Download Experimental Study on China’s Interest Rate Policy Output Effect

Experimental Study on China’s Interest Rate Policy Output Effect
TANG Anbao LI Yan
School of Management, China University of Mining and Technology, Xuzhou, P.R.China, 221116
Abstract: This paper applies regression analysis and Granger test to make an empirical analysis on
China’s interest rate policy output effect and its transmission effect. The conclusion is China’s interest
rate policy output effect does exist, but the effect is weak on the whole. Nominal interest rate output
effect hardly exists, while there is evident negative correlation and causality between real interest rate
and output. China’s interest rate policy output effect is weak because the transmission pathway of
interest rate and output is obstructed. It is mainly reflected as investment and consumption is not
influenced sensitively by the change of interest rate, and the transmission effect of interest rate change is
not so good. Comparatively, the transmission effect of the change of interest rate (especially real interest
rate) is more evident.
Keywords: Interest rate, Output effect, Transmission effect
1 Introduction
Interest rate policy is the guiding principle and measure the monetary authorities takes to control
interest rate for specialized macro-economic goal, and it is an important part of the monetary policy.
Whether interest rate policy can improve economic growth depends on whether the interest rate and the
output has the interactive relation as positive correlation or negative correlation in one country’s
economic operation, which means interest rate policy has the output effect.
The study on the relation between interest rate and output from the aspect of interest rate policy,
including theoretical debate and empirical test, mainly focuses on that interest rate influences output.
Fuhrer& Moore（1995）studied the data of America from 1965 to 1994 with simplified empirical method
and found that short-term nominal interest rate and real output has the negative correlation. It is also
verified that the relation between interest rate and output as IS-LM model describes exists. Levy&
Halikias(1997) described the transmission mechanism interest rate influences output under Dual-Assets
model and thought after the central bank increases interest rate, with asset restructure of commercial
banks and families, real interest rate of capital market increases, which makes investment and durable
consumer goods expenditure decrease and real output decrease. McKinnon and Shaw' (1973) thought
interest rate’s influence on output depends on development of financial market and financial system. In
developing countries there exists financial depression and real interest rate and economic growth
changes in the same direction. In developed countries, interest rate and output changes reversely. Alan
Gelb（1989）made a study of 34 underdeveloped countries and found that real interest rate and output has
the strong positive correlation.
Since 1996, China has applied interest rate policy to control and regulate economy frequently. The
study on interest rate policy output effect in our country has developed thoroughly. Zeng Xianjiu(2001)
applied the data of China from 1978-1998 to make an empirical analysis on the relation between China’s
interest rate and output and verified that China’s interest rate has output effect at some degree. Xie Ping
(2003) made an empirical study on China’s interest rate effect in
the past ten years with empirical
method and found that the predicting ability of real interest rate on nominal and real output is evidently
higher than other financial variables. Qian Shuitu(2004) made an empirical analysis under the
hypothesis of financial regulation with the viewpoint of Ronald MacKinnon and Edward Shaw and
verified that China’s nominal interest rate has no relation with GDP increase rate but real interest rate
has a pulling effect on economic growth.
The studies above lay a foundation or offer a reference to test China’s interest rate policy output
effect and transmission effect, but an accordant conclusion has not been made. The interest rate
regulation in China and high level of interest rate marketization must influence interest rate policy
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output effect and its transmission mechanism differently. The high saving rate existing in China for a
long time and financial depression common in developing countries are different significantly. Thus, to
make empirical study on China’s interest rate policy output effect and transmission effect with new data
will have an important realistic meaning. This paper will make empirical analysis on China’s interest
rate policy output effect from the two aspects of the relation between interest rate and output and
transmission pathway of interest rate policy, estimate China’s interest rate policy output effect and find
the reason from transmission pathway. All the tests are operated with EVIEWS.
2 Empirical Analysis on the Relation between China’s Interest Rate Policy and
Output
11
11
10
10
9
9
GDPG
GDPG
2.1 Qualitative Description
Make GDPG represent GDP increase rate, RR represent real loan interest rate and NR represent
nominal loan interest rate. Apply the annual data of one-year nominal loan interest rate，real loan interest
rate，GDP increase rate from 1985 to 2005 and the quarterly data of them from 1996 to 2005 to make a
qualitative analysis of interest rate and output.(Qualitative Analysis: Data comes from China Statistics
Yearbooks, China Labor Statistics Yearbook 2005, The People’s Bank of China’s Annual Report 2004
and PRC Statistic Bureau Website. Variable Description: China’s CPI increase rate represents inflation
rate; yearly loan interest rate comes from the weighted average of monthly loan interest rate; real loan
interest rate= nominal loan interest rate- inflation rate).
From the annual data from 1985 to 2005, when real loan interest rate is approaching zero, even
negative, GDP increase rates are all high, more than 10%; when real loan interest rate is higher, GDP
increase is evidently becoming slow. The correlation between nominal loan interest rate and GDP is
weak, and their change trend in the same direction is more evident after 1991. Also, Figure 1 and Figure
2 show that GDP increase rate and real loan interest rate have the strong reverse change trend while
GDP increase rate and nominal loan interest rate have the weak change trend in the same direction.
8
7
8
7
6
6
0
2
4
6
8
10
RR
4
6
8
10
12
14
NR
Figure 1 Scatter diagram of GDP increase rate with nominal loan interest rate and real loan interest rate
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14
12
10
8
6
4
2
0
96
97
98
99
NR
00
01
RR
02
03
04
05
GDP G
Figure 2 Tread Graph of GDP increase rate (GDPG) with real loan interest rate (RR) and nominal loan
interest rate (NR)
2.2 Regression Analysis
2.2.1 Nominal Interest Rate and Output
Make NR represent one-year current capital nominal loan interest rate, RR represent one-year current
capital real loan interest rate, GDPG represent GDP increase rate, GDPG(-t) represent GDP with t-stage
lag, NR(-t) represent NR with t-stage lag and RR(-t) represent RR with t-stage lag. Apply quarterly data
of the relative variables from the first quarter in 1996 to the fourth quarter in 2005 and make regression
analysis on the relation between nominal interest rate and output.
Make unitary regression analysis on GDP increase rate and nominal interest rate. The result is:
GDPG=7.519+0.155NR
14.219
2.071
（
）（
2
）
2
R = 0.101 R =0.078 D-W=0.406 F=4.288
It can be thought that linear relation of GDP increase rate and nominal interest rate exists, but the
correlation is weak.
Then survey the nominal interest rate’s lagging effect on GDP with nominal interest rate lagging one
to four stages respectively. Through regression analysis, from one-stage lag, nominal interest rate and
GDP increase rate has the negative or weak positive correlation, and the current stage nominal interest
rate makes the biggest effect on GPD increase, with change in the same direction. The interest rate
policy output effect is more evident with two-stage lag and the correlation coefficient is significant.
2.2.2 Real Interest Rate and Output
Make unitary regression analysis on real increase rate and output. The result is:
GDPG=10.192-0.313RR
（36.482） （-6.304）
R 2 = 0.511
R 2 =0.498
D-W=0.758
F=39.736
On each level of α, t-test is passed and there is linear correlation between GDP increase rate and
real interest rate which is more significant than nominal interest rate. Survey the real interest rate’s
lagging effect on GDP with real interest rate lagging one to five stages respectively. Through regression
analysis it is found that the influence of real interest rate with current stage and four-stage lag on output
is more significant.
2.3 Granger Test
From the regression analysis above we find that interest rate (especially real interest rate) and output
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is correlated, but the regression analysis cannot identify their causality. In order to test whether interest
rate is a factor that influences output, this section adopts Granger test to analyze the sequence of relative
variables from the first quarter in 1996 to the fourth quarter in 2005.
Granger test is a method to test the causality of economic variables with statistical technology and its
basic principle is to make use of time difference and hysteretic effect that economic relationships
develop the effect and estimate the existence and the direction of causality on the base of significance
degree that the prior index of economic variables explain and influence the corresponding indexes.
Granger test on time sequence requires that the relative data sequence is stationary. In reality, most time
sequences are not stationary, so they should be changed to stationary sequence through difference data
before Granger test.
2.3.1 Stationary Test of Sequence
This paper adopts Augmented Dickey-Fuller Test of unit root to test stationary of sequence and test
whether the difference time series of zero to M-order is stationary sequence. If there is no unit root for
the sequence after d-order difference, the sequence is called d-order integrated time sequence or I (d)
sequence. The ADF test results for each variable sequence are shown in Table 1.
Table 1 ADF Test Results for Each Variable Sequence from Quarter 1 in 1996 to Quarter 4 in 2005
Test Form
ADF Test
Critical
Critical
Critical
Variables
Statistic
Value at 1% Value at 5% Value at 10%
Conclusion
C T L
Level
Level
Level
Unit Root
-2.6069
-2.9378
-3.6067
-2.1455
GDPG
C 0 0 ①
No
Unit Root
-2.6092
-2.9422
-3.6171
-4.7215
DGDPG
C 0 1
-2.6069
-2.9378
-3.6067
-5.2241
No Unit Root
NR
C 0 0
-2.6069
-2.9378
-3.6067
-1.5286
Unit Root
RR
C 0 0
-2.6092
-2.9422
-3.6171
-3.1517**
No Unit Root
DRR
C 0 1
（，，）
（ ，，）
（ ，，）
（ ，，）
（ ，，）
（ ，，）
①C in the bracket(C，T，L)means that there is constant term when testing unit root(c=0 means there is no constant
term).T means there is trend term(T=0 means there is no trend term).L means there is no lagging number of
autocorrelation for regression residuals and lagging number is confirmed by AIC criterion. *, **, *** represent
respectively there is no unit root at confidence level of 1%, 5% and 10%.
It is clear in Table 1: nominal interest rate sequence is I (0) sequence, and the sequence of real interest
rate and output is I (1) sequence.
2.3.2Ganger Test on Real Interest Rate and output
Because the integration orders of nominal interest rate and output are different, the reliability is not
strong if using Ganger test directly, and from the analysis result above, the correlation of nominal
interest rate and output is weak, so this paper just makes Ganger test on real interest rate and output
below.
The regression analysis above shows that real interest rate with four-stage lag makes the greatest
effect on output, but if lag length is too long the test result will be changed. So this paper chooses
distribution lag model with two-stage lag length to test it. And the result is shown in Table 2.
Table 2 Ganger Test Result on Real Interest Rate and Output
Null Hypothesis H0
Sample
Lagging
F Statistics
Order
RR does not Granger Cause GDPG
GDPG does not Granger Cause RR
38
38
2
2
3.5085
0.2223
Probability
0.0415
0.8018
It is shown in Table 2 that under the hypothesis “RR is not GDPG’s Granger Causality”, F=3.5085
with two-stage lag.
When significance level is beyond α=0.05, the critical value is 3.32, so test passes, and the hypothesis
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is not accepted, which means when confidence level of real interest rate is at 95.85%, it is output’s
Granger causality. This confirms that real interest rate influences output. But under the hypothesis
“GDPG is not RR’s Granger Causality”, F-test does not pass, which confirms that GDP increase rate is
not real interest rate’s Granger causality.
3 Empirical Analysis on the Transmission Effect of China’s Interest Rate Policy
Output Effect
Mainstream economics theory thinks the change of interest rate influences output through investment
and consumption, which means interest rate output effect is got mainly through the two transmission
pathways as investment and consumption. So whether the transmission effect is strong or weak
influences interest rate output effect directly.
3.1 Empirical Analysis on the Transmission Effect of the Change of Interest Rate on Investment
Whether interest rate is effective or not mainly depends on the Interest rate elasticity of investment. If
the change of interest rate can influence investment effectively, it can improve economic development.
The analysis on the relevance of investment and interest rate can test the transmission effect of the
change of interest rate on investment.
FI, RR, NR represent increase rate of social fixed assets investment, one-year real loan interest rate of
fixed assets, and one-year nominal loan interest rate of fixed assets. Apply annual data from 1985 to
2005 and the data comes from China Statistics Yearbooks, finance and economics database in colleges
and universities, The People’s Bank of China’s Quarterly Report.
3.1.1 Nominal Interest Rate and Fixed Assets Investment
Make regression analysis on nominal loan interest rate NR and increase rate of fixed assets
investment FI. The result is:
FI=22.862-0.269NR
1.823
-0.180
（
2
）（
）
2
R = 0.002 R =-0.051 D-W=0.924 F=0.033
T-test passes only when α=0.1, which means it almost does not exist linear relation between increase
rate of fixed assets investment and nominal loan interest rate, and the correlation is very weak..
Make regression analysis on nominal interest rate with one-stage lag and two-stage lag and increase
rate of fixed assets investment. The result is nominal interest rate of the previous stage influences fixed
assets investment of the current stage a lot. The coefficient is -0.624510, but the correlation is not
2
enough. R is only 0.009 and F statistics is only 0.170.
3.1.2 Real Interest Rate and Fixed Assets Investment
Make regression analysis on real interest rate RR and increase rate of fixed assets investment FI. The
result is:
FI=21.526-0.679RR
6.886
-1.324
（
2
）（
）
2
R = 0.084 R =0.036 D-W=1.081 F=1.753
T-test does not pass at the different fixed significance levels of α. So it is clear that the linear relation
of increase rate of fixed assets investment and real interest rate of the current stage is not evident
enough.
Investment of the current stage is usually influenced by investment of the previous stage, so the
influence of interest rate of the current stage on investment of the current stage seems to be very
important. Make regression analysis on real interest rate with continuous four-stage lag and the result is
real interest rate of the current stage influences fixed assets investment most and the influence decreases
when the time goes back. T-test of RR and RR(-1) passes only when α is at the level of 0.05 and 0.1, but
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it does not pass with other lag stage. So there is linear relation between real interest rate of the current
and previous stage and fixed assets investment, but the influence is relatively weak on the whole.
3.2 Empirical Analysis on the Transmission Effect of the Change of Interest Rate on Consumption
In theory, the change of interest rate can adjust consumption and this can enlarge the consumption
demand and stimulate production. Since 1996, China has decreased interest rate for eight times
continuously, which is to make use of interest lever to enlarge domestic demand and lead economic
development. But the practice has proved that the effect of the change of interest rate on consumption is
not evident enough. We can analyze the interrelation of interest rate and consumption from the aspect of
their correlation and test the transmission effect of the change of interest rate on consumption.
CG, HR, RR represent increase rate of the total retail amount of commodities, one-year nominal
deposit interest rate, one-year real deposit interest rate. Apply annual data of the relative variables from
1985 to 2005 and the data comes from China Statistics Yearbooks from 1989 to 2004, finance and
National Statistics Bureau Website of China.
3.2.1 Nominal Interest Rate and Consumption
Make regression analysis on one-year nominal deposit interest rate NR and increase rate of the total
retail amount of commodities CG. The result is:
CG=9.352+0.889 NR
2.662
1.810
（
）（
2
）
2
R =0.147 R =0.102 D-W=1.430 F=3.277
The coefficient of NR is positive, which proves that nominal interest rate of the current stage does not
2
have a guiding effect on consumption. Considering R , interest rate of the current stage influences
consumption little. Consumption is easily influenced by its previous stage level, so make regression
2
analysis with one or two-stage lag. The result is: R =0.197. Its value is still very small. Considering tstatistics from NR to NR (-2), all t-test does not pass. So it is clear that nominal interest rate has a little
or no effect on consumption.
3.2.2 Real Interest Rate and Consumption
Make regression analysis on one-year real deposit interest rate RR and increase rate of the total retail
amount of commodities CG. The result is:
CG=14.428-1.104RR
12.687
-5.077
（
）（
2
）
2
R =0.576 R =0.553 D-W=1.469 F=25.779
The coefficient of RR is negative, the same with theoretical analysis. T-test passes at the different
fixed significance levels of α. And the regression result is better. So real interest rate of the current stage
has some effect on consumption and decrease of real interest rate will promote increase of consumption.
To survey the impact of interest rate of the previous stage on consumption of the current stage, make
regression analysis on real deposit interest rate with one or two-stage and increase rate of the total retail
amount of commodities. The result is:
CG=13.605-1.424RR+0.499 RR(-1)-0.581 RR(-2)
13.291 -5.598
1.761
-2.293
（
2
）（
）（
）（
）
2
R =0.719 R =0.663 D-W=1.859 F=12.785
Considering the coefficient, the coefficient of interest rate of the current stage is -1.424, which means
it reverse impact on consumption is the greatest one comparing other two stages. Considering tstatistics from NR to NR (-2), all t-test passes and the significance of the current level is the greatest one.
From this we can get real interest rate has some reverse effect on consumption and real interest rate of
the current stage influences it most.
4 Conclusion and Implication
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4.1 China’s interest rate policy output effect does exist, which is the objective basis of using interest rate
lever to adjust economy, but the effect is weak on the whole.
4.2 Correlation between nominal interest rate and output is very weak, which proves that nominal
interest rate cannot play an important role in GDP increase and its output effect hardly exists. While
there is evident negative correlation and causality between real interest rate and output, which proves
real interest rate output effect does exist, but not very great. So the impact of inflation should be deeply
considered when using the change of interest rate to adjust micro-economy.
4.3 China’s interest rate policy output effect is weak because the transmission pathway of interest rate
and output is obstructed. It is mainly reflected as investment and consumption is not influenced
sensitively by the change of interest rate, and the transmission effect of interest rate change is not so
good. So to improve China’s interest rate policy output effect should focus on making the transmission
pathway of interest rate and output unimpeded.
4.4 Comparatively, the transmission effect of the change of interest rate (especially real interest rate) is
more evident. So the impact of interest rate change on consumption should be paid much attention when
carrying out interest rate policy, thus interest rate can play an important role in influencing consumption.
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The author can be contacted from e-mail : [email protected]
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