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What Prompts the People’s Bank of China to Change its Monetary Policy Stance—Evidence from a Discrete Choice Model By Dong He and Laurent L. Pauwels Research Department Hong Kong Monetary Authority Abstract In Mainland China, the monetary policy stance of the People’s Bank of China (PBC) is not observed explicitly even though it makes annual announcements of indicative targets on monetary aggregates. In this paper, we model the PBC’s implicit policy stance as a latent variable, and changes in the reserve requirement ratio, policy interest rates, and the scale of open market operations are taken as signals of movement of this latent variable. We run a discrete choice regression that relates these observed indicators of policy stance to major trends of macroeconomic and financial developments, which are represented by common factors extracted from a large number of variables. The predicted value of the estimated model can then be interpreted as the implicit policy stance of the PBC. In the second step, we explain the variations of the PBC’s policy stance by measures of its policy objectives on inflation, growth, and financial stability. We find that deviations of CPI inflation from an implicit target and deviations of broad money growth from the announced targets figured significantly in PBC’s policy changes, but not output gaps. Keywords: Monetary policy, the People’s Bank of China, factor models, discrete choice models JEL Codes: E52, E58, C25, C32