China’s Monetary Policy and Interest Rate Liberalization: Lessons from International Experiences

May 1, 2014

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Wei Liao, and Sampawende J Tapsoba. China’s Monetary Policy and Interest Rate Liberalization: Lessons from International Experiences, (USA: International Monetary Fund, 2014) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

China has been moving to a more market oriented financial system, which has implications for the monetary policy environment. The paper investigates the stability of the money demand function (MDF) in light of progress in financial sector reforms that, for example, have resulted in significant financial innovation (so-called shadow banking) and more liberalized interest rates. The analysis of international experience suggests that rapid development of the financial system often leads to structural shifts in the MDF. For example, financial innovation and liberalization alter the sensitivity of money balances to income and the interest rate. For China, we find that the stable long-run relationship between money demand, output, and interest rates that existed between 2002 and 2008 disappears after 2008. This coincides with the period of rapid financial innovation, especially the growth in off-balance sheet and nonbank financial intermediation. The results suggest that usefulness of M2 as an intermediate monetary target has declined with financial innovation and reform. A result that underscores the importance of moving toward increased reliance on more price-based targets such as interest rates.

Subject: Banking, Demand for money, Housing prices, Monetary base, Money, National accounts, Personal income, Prices, Velocity of money

Keywords: Demand for money, Financial Innovation, Financial Liberalization, Housing prices, Interest rate, Interest rate liberalization, Interest rate parameter, Interest rate sensitivity, Lending interest rate ceiling, Liberalization, Liberalization variable, MDF, Monetary base, Monetary policy, Money Demand Function, Personal income, Velocity of money, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2014/075
Stock No:

WPIEA2014075
ISBN:

9781484366295
ISSN:

1018-5941

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