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Chinese Monetary Policy: Dual Shocks on a DualMarket
Makram El-Shagi and Lunan Jiang
Center for Financial Stability and Development
Research Seminar @ UniCamp
CFDSA T H E N A N U N I V E R S I T Y
Outline
1 Motivation
2 Institutional Background
3 Method
4 Results
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 1 / 26
Outline
1 Motivation
2 Institutional Background
3 Method
4 Results
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 2 / 26
MotivationMotivation
With the financial crises and interest rates hitting the zero lowerbound in the US and Europe there is renewed interest in
a how policy affects the entire yield curve rather than just the short endb how policy affects quantity measuresc whether CBs can and should tackle exuberance on (individual) asset
markets
Why is China special?a China has traditionally conducted a more involved monetary policyb China has traditionally emphasized quantity aggregates more stronglyc There is some concern about exuberance in the Chinese housing
market
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 3 / 26
MotivationOur contribution
We provide a model of Chinese monetary policy that accounts for ..the main instruments of Chinese monetary policyspecial features of the Chinese financial systemthe impact of monetary policy on the housing market (where themajority of Chinese savings goes to)
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 4 / 26
Outline
1 Motivation
2 Institutional Background
3 Method
4 Results
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 5 / 26
Institutional BackgroundChinese bond market
There are two institutionally separate bond markets in China, the interbankmarket and the exchange market that differ in a number of respects
participants (Major national commerical banks vs. small-medium-sizeinstitutional investors)trading rules (OTC vs. Exchange)regulation (PBoC vs. SEC)different corporate bondsPBoC conduct monetary policy in interbank market
But:Chinese government bonds are traded on both!
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 6 / 26
Institutional BackgroundChinese Treasury Bonds
Chinese treasury bonds are mainly issued and traded domesticallyThe maturity of treasury bonds includes 1-year, 3-year, 5-year, 7-year,10-year, and 50-yearChinese central government started only recently to issue treasurybonds on a regular frequency basis in order to pin down thebenchmark yield curves rather than meet fiscal needsPBoC now emphasizes the control of yield curves to improve themonetary transmission channels and coordinate its action onstabilizing exchange rates
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 7 / 26
Institutional BackgroundThe policy tools of PBoC
The People’s Bank of China has a very rich toolbox to implementmonetary policies, including:
reserve ratios and central bank billsopen market operation on treasury bonds, central bank bills, and evencorporate bondsrepo rate, discount rate, and relending rateliquidity facilities such as MLF,SLF and SLObenchmark loan and deposit rateswindow guidance and loan growth controlsspecial and differentiate reserve ratio
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 8 / 26
Institutional BackgroundBenchmark rate changes and open market operations
weeks
cum
ulat
ive
OM
O
−3 −2 −1 0 1 2 3 4 5 6 7 8 9 10 11 12
−10
000
−50
000
5000
1000
0
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 9 / 26
Outline
1 Motivation
2 Institutional Background
3 Method
4 Results
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 10 / 26
MethodStep 1: Estimating the yield curve - Basics
Our yield curve function follows the seminal work Nelson&Siegel 1987.
rt(τ) =[
1 1−e−λτ
τλ1−e−λτ
τλ − e−τλ] Lt
StCt
+ εt (1)
This specification explains yields of different maturities as a functionof three underlying parameters, usually level (L), slope (S) andcurvature (C) of the yield curveWhen τ goes to infinity, Lt represents the long-term yield; When τgoes to zero, Lt − St represents the short-term yield, and Ctdetermines where the hump is located
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 11 / 26
MethodStep 1: Estimating the yield curve - Basics
0 10 20 30 40
0.0
0.2
0.4
0.6
0.8
1.0
1.2
maturity
fact
or lo
adin
gs level
slope
curvature
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 12 / 26
MethodStep 1: Estimating the yield curve - Single market
Diebold et al. (2006) propose to assume an autoregressive process for theunderlying parameters.Then, equation 2 works as measurement equation of a state space modelwith the corresponding state equation 3:
rt(τ) =[
1 1−e−λτ
τλ1−e−λτ
τλ − e−τλ] Lt
StCt
+ εt (2)
LtStCt
=
µLµSµC
+ A
Lt−1St−1Ct−1
+ ηt . (3)
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 13 / 26
MethodStep 1: Estimating the yield curve - Single market
The restriction on the shock εt and ηt is as below:
VarCov(εtηt
)=[
R 00 Q
]=
r1 0 · · · 0 0 0 00 r2
......
... . . . 0 0 0 00 · · · 0 rM 0 0 00 0 0 q11 q12 q130 · · · 0 0 q21 q22 q230 0 0 q31 q32 q33
(4)
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 14 / 26
MethodStep 1: Estimating the yield curve - Dual market
measurement equation:
rib,t(τ1)rib,t(τ2)
...rib,t(τM)rex ,t(τ1)rex ,t(τ2)
...rex ,t(τM)
=[
Hib 00 Hex
]
Lib,tSib,tCib,tLex ,tSex ,tCex ,t
+[εib,tεex ,t
], (5)
andH(τi ) =
[1 1−e−λτi
τλ1−e−λτi
τλ − e−τiλ]
(6)
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 15 / 26
MethodStep 1: Estimating the yield curve - Dual market
state equation
Lib,tSib,tCib,tLex ,tSex ,tCex ,t
=[µibµex
]+[
A11 A12A21 A22
]
Lib,t−1Sib,t−1Cib,t−1Lex ,t−1Sex ,t−1Cex ,t−1
+[ηib,tηex ,t
], (7)
A11 and A22 respectively govern the dynamics of yield curve factors withinmarkets, and A12 and A21 govern the dynamics of yield curve factorsacross two market
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 16 / 26
MethodStep 1: Estimating the yield curve - Dual market
The restriction on the shock εt and ηt is as below:
VarCov(εtηt
)=
Rib 0 0 00 Rex 0 00 0 Qib,ib Qib,eX0 0 Qex ,ib Qex ,ex
(8)
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 17 / 26
MethodStep 1: Estimating the yield curve - Data
Data:The daily treasury bond yields series ranges from Jan 2008 to Dec2016 in WIND databasetwo kinds of weekly alignment, weekly average and Wednesdayobservationdiscretize the maturity from 0 to 10 year with a step 0.25, that is3-month, and interpolate the observed yieldsUnfortunately there are still missing observation given the fixedmaturity grids especially in the earlier part of period of interest (wehave to handle missing variables), because the central governmentdoes not issue bonds frequently enough
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 18 / 26
MethodStep 1: Estimating the yield curve - Equilibrium results
0 10 20 30 40
2.8
3.0
3.2
3.4
maturity
yiel
ds
Interbank
Exchange
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 19 / 26
MethodStep 2: The structural VAR
Recuced form estimated as LASSO VAR (similar to Bayesian VARwith slab and spike priors)Structural identification with blockwise recurse identification in thespirit of Christiano/Eichenbaum/Evans (1999)
macrobraterepo
liquidityfib,tfex ,t
t
=p∑
l=1Bl
macrobraterepo
liquidityfib,tfex ,t
t−p
+ Cεt , (9)
macro = [ip cpi hsales]T
liquidity = [loans m2]T
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 20 / 26
Outline
1 Motivation
2 Institutional Background
3 Method
4 Results
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 21 / 26
ResultsThe policy rates
0 10 20 30 40
0.0
0.2
0.4
0.6
months
irf
Repo shock on repo
0 10 20 30 40
−0.
10−
0.05
0.00
0.05
0.10
months
irf
Repo shock on loan rate
0 10 20 30 40
−0.
050.
000.
050.
100.
150.
200.
25
months
irf
Loan rate shock on repo
0 10 20 30 40
−0.
050.
000.
050.
10
months
irf
Loan rate shock on loan rate
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 22 / 26
ResultsBond market
0 10 20 30 40
−0.
050.
000.
050.
10
months
irf
Repo on 1yr IB
0 10 20 30 40
−0.
04−
0.02
0.00
0.02
0.04
0.06
0.08
months
irf
Repo on 10yr IB
0 10 20 30 40
−0.
010.
000.
010.
020.
030.
04
months
irf
Repo on 1yr EX
0 10 20 30 40
−0.
02−
0.01
0.00
0.01
0.02
0.03
months
irf
Repo on 10yr EX
0 10 20 30 40
−0.
020.
000.
020.
04
months
irf
Lrate on 1yr IB
0 10 20 30 40
−0.
02−
0.01
0.00
0.01
0.02
0.03
0.04
months
irf
Lrate on 10yr IB
0 10 20 30 40
−0.
010.
000.
010.
02
months
irf
Lrate on 1yr EX
0 10 20 30 40
−0.
005
0.00
00.
005
0.01
00.
015
0.02
0
months
irf
Lrate on 10yr EX
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 23 / 26
ResultsMacro economy
0 10 20 30 40
−0.
002
0.00
00.
002
0.00
4
months
irf
Repo on GDP
0 10 20 30 40
−0.
001
0.00
00.
001
0.00
20.
003
0.00
4
months
irf
Repo on CPI
0 10 20 30 40
−0.
004
−0.
002
0.00
00.
002
months
irf
Repo on M2
0 10 20 30 40
−0.
003
−0.
002
−0.
001
0.00
00.
001
months
irf
Lrate on GDP
0 10 20 30 40
−1e
−03
−5e
−04
0e+
005e
−04
months
irf
Lrate on CPI
0 10 20 30 40
−0.
004
−0.
003
−0.
002
−0.
001
0.00
00.
001
months
irf
Lrate on M2
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 24 / 26
ResultsHousing and loans
0 10 20 30 40
−0.
020
−0.
015
−0.
010
−0.
005
0.00
00.
005
0.01
0
months
irf
Repo on Loans
0 10 20 30 40
−0.
006
−0.
004
−0.
002
0.00
00.
002
months
irf
Repo on Real estate
0 10 20 30 40
−0.
025
−0.
020
−0.
015
−0.
010
−0.
005
0.00
00.
005
months
irf
Lrate on Loans
0 10 20 30 40
−0.
004
−0.
002
0.00
00.
002
months
irf
Lrate on Real estate
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 25 / 26
THANK YOU!
El-Shagi/Jiang (CFDS@HenU) Chinese MP: 2x2 09/10/2018 26 / 26
