spell of deflation. The study also employs deviations of actual money growth from the rule-determined growth rate (surplus money) to forecast China's inflation rate. Test results suggest that surplus money generally improves forecast accuracy compared to naive inflation forecasts, based solely on prior inflation rates. These results are however dependent on the particular forecast period, especially as regards consumer prices. On the other hand, surplus money generally improves the forecasts of wholesale (corporate goods) prices, regardless of the forecast period. The study finally takes up the possibility of using the McCallum rule to identify monetary policy shocks. Here, the tool of choice is a structural vector autoregressive model. Testing indicates that, for the Chinese economy, monetary expansion in excess of the McCallum rule prescription leads to growth of nominal GDP. In general, the study suggests that monetary policy rules based on the money stock may be useful in analysing China's monetary policy.
1 Taylor, John B. (1993): Discretion versus Policy Rules in Practice, Carnegie-Rochester Conference Series on Public Policy 39, 195-214
2 McCallum, Bennett T. (1988): Robustness Properties of a Rule for Monetary Policy, Carnegie-Rochester Conference Series on Public Policy 29 (Autumn), 173-203 |