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Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
The Effectiveness of Monetary Policy in China:
Evidence from a Qual VAR
Hongyi Chen1 Kenneth Chow1 Peter Tillmann2
1Hong Kong Institute for Monetary Research
2University of Giessen, Germany
HKIMR
October 2015
Chen, Chow, Tillmann Monetary Policy in China HKIMR 1 / 30
September 2016
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Motivation
• Understanding Chinese monetary policy becomes increasingly more
important.
• At the same time, the policy framework is not straightforward to
model using conventional models.
• The PBoC uses more than one instrument to implement policy:
• Makes standard VARs not suitable.
• Difficult to quantify the effect of the overall policy stance.
• Here we propose a Qual VAR to model Chinese monetary policy:
• A latent variable filtered out of the data summarized the policy stance.
• The model retains the usefulness of standard monetary policy VARs.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 2 / 30
summarizes
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
• We use Dueker’s (2005) Qual VAR: Include binary information on
policy announcements in an otherwise standard VAR.
• The binary policy announcements are interpreted as realizations of a
latent, unobservable pressure for policy tightening or easing,
respectively.
• Advantages:1 Handles the multitude of different instruments: RRR, lending rates,
deposit rates, ...2 Acknowledges the endogenous nature of policy steps by allowing for a
feedback of the business cycle on policy.3 Identifies the shock component of policy using sign restrictions.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 3 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Literature
• Two recent papers are particularly related to what we do.1 He and Pauwels (2008):
I Code tightening/easing actions implemented by different instruments
as a -1/ 0/ +1 series.
I Estimate a discrete choice model.
I Show that the reaction function of the PBoC is a function of the
inflation and money gap, but not the output gap.
2 Fernald, Spiegel and Swanson (2014):
I Estimate a Factor-augmented VAR model robustify results despite
concerns about data quality.
I A shock to RRR or policy-determined interest rates is transmitted in a
way that similar to advanced economies.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 4 / 30
is similar to advanced economies.
Estimate a Factor-augmented VAR model in order to handle concerns
about data quality and structural change.
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
The Qual VAR
• Suppose we observe a binary dependent variable, yt ∈ {0,1}, driven by
a continuous latent variable y∗
yt =
{
0
1
if y∗t ≤ 0
if y∗t > 0(1)
• A Qual VAR puts an equation that relates the latent variable to
observables into a VAR system.
• A Qual VAR with k variables and p lags can be written as
Φ(L)Yt = µ + εt (2)
where
Yt =
(
Xt
y∗t
)
(3)
consists of macroeconomic data, Xt, and the latent variable, y∗t .
• The latent variable is estimated using MCMC techniques.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 5 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
• Dueker (2005) shows that Gibbs sampling enables the joint estimation
of the VAR coefficients, Φ, the covariance matrix of the VAR
residuals, Σ, and the latent variable, y∗t .
• Distributional assumptions:1 The VAR coefficients, Φ, are normally distributed with the mean and
the variance given by the OLS estimates.2 For the covariance matrix, Σ, an inverted Wishart distribution is
assumed.3 The latent variable, y∗, that is required to be positive whenever yt is
equal to one, is said to follow a truncated normal distribution.
• We do 10,000 draws, from which the first 2,000 are discarded.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 6 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Data
• We estimate the Qual VAR on monthly data from 1999:01 to 2015:07.
• The following y-o-y growth rates are included in Xt:1 industrial production.2 CPI.3 real consumption4 stock prices.
• Alternatively, we include the y-o-y growth of1 loans to non-financials.2 house prices.
• Most growth rates exhibit a low-frequency trend. We believe this
reflects structural developments and detrend the variables with a
three-year moving average.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 7 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
• We model tightening and easing steps in separate models, a tightening
model and an easing model.
yt,i =
{
0
1
if y∗t,i ≤ 0
if y∗t,i > 0for i ∈ {tight, ease}
• The two alternative variables should be interpreted as reflecting
tightening and easing pressure relative to a neutral stance.
• Separate tightening and easing estimates shed light on asymmetry of
policy transmission.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 8 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
date RRR Lending Rate Dep. Rate date RRR Lending Rate Dep. Rate
2003/09 +1.00 2008/01 +0.502004/04 +0.50 2008/03 +0.502004/10 +0.37 +0.27 2008/04 +0.502006/04 +0.27 2008/05 +0.502006/07 +0.50 2008/06 +1.002006/08 +0.50 +0.27 +0.27 2010/01 +0.502006/11 +0.50 2010/02 +0.502007/01 +0.50 2010/05 +0.502007/02 +0.50 2010/10 +0.25 +0.252007/03 +0.27 +0.27 2010/11 +1.002007/04 +0.50 2010/12 +0.50 +0.25 +0.252007/05 +0.50 +0.18 +0.27 2011/01 +0.502007/06 +0.50 2011/02 +0.50 +0.25 +0.252007/07 +0.27 +0.27 2011/03 +0.502007/08 +0.50 +0.18 +0.27 2011/04 +0.50 +0.25 +0.252007/09 +0.50 +0.27 +0.27 2011/05 +0.502007/10 +0.50 2011/06 +0.502007/11 +0.50 2011/07 +0.25 +0.252007/12 +1.00 +0.18 +0.27
Tightening steps of the PBoC
Chen, Chow, Tillmann Monetary Policy in China HKIMR 9 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
date RRR Lending Rate Dep. Rate date RRR Lending Rate Dep. Rate
1999/06 -0.54 -1.53 2012/05 -0.501999/11 -2.00 2012/06 -0.25 -0.252002/02 -0.54 -0.27 2012/07 -0.31 -0.252008/09 -0.25 -0.27 2014/11 -0.40 -0.252008/10 -0.50 -0.54 -0.54 2015/02 -0.502008/11 -1.08 -1.08 2015/03 -0.25 -0.252008/12 -1.75 -0.27 -0.27 2015/04 -1.002011/12 -0.50 2015/05 -0.25 -0.252012/02 -0.50 2015/06 -0.25 -0.25
Easing steps of the PBoC
Chen, Chow, Tillmann Monetary Policy in China HKIMR 10 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Identification
• To identify a monetary policy shock, we impose sign restrictions
following Uhlig (2005).
model latent variables ∆IP ∆CPI ∆Cons ∆StockP
tightening + - - unrestricted
easing + + + unrestricted
• The restrictions are imposed for t = 1, ...4.
• We also report Fry-Pagan median-target responses.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 11 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Results
� � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �� � �� �� � �� �� � �� �� � �� �� �� �� ��� ��� ��� �� �
� � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �� � �� �� � �� �� �� �� ��� ��� �Latent tightening (left) and easing (right) pressure for the baseline model
Chen, Chow, Tillmann Monetary Policy in China HKIMR 12 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions� � � � �� � � � � � ��� � � � � � � � � �� �� � ��� � ��� � ��� � ��� � �� � � �
� � �� � �� � � �� � �� ! � � � �� � � � � � � � � �� �� " �� �� # �� �� � ��� � ��� � �
$ � � �� % � �� � ! �� � � � � � � � � �� �� � �� �� � ��� � ��� � ��� � �
$ � � �� % � � � � �� � � � � � � � � �� �� � �� �� � �� �� � ��� � ��� � �
& � � ! ' �� � ! �� � � � � � � � � �� �� � ��� � ��� � �� �� � �� �� � �
Response to PBoC tightening in the baseline model
Chen, Chow, Tillmann Monetary Policy in China HKIMR 13 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions() *+ , * -. / 0 + , 1 2 *34 5 6 4 6 5 7 4 7 58 49 7 549 4 449 7 549 5 449 : 56 9 4 4; , <= 1 *. 2 ) > -. / < = ? * 2 / ,4 5 6 4 6 5 7 4 7 58 49 @ 48 49 7 449 4 449 7 449 @ 4
A / , 1= B + . -. 2 ? + 14 5 6 4 6 5 7 4 7 58 49 7 449 4 449 7 449 @ 4
A / , 1= B 0 * 2 / ,4 5 6 4 6 5 7 4 7 58 49 5 48 49 7 549 4 449 7 549 5 4C * / ? D -. 2 ? + 14 5 6 4 6 5 7 4 7 58 5 9 4 44 9 4 45 9 4 46 4 9 4 46 5 9 4 4Response to PBoC easing in the baseline model
Chen, Chow, Tillmann Monetary Policy in China HKIMR 14 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
� � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �� � �� � �� �� �� �� ����� � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � �� � �� � �� � �� � �� ���Latent tightening (left) and easing (right) pressure for the model with loans
Chen, Chow, Tillmann Monetary Policy in China HKIMR 15 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions() *+ , * -. / 0 + , 1 2 *34 5 6 4 6 5 7 4 7 58 49 7 549 4 449 7 549 5 449 : 56 9 4 4; , <= 1 *. 2 ) > -. / < = ? * 2 / ,4 5 6 4 6 5 7 4 7 58 49 @ 48 49 7 449 4 449 7 4
A / , 1= B + . -. 2 ? + 14 5 6 4 6 5 7 4 7 58 49 7 48 49 6 449 4 449 6 449 7 4
( /) , 14 5 6 4 6 5 7 4 7 58 49 5 449 4 449 5 46 9 4 46 9 5 4C * / ? D -. 2 ? + 14 5 6 4 6 5 7 4 7 58 5 9 4 44 9 4 45 9 4 46 4 9 4 4
Response to PBoC tightening in the model with loans and stock prices
Chen, Chow, Tillmann Monetary Policy in China HKIMR 16 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions() *+ , * -. / 0 + , 1 2 *34 5 6 4 6 5 7 4 7 58 49 7 549 4 449 7 549 5 449 : 56 9 4 4; , <= 1 *. 2 ) > -. / < = ? * 2 / ,4 5 6 4 6 5 7 4 7 58 49 @ 48 49 7 449 4 449 7 449 @ 449 E 4
A / , 1= B + . -. 2 ? + 14 5 6 4 6 5 7 4 7 58 49 7 449 4 449 7 449 @ 4
( /) , 14 5 6 4 6 5 7 4 7 58 6 9 5 48 6 9 4 48 49 5 449 4 449 5 4C * / ? D -. 2 ? + 14 5 6 4 6 5 7 4 7 58 5 9 4 44 9 4 45 9 4 46 4 9 4 46 5 9 4 47 4 9 4 4
Response to PBoC easing in the model with loans and stock prices
Chen, Chow, Tillmann Monetary Policy in China HKIMR 17 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions() *+ , * -. / 0 + , 1 2 *34 5 6 4 6 5 7 4 7 58 49 7 549 4 449 7 549 5 449 : 56 9 4 4; , <= 1 *. 2 ) > -. / < = ? * 2 / ,4 5 6 4 6 5 7 4 7 58 49 F 48 49 7 48 49 6 449 4 449 6 449 7 4
A / , 1= B + . -. 2 ? + 14 5 6 4 6 5 7 4 7 58 49 7 48 49 6 449 4 449 6 4
( /) , 14 5 6 4 6 5 7 4 7 58 49 5 449 4 449 5 46 9 4 46 9 5 4G /= 1 + -. 2 ? + 14 5 6 4 6 5 7 4 7 58 79 4 48 6 9 5 48 6 9 4 48 49 5 449 4 449 5 4
Response to PBoC tightening in the model with loans and house prices
Chen, Chow, Tillmann Monetary Policy in China HKIMR 18 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions() *+ , * -. / 0 + , 1 2 *34 5 6 4 6 5 7 4 7 58 49 5 449 4 449 5 46 9 4 4; , <= 1 *. 2 ) > -. / < = ? * 2 / ,4 5 6 4 6 5 7 4 7 58 49 @ 48 49 7 449 4 449 7 449 @ 4
A / , 1= B + . -. 2 ? + 14 5 6 4 6 5 7 4 7 58 49 7 449 4 449 7 449 @ 4
( /) , 14 5 6 4 6 5 7 4 7 58 6 9 5 48 6 9 4 48 49 5 449 4 449 5 4G /= 1 + -. 2 ? + 14 5 6 4 6 5 7 4 7 58 79 4 48 6 9 5 48 6 9 4 48 49 5 449 4 449 5 4
Response to PBoC easing in the model with loans and house prices
Chen, Chow, Tillmann Monetary Policy in China HKIMR 19 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
A Conventional VAR
• How large is a one-standard deviation shock in the latent variable?
• For comparative purposes, we transform the Qual VAR into a VAR
with RRR as the policy instrument.
• All other aspects (restrictions, variables, sample, ...) remain
unchanged.
• When scaled by the response of ∆IP we find that a latent easing shock
is equivalent to a 0.20pp cut in RRR.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 20 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness ConclusionsH + I= 2 . + < H + 1 + . J + H) * 2 /4 5 6 4 6 5 7 4 7 58 49 F 48 49 7 48 49 6 449 4 449 6 4; , <= 1 *. 2 ) > -. / < = ? * 2 / ,4 5 6 4 6 5 7 4 7 58 49 7 549 4 449 7 549 5 449 : 5
A / , 1= B + . -. 2 ? + 14 5 6 4 6 5 7 4 7 58 49 7 449 4 449 7 449 @ 4
A / , 1= B 0 * 2 / ,4 5 6 4 6 5 7 4 7 58 49 5 48 49 7 549 4 449 7 549 5 449 : 5C * / ? D -. 2 1 + 14 5 6 4 6 5 7 4 7 58 6 49 4 48 59 4 449 4 459 4 46 49 4 46 59 4 4
Shock to Required Reserve Ratio in conventional VAR
Chen, Chow, Tillmann Monetary Policy in China HKIMR 21 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Robustness
• Concerns about the quality of Chinese macro data.
• Famously, Li Keqiang, then party secretary in the Liaoning province,
suggested measuring real activity using electricity consumption, new
bank loans and cargo freight volume.
• We construct a pseudo Li-Keqiang-index from electricity and freight
volume (normalized series, average of electricity and freight, in y-o-y
growth rates).
• The baseline results remain unchanged. Again, we find a strong effect
on real activity.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 22 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
K L L L M N N K M N N O M N N P M N N Q M N N L M N K K M N K O M N K PPR NQR PK NR NK MR PK PR NK QR PM NR N
S NR OS NR MS NR KNR NNR KNR MNR ONR TU V W X Y Z [ \ ]̂ _ [̀ W X a Z \̀ V b̂ c d Z Y a ]̂ c ef \ g c h \ ] V i \ V W c jGrowth of industrial production and pseudo Li-Kequiang-index
Chen, Chow, Tillmann Monetary Policy in China HKIMR 23 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions() *+ , * -. / 0 + , 1 2 *34 5 6 4 6 5 7 4 7 58 49 5 449 4 449 5 46 9 4 4( 2 k + I 2 ) , l ; , < + m4 5 6 4 6 5 7 4 7 58 49 4 449 4 449 4 449 4 649 4 649 4 6
A / , 1= B + . -. 2 ? + 14 5 6 4 6 5 7 4 7 58 49 7 48 49 6 449 4 449 6 449 7 449 F 4
A / , 1= B 0 * 2 / ,4 5 6 4 6 5 7 4 7 58 49 7 549 4 449 7 549 5 449 : 56 9 4 4C * / ? D -. 2 ? + 14 5 6 4 6 5 7 4 7 58 6 49 4 48 59 4 449 4 459 4 46 49 4 4
Response to PBoC easing in the model with Li Keqiang index of economic activity
Chen, Chow, Tillmann Monetary Policy in China HKIMR 24 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
• An experiment: Is the monetary transmission different between
state-owned and shareholder-owned firms?
• We substitute industrial production by the change in value added by
these two firm types.
• The transmission of policy shocks is indeed highly different: after a
tightening state-owned firms suffer less, after an easing they benefit
more.
• Certainly an interesting topic for a separate paper.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 25 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusionsno pq r s t t r t uv wo w rx y z { r t |} ~ � } � ~ � } � ~� �� ~ }� �� } }� }� ~ }}� } }}� ~ } no pq r s t t r t uv � o � r � y p t � { � r { w r � � � � v r |} ~ � } � ~ � } � ~� � � ~ }� � � } }� }� ~ }}� } }}� ~ }
no pq r s t t r t uv wo w rx y z { r t |} ~ � } � ~ � } � ~� }� ~ }}� } }}� ~ }�� } } no pq r s t t r t uv � o � r � y p t � { � r { w r � � � � v r |} ~ � } � ~ � } � ~� }� ~ }}� } }}� ~ }� � } }
Chen, Chow, Tillmann Monetary Policy in China HKIMR 26 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Conclusions
• We proposed a Qual VAR to model Chinese monetary policy:
• Summarizes the policy stance by a latent variable.
• Allows policy to be analyzed in a VAR framework - with all the
advantages of a VAR over alternative models, e.g. focuses on
unexpected shocks, facilitates a comparison with advanced countries’
policy framework, ...
• Sheds light on the asymmetry of the transmission process.
• Main findings:1 The monetary transmission to output and inflation is similar to
Western economies - despite less developed financial system and weak
institutions.2 A monetary tightening lacks grip on asset prices - which raises financial
stability concerns.
Chen, Chow, Tillmann Monetary Policy in China HKIMR 27 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Additional slides
Chen, Chow, Tillmann Monetary Policy in China HKIMR 28 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions; , < = 1 *. 2 ) > -. / <= ? * 2 / , � 2 , � 0� ) � �6 � � � 7 4 4 6 7 4 4 F 7 4 4 5 7 4 4 : 7 4 4 � 7 4 6 6 7 4 6 F 7 4 6 559 4 46 49 4 46 59 4 47 49 4 4A / , 1= B + . -. 2 ? + 1 � 2 , � 0� ) � �4 7 5 5 4 : 5 6 4 4 6 7 5 6 5 4 6 : 58 79 5 449 4 479 5 459 4 4:9 5 46 49 4 4
( /) , 1 � 2 , � 0� ) � �4 7 5 5 4 : 5 6 4 4 6 7 5 6 5 4 6 : 549 4 46 49 4 47 49 4 4F 49 4 4@ 49 4 4
H + ) > A / , 1= B 0 * 2 / , � 2 , � 0� ) � �6 � � � 7 4 4 6 7 4 4 F 7 4 4 5 7 4 4 : 7 4 4 � 7 4 6 6 7 4 6 F 7 4 6 55 9 4 46 4 9 4 46 5 9 4 47 4 9 4 47 5 9 4 4C * / ? D -. 2 ? + 1 � 2 , � 0� ) � �6 � � � 7 4 4 6 7 4 4 F 7 4 4 5 7 4 4 : 7 4 4 � 7 4 6 6 7 4 6 F 7 4 6 58 6 4 49 4 449 4 46 4 49 4 47 4 49 4 4F 4 49 4 4
G /= 1 + -. 2 ? + 1 � 2 , � 0� ) � �6 � � � 7 4 4 6 7 4 4 F 7 4 4 5 7 4 4 : 7 4 4 � 7 4 6 6 7 4 6 F 7 4 6 58 7 49 4 48 6 49 4 449 4 46 49 4 47 49 4 4F 49 4 4Growth rates (red) and three-year moving average (dotted)
Chen, Chow, Tillmann Monetary Policy in China HKIMR 29 / 30
Motivation Literature The Qual VAR Data Results Conventional VAR Robustness Conclusions
Financial Times, September 29 2015
Chen, Chow, Tillmann Monetary Policy in China HKIMR 30 / 30
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