A DSGE Model for China s Monetary and Macroprudential Policies

Transcription

1 MPRA Munich Personal RePEc Archive A DSGE Model for China s Moneary and Macroprudenial Policies Peer Sinclair and Lixn Sun The deparmen of economics, Universiy of Birmingham, The Cener for Economic Research, Shandong Universiy May 24 Online a hp://mpra.ub.uni-muenchen.de/6258/ MPRA Paper No. 6258, posed 6. March 25 6:54 UTC

2 A DSGE Model for China s Moneary and Macroprudenial Policies Peer Sinclair, Lixin Sun 2 Absrac: This paper develops a calibraed DSGE model for simulaing China s moneary policy and macroprudenial policy. The empirical resuls show, firs, ha he ineres rae is a beer insrumen for China s moneary policy han he required reserve raio when he cenral bank is solely concerned by he price sabiliy; second, ha he loan-o-value (LTV) raio is a very useful macroprudenial ool for China s financial sabiliy, and he required reserve raio could be used as an insrumen for boh objecives. Wheher macroprudenial policy complemens or conflics wih moneary policy depends upon he insrumens choices of wo policies. Our policy experimens sugges hree combinaion choices of insrumens for China s moneary and macroprudenial policies. Keywords: DSGE Model, Moneary Policy, Macroprudenal Policy, China s Economy JEL Code: E52, E6, G8 Peer Sinclair is a professor of economics from he Deparmen of Economics, Universiy of Birmingham, UK. p.j.n.sinclair@bham.ac.uk; or peer.sinclair@bankofengland.co.uk. 2 Lixin Sun (corresponding auhor) is an associae professor of macroeconomics from he Cener for Economic Research, Shandong Universiy. sunlixin@gsm.pku.edu.cn or lxsun@sdu.edu.cn. Address: The Cener for Economic Research, Shandong Universiy, 27# Shandananlu, Jinan, 25, P.R.China

3 A DSGE Model for China s Moneary and Macroprudenial Policies. Inroducion The Grea Recession of ignied research ineress on he sysemic risks and financial sabiliy, which is he main objecive of he macroprudenial policy implemened by he cenral bank in mos counries, as he price sabiliy o moneary policy. This riggers he debae on he ineracions and he coordinaion beween moneary and macroprudenial policies, because wo policies could be eiher complemens or subsiues, which is a dilemma o he policymakers (Borio e al., 22). In his paper, a New Keynesian DSGE model is developed o analyse he inerdependencies of China s moneary policy and macroprudenial policy. The model borrows he spiris of Iacoviello (25) and Chen e al. (22) by incorporaing a banking secor and some unique feaures of China s macroeconomic policies. DSGE models are main oolkis employed by he economiss o sudy he ineracions beween moneary and macroprudenial policies. Woodford (2), and Curdia and Woodford (2) discuss he financial insabiliy under Taylor rule by using a simple DSGE model. Using DSGE models incorporaing financial fricions, heerogenous agens and housing for US and Euro Area, Bean e al. (2), and Gerler and Karadi (29) analyse he ineracions beween moneary and macroprudenial policies. Kannan e al. (29) shows ha macroprudenial policy is helpful o moneary policy in sabilizing he price level in a DSGE model. Angelini e al. (2) find ha macroprudenial policy complemens moneary policy under a DSGE model wih a banking secor. Glocker and Towbin (22) invesigae he

4 circumsances under which reserve requiremens are an appropriae insrumen for price or financial sabiliy by building a small open-economy DSGE model. Quin and Rabanal (23) esimae an open-economy DSGE model for Euro Area o sudy he inerdependencies of moneary and macroprudenial policies. They find ha he inroducion of a macroprudenial rule would help in reducing macroeconomic volailiy, improving welfare, and parially subsiuing for he lack of naional moneary policies. DSGE models are also inroduced o simulae China s moneary and macroprudenial policies. A successful DSGE model for China s moneary policy was developed by Chen e al. (22), which capures many special feaures of China s moneary policy. Ma and Chen (22) provide a calibraed DSGE model for he coordinaion of China s macroprudenial policy. They find ha Friedman s simple rule is also fi for he implemenaion of China s macroprudenial policy, and a reasonable combinaion of moneary, credi and macroprudenial policies can do a good job in sabilizing economy and finance. Chen (23) invesigaes he effecs of moneary and macroprudenial policies argeing on China s real esae marke. Our DSGE model, which follows Iacoviello (25) and Chen e al. (22), capures many unique characers of China s moneary and financial sysems. We find ha he required reserve raio as an imporan moneary policy ool employed by he PBOC over decades could also be a very useful insrumen of China s macroprudenial policy, and he loan-o-value (LTV) raio is anoher good macroprudenial ool for China s financial sabiliy. The empirical resuls show ha wheher he moneary policy and he macroprudenial policy are complemens or subsiues in China depends upon he

5 choice of he policy insrumens. Our policy experimens sugges hree combinaion choices of insrumens for China s moneary and macroprudenial policies. The remainder of he paper is srucured as follows. Secion 2 oulines China s moneary policy and financial regulaion sysem. Secion 3 describes he DSGE model in deail. Secion 4 provides he model calibraion according o he ime series daa of China s economy. Secion 5 discusses he policy experimens and presens he empirical resuls. Secion 6 concludes. 2. China s Moneary Policy and Financial Regulaion Sysem The People s Bank of China (hereafer PBOC), China s cenral bank, did no operae as a cenral bank unil Sepember 983. Afer raificaion on 8 March 995, he PBOC began o implemen moneary policy legally as China s cenral bank. According o The Law of he People's Republic of China on he People's Bank of China (995) he PBOC shall, under he leadership of he Sae Council, formulae and implemen moneary policies and exercise supervision and conrol over he banking indusry. While China s moneary policy aims primarily o mainain he sabiliy of he currency, is governmen lays down more specific arges, including annual GDP growh above 7%, a sable exchange rae, low unemploymen, and, i appears, an annual inflaion rae of 3%. China sared o anchor on an inermediae arge in he lae 98s. Unil 986, he PBOC had no explici inermediae moneary arges given a cenrally-planned economic sysem in China. During he period , currency in circulaion and banks loan porfolio were adoped as inermediae arges. In Sepember 994, hree

6 levels of money supply indicaors, M, M, and M2 were defined and announced. Since 996, he PBOC formally ook money supply (moneary argeing) as an inermediary arge. China s moneary policy also differs from he convenional cenral banking in several oher respecs, which affec he consrucion of a DSGE model. Firs, he PBOC conrols he reail deposi rae and loan rae besides he policy rae. Bu he markeizaion of ineres raes sill has some way o go. Second, he required reserve raio is an imporan insrumen of China s moneary policy. Third, he PBOC ofen employs non-marke regulaing orders, such as window guidance and loan quoas, o inervene business aciviies of commercial banks direcly (Chen e al. 22). Figure summarizes he general framework of China s moneary policy. Figure he Framework of Moneary Policy in China The Sae Council Leadership China s Moneary Auhoriy PBOC Moneary Policy Commiee: Consulan Goals or Objecives: Mainaining sabiliy of he value of he currency and hereby promoing economic growh In realiy, muli-goals: Economic growh, Price sabiliy, Fixed exchange rae (before 25), Employmen creaion ec. Targes and Inermediae Targes: Money supply volume or Moneary Aggregae: M and M2 Moneary Base Insrumens: Open marke operaions, required reserve raio, base ineres rae, rediscouning and cenral bank lending, exchange rae, window guidance Banking and Financial Sysem Foreign Exchange Marke Sock Marke Bond Marke Money Marke Moneary Policy Transmission Channels Source: By Auhor

7 China s financial sysem (Figure 8) consiss of a banking secor, financial markes, and a nonsandard financial secor. The large banking secor is dominaed by he big-four sae-owned commercial banks, despie he enry and growh of many domesic and foreign banks and financial insiuions in recen years. China Banking Regulaory Commission (CBRC), is he sae auhorized supervisory body for he banking sysem. I was separaed from he PBOC in 24. Figure 2 shows he deposis and loans in he banking secor. Figure 3 shows broad and narrow money in China. Figure 2 Deposis and Loans in he Banking Secor (Uni: Billion RMB) Deposis Loans Source: CEIN (China Economic Informaion Neworks) Figure 3 Broad and Narrow Money in China (Uni: Billion RMB) M2 M M Source: CEIN

8 Two sock markes, he Shanghai Sock Exchange and Shenzhen Sock Exchange, were esablished in 99. Afer wo decades developmen, hey are sill underdevelopmen and inefficiency in allocaing he financial resources because of highly speculaions and more inside rading, bu hey are growing in imporan for China s developmen. China s Securiies Regulaory Commission (CSRC), esablished in Ocober 992, is responsible for regulaing he sock markes and he sill embryonic fuures markes. Figure 5 presens he indices of socks in wo sock markes. Figure 5 Indices of Socks in Two Sock Markes Shanghai Index Shenzhen Index Source: CEIN There are hree bond markes in China: he iner-bank bonds marke, he sock marke and he commercial bank over-he-couner marke. Wholesale ransacions of booked bonds and policy banks bonds are conduced in he Iner-bank bonds marke by insiuional invesors, while bonds are raded a he Sock Exchange by insiuions and individuals. In he over-he-couner marke, reasury bonds are issued o individuals and corporaions where hey are raded by invesors. Among hese hree

9 markes he sock exchange rade dominaes according o urnover. The whole bond marke is organized by 2-level cusody arrangemens. As China s cenral Securiies deposiory (CSD) for he bond Marke, China Governmen Securiies Deposiory Trus & Clearing Co. Ld, (CGSDTC) akes he responsibiliy of he General Cusodian, which is under supervision of he PBOC. Figure 6 presens he proporions of he bonds rading in he inerbank marke. Figure 6 Proporions of he Bonds Trading in Inerbank Marke % 9% 8% 7% 6% 5% 4% 3% 2% % % 9-2 Days Trading 6-9 Days Trading 3-6 Days Trading 2-3 Days Trading 5-2 Days Trading 8-4 Days Trading 7 Days Trading Overnigh Trading Source: CEIN For many years, China had a fixed exchange rae sysem. Foreign exchange ransacions have been sricly conrolled by he governmen up o now, alhough some deregulaion is under way. Wih he capial flows conrolled, China can have an independen moneary policy under a fixed exchange rae regime. The paricipans in foreign exchange markes are composed primarily of insiuional invesors in China. On July 2 25, he Chinese governmen reformed he exchange rae regime by moving o a managed floaing exchange rae sysem wih reference o a baske of

10 currencies. On May 8 25, foreign currency rading was formerly launched in he iner-bank foreign exchange marke where spo ransacions of eigh currency pairs were conduced 3. On Augus 2 25, he PBOC released a Noice on Expanding Designaed Banks Forward Purchases and Sales Business and Launching RMB and Foreign Currencies Swaps which permis qualified commercial banks o underake RMB and foreign currency swaps. Furher, on January 4 26, he PBOC issued he Public Announcemen on Furher Improving he Iner-Bank Spo Foreign Exchange Marke (Public Announcemen of he PBOC No. [26]), inroducing he marke-maker sysem and over he couner ransacions (OTC ransacions) ino he iner-bank spo foreign exchange marke. The foreign exchange markes are regulaed by he Sae Adminisraion of Foreign Exchange, which is direced by he PBOC (generally, he head of he SAOEF is one of he depuy presidens of he PBOC). Figure 7 presens he Evoluion of he Exchange Rae of RMB (Chinese Currency) vs. US$ Figure 7 Exchange Raes of Chines RMB agains US$ Exchange Raes of RMB Source: CEIN 3 These were he US dollar agains he Ausralian, Canadian and Hong Kong dollars, he euro, he Japanese yen, serling and he Swiss franc, and for euro-yen ransacions.

11 Figure 8 China s Moneary and Financial Regulaing Sysem CBRC (China Banking Regulaory Commission) China s Financial Sysem The People s Bank of China (PBOC, Cenral Bank) China Securiies Regulaory Commission Banking and Inermediaion Secor Non Sandard Financial Secor: Inerne Finance, ec. Financial Markes Sock Markes (Shanghai, Shenzhen) Three Policy Banks: Commercial Banks Abou 5 Credi Cooperaives Foreign Banks Branches, REP. Fuure Markes. China Developmen Bank (CDB) 2. Agriculural Developmen Bank of China (ADBC) 3. Expor and Impor Bank of China (EIBC) Four Big Sae-Owned Commercial Banks.. Bank of China (BOC) 2. China Consrucion Bank 3. Commercial & Indusrial Bank 4. Agriculural Bank of China More han Ten Naionwide Regional Shareholding Commercial Banks Niney Ciy-owned Shareholding Commercial Banks Bond Markes Foreign Exchange Markes Insurance Markes CGSTDC Sae Admini. of Foreign Exchange China Insurance Regulaory Commission

12 China s insurance markes are also dominaed by big sae-owned insurance corporaions, which are regulaed by China Insurance Regulaory Commission (CIRC). The PBOC, CRBC, CSRC, and CIRC are parallel regulaors under he Sae Council, China s cenral governmen, alhough he PBOC is auhorized o oversigh he moneary and financial sabiliies. 3. The Model Following Iacoviello (25) and Chen e al. (22), our model economy consiss of heerogeneous households including savers (paien households) and borrowers (impaien households), enrepreneurs, firms, a banking secor, a cenral bank and governmen. Moneary auhoriy (cenral bank, PBOC) is responsible for conducing he moneary policy and he macroprudenial policy. Governmen (fiscal auhoriy) implemens a balance budge policy (Ricardian equivalence is assumed o hold.) 3. Households 3.. Savers The agen of he saving (paien) households maximizes he presen value of he sream of uiliies in an infinie horizon: s s s ( H ) Max. E s (ln c AN ln N ), () where s c denoes he real consumpion of he savers a ime, s denoes he subjecive discoun facor of savers, s N denoes he services of he accumulaed ne propery mainly comprising durable goods and real esae., wih is coefficien A N ; s H denoes he labour hours provided by he savers, is labour supply aversion coefficien.

13 The budge consrain faced by he savers is c q N d w H ( R / ) d T Div., (2) s s s s d s s where q represens he real price of he services from he ne propery; d represens he deposis of he savers in he commercial banks, d R is he gross ineres rae of s s deposi; w W / P is real wage; s T is he lump sum ax paid o he governmen by he savers; Div. s is he dividend from he commercial banks and reailers. The firs order condiions are c R ( ) (3) d se s s c s s s w ( H ) / c, (4) q A q (5) c N c N se( ), s s s Equaion (3) is Euler equaion, equaion (4) is a labour supply equaion, and equaion (5) shows he dynamic evoluion of he asse price Borrowers Borrowers (impaien households) borrow money from commercial banks o smooh heir consumpion. Their problem is given by b b b ( H ) Max. E b(ln c ln N ), (6) where he erms for borrowers wih superscrip b have similar meaning as for savers. represens a shock o ne propery following an AR() process. The budge consrains saisfies c q N R b / w H b T Div. ( N / N ) q N / 2, (7) b b l b b b b b b b b 2 b b wih a borrowing consrain: R b V E [ q N ] (8) l b b b where b denoes he loans obained by he borrowers from he commercial banks; b l R

14 denoes he lending ineres rae; he las erm b on he righ hand of equaion (7) denoes he propery adjusmen coss. b v is a ime-varying loan-o-value raio, which is a key insrumen for China s macroprudenial policy. The FOCs are: c R (9) l b l be ( ) b b R c b b b w ( H ) / c, () q N q N () c N N c N b b b b ( b ) be ( ( b )) v q, b b b b b where b denoes he muliplier on he borrowing consrain (8) Enrepreneurs The enrepreneurs produce inermediae goods by using a Cobb Douglass producion funcion. Following Iacoviello (225), he problem of he enrepreneur is given by max. E E Ec (2) Subjec o he following budge consrains: Producion funcion: Y A K ( ) ( ) ( ) N H H (3) E s ( ) b ( )( ) Capial accumulaion: Flow of Funds: I K ( ) K (4) Y / X b c q N R b / w H w H I E E E l E s s b b E E 2 E 2 E ( N / N ) q N / 2 ( I / K ) K (2 ), (5) where he las erm in he righ hand of equaion (5) denoes he capial insallaion coss; E b represens he loans borrowed by he enrepreneurs, represens he depreciaion rae of he capial; E N denoes he ne propery owned by he enrepreneurs, which could be collaeral when hey borrow money from he commercial banks.

15 The borrowing consrain for he enrepreneurs saisfies R b V E [ q N ] (6) l E E E where E V is a ime-varying loan-o-value raio for borrowing of he enrepreneurs. 3.2 Reailers Reailers produce he final goods by differeniaing he inermediae goods. The producion funcion of he final good producer is f f f f /( f ) i, (7) Y [ Y di],, where Y i, denoes he inermediae good provided by he h i inermediae producer (Enreprenuer). f is a coefficien governing he mark-up of he coss of he final good producer. Assuming ha he final good producer operaes in a perfecly compeiive marke, so he price of is oupu, P, and he prices of is inpus, P i,, are given exogenously. The relaionship beween hese wo prices saisfies f /( f ) i, P [ P di], (8) Profi maximizaion produces a demand funcion for he oupu of he h i inermediae producer Y Y P f ( ), (9) i, i, f P Following Iacoviello (25), assuming ha fracion of reailers can change heir prices opimally, he opimal price level is denoed by * P, oher prices keep unchanged, hen he aggregae price level can be calculaed by f * f /( f ) P [ P ( )( P ) ], (2) The above pricing behaviours imply a following Phillips curve: ( )( s ) ˆ ˆ ˆ se X, (2)

16 3.3 Commercial Banks Following Chen e al. (22), a represenaive commercial banks manages is loans ( L ), deposis ( D ), excess reserves ( E ), and borrowings from he inerbank marke ( IB ). Therefore is balance shee is: IB( RRR) D L E (22) where RRR denoes he required reserve raio. The profis of he commercial bank are given by ( r ) L L ( r ) E E [( r ) RRR ( r )] D B l e d r ( RRR )D ( r ) IB IB C ( E) C ( L) ib (23) where e r is he ineres rae for excess reserves; r r denoes he ineres rae for required reserves, ib r denoes he ineres rae for inerbank borrowing; C (E) ( cd[( RRR ) D ] cl L cee represens he coss of managing loans, deposis 2 cb 2 and reserves; C ( L) ( L L ) represens he coss of managing he loans o mee he 2 loan arge cb L se by he cenral bank. Subsiuing (22) ino (23) produces B ( r l r ib ) L ( r e r ib ) E [ r d RRR r r ( RRR ) r ib ] D C ( E) C ( L) (24) The problem of he commercial bank is given by B max. E B (25) yielding he following FOCs: l ib cb r r c L ( L L), (26) l e ib r r c E, (27) e r RRR r RRR r c RRR, D(28) d r 2 ( ) ib ( d ) The marke ineres rae of loans, l r, and he marke ineres rae of deposis, d r, are, conneced wih he exogenous ineres rae of loans and deposis ( r d cb, r l, cb, which are

17 se by he PBOC ) by wo posiive ime-varying parameers: r r,, for any, (29) l, l cb r r,, for any. (3) d d, cb 3.4 Moneary Auhoriy In China, he PBOC is auhorized o conduc moneary policy and macroprudenial policy o ensure moneary sabiliy and financial sabiliy Moneary Policy China differs sharply from advanced economies in he way moneary policy works. The PBOC no only conrol he policy rae, i also se deposi and lending raes (Chen e al. 22). Moreover, he nonmarke insrumens, such as window guidance and loan arges, are ofen employed by he PBOC. Finally, he PBOC's favoured insrumen is he required reserve raio less used, if a all, in advanced economies. Following Chen e al. (22), we sugges following rules o simulae he implemenaion of China s moneary policy: Firs, a kind of Taylor rule for he ineres rae: r y r (3) r y r, where r denoes a shock from he policy rae. The second rule relaes o he deposi raes se by he PBOC: d, cb d d d, cb r ( r ) r r r, (32) Similarly, he PBOC ses he lending rae according o: l, cb l l l, cb r ( r ) r rr, The fourh rule is he credi arge rule, which is given by cb cb cb cb l ( l )( lyl ) l l, (33) The final rule is for he required reserve raio, which saisfies R y R RRR ( RRR)( RRR yrrr ) RRR RRR, (34)

18 3.4.2 Macroprudenial Policy We follow oher auhors 4 by specifying wo macroprudenial policy insrumens: loan-o-value (LTV) raio and required reserve raio (RRR). Le he loan-o-value raio, b V, response o he loan arge and asse price 5, yielding: Vˆ Vˆ ( ) qˆ ( ) lˆ, (35) b b v v v q v l When he required reserve raio is used as an insrumen of macroprudenial policy, i responses o he loan arge as well as o he rae of inflaion, equaion (34) is replaced by R y m l ( )( ) ( ) ( ˆ ˆcb m RRR RRR RRR RRR y RRR RRR l l ) RRRRRR, (36) 3.5 Governmen and Fiscal Policy China s governmen is assumed o adhere o a coninuously balanced budge, is budge consrain is G T (37) Fiscal policy is implemened by conrolling he ax and he governmen spending. 3.6 General Equilibriums The Aggregae Resources Equilibrium saisfies c c c i G y (38) s b E The governmen spending is assumed o be given exogenously. Because he inerbank borrowings cancel ou in he whole marke, equaion (22) implies ha he loan marke equilibrium saisfies ( RRR ) D L RR E (39) where RR denoed he required reserves. 3.7 The Process of Shocks We simulae he effecs of six srucural economic shocks. These are shocks o echnology, ne propery, cos, R, RRR and LTV. The fourh is a moneary policy 4 See, for example, Glocker and Towbin (22). 5 This is because ha, housing prices conain significan useful informaion abou aggregae price movemens, response of he moneary policy o he asse prices help sabilise macroeconomic sabiliy (Bernanke and Gerler, 999; Cecchei e al., 2;), and he volailiy in asse prices is a key indicaor for he financial sabiliy (Bernanke and Gerler, 999; Borio and Lowe, 22; and so on).

19 innovaion, and he las wo are macroprudenial insrumen shocks. Mos shocks (excluding he fourh one) follow AR () processes: Where {,a,rrr,u } ˆ ˆ, iid (, 2 ),, N (4) 4. Parameers Calibraion Following Chen e al. (22), Iacoviello (25), Glocker and Towbin (22), Quin and Rabanal (23), Sun and Sen (2), Sun (22), and oher regarding Chinese lieraure, we calibrae all he parameers in Table. Table Calibraion of Parameers Idenificaion Value Descripion.99 Discoun facor of savers (Paien households) s.95 Discoun facor of borrowers (Impaien Households) b.98 Discoun facor of enrepreneurs E.3 Depreciaion rae of capial A. Coefficien of ne propery service N 2.2 Labour supply aversion.42 Capial share in producion.3 Ne propery share in producion.7 Paien households wage share. Coefficien of enrepreneurs propery adjusmen cos E. Coefficien of borrowers propery adjusmen cos b 2. Coefficien of capial adjusmen cos X.5 Seady-sae gross mark up.75 Probabiliy fixed price E V.85 Seady-sae loan-o-value enrepreneurs b V.6 Seady-sae loan-o-value borrowers

20 c 2. cos coefficien for deposis d c. cos coefficien for loans l c. cos coefficien for excess reserves e 5 coefficien deermining he window guidance for loans. Inflaion coefficien in Taylor rule. Oupu gap coefficien in Taylor rule y.75 Persisence coefficien of policy rae in Taylor rule r d.7 Persisence coefficien for deposi rule r l.7 Persisence coefficien for loans rule r cb.2 Persisence coefficien for loan arge rule l 5 Inflaion coefficien in loan arge rule l y 5. Oupu gap coefficien in loan arge rule l R.9 Persisence coefficien of ineres rae of required reserves RR R.6 Persisence coefficien of required reserve raio rule RRR l. Loan coefficien in required reserves raio rule RRR 5. Inflaion coefficien in required reserves raio rule RRR y 2. Oupu coefficien in required reserves raio rule RRR.9 Persisence coefficien for loan-o-value raio v.75 Asse price coefficien in he loan-o-value rule q.87 Loan arge coefficien in he loan-o-value rue l.85 Persisence coefficien for ne propery service shocks J.75 Persisence coefficien for cos-push shocks u

21 .5 Persisence coefficien for echnology shocks a.85 Persisence coefficien for required reserve raio shocks RRR Sandard error of ne propery service shock J.7 S.E of cos-push shock u.3 S.E. of echnology shock a S.E. of required reserve raio shock RRR.27 S.E. of policy rae shock R According o equaion (3), he seady-sae value of deposi rae is calculaed by d r / s ; we se seady-sae ineres rae on require reserves a.9, same as he seady-sae ineres rae on excess reserves. The seady-sae for he require reserves raio is se a % o mach is average level in he Chinese daa. The seady-sae raio for deposis o oupu is.5; oher seady-sae values are calculaed following Iacoviello (25) and Chen e al. (22). The discoun facor of savers is se o.99, implying ha he annual rae of s ineres in China is 4% (he gross rae is.4); so he discoun facors of borrowers and enrepreneurs are se a.95 and.98 respecively; China s annual rae of depreciaion is abou 2%, so he quarerly value of he depreciaion is se o.3. Following he esimaion of Sun Lixin e al. (2), he labour supply aversion and capial share in producion ake 2.2 and.42 respecively. The coefficiens of capial adjusmen coss follow Iacoviello (25), and he coefficiens of managing deposis and loans are se following Chen e al. (22). The persisence parameers are mainly calibraed following he esimaion in Sun e al. (2), and mos persisen coefficiens of shocks are also calibraed following Sun e al. (2). The sandard variances of he shocks and he parameers of China s moneary policy follow Chen e al. (22) and Sun e al. (2).

22 5. Policy Experimens and Empirical Analysis 5. The Policy Experimens Following Glocker and Towbin (22), we assume ha he cenral bank s objecive is o minimize an exogenously given loss funcion. The radiional price sabiliy loss funcion 6 is defined as PS E ˆ (4) 2 2 [ y y ] where y denoes he policymakers subjecive weigh of oupu sabiliy, relaive o price sabiliy. y ˆ denoes he oupu gap, which is a very imporan variable o he objecives of China s moneary policy. When he financial sabiliy is added o he objecives of he cenral bank, he loss funcion is given by PS FS E[ yˆ Lˆ qˆ ] (42) y L q where Lˆ, q ˆ denoe he deviaions of loans and asse prices from heir seady sae respecively. We design he following 4 policy experimens o assess he effecs of moneary policy and macroprudenial policy and heir inerdependencies 7. Policy Experimen I: Only Moneary Policy: Ineres Rae and Required Reserve Raio are Policy Insrumens Respecively In which we keep he equaion (3)-(34), screening ou he effecs of macroprudenial policy 6 The reason for choosing his ype of loss funcions by he cenral bank can refer o he discussions by Glocker and Towbin (22). 7 In designing our policy experimens, we do follow he Tinbergen rule-one insrumen for one objecive-in moneary policy, ye no in macroprudenial policy, as sressed by Lim e al. (2): muliple insrumens should be used for financial sabiliy.

23 Policy Experimen II: Moneary Policy and Macroprudenial Policy: Ineres Rae and Required Reserve Raio are Moneary Policy Insrumens Respecively; Loan-o-value raio is aken as he insrumen of Macroprudenial Policy. In his experimen, besides he moneary policy rules including equaion (3)-(34), we add a macroprudenial policy operaion: Loan-o-value rule (equaion (35)). Policy Experimen III: Moneary Policy and Macroprudenial Policy: Ineres Rae is Moneary Policy Insrumen, and Required Reserve Raio Is Macroprudenial Policy Insrumen. In his es, we include equaions (3)-(33) for moneary policy, and equaion (34) is replaced by equaion (36) for macroprudenial policy. Policy Experimen IV: Moneary Policy and Macroprudenial Policy: Ineres Rae Is he Insrumen of Moneary Policy, and LTV and RRR Are he Insrumens of Macroprudenial Policy. In his experimen, we es he combinaion effecs of moneary policy wih equaions (3)-(33), and of macroprudenial policy wih equaions (35)-(36). All he empirical resuls are presened and discussed in secion Empirical Analysis 5.2. The Effecs of Moneary Policy Shocks If he PBOC's moneary policy is concerned wih price sabiliy, is wo insrumens are he policy rae and required reserve raio. Figure 9 presens he effecs of shocks from policy rae. When policy rae increases 27 base poins by a posiive shock, inflaion falls.5%,

24 he price of asses falls abou 2.5% immediaely, deposis fall abou %, oupu declines 2.5% afer 3 quarers, consumpion of households decreases abou.8%, invesmen doesn decrease, so he fall in he oupu comes from he decrease in households consumpion. Figure 9 The Effecs of Policy Rae Shocks (Policy rae increases 27 base poins).4 rha.2 piha 5 qha yha cpha ciha iha lha dha Figure shows he effecs of required reserve raio shocks. A shock o he required reserve raio raises i abou %. This causes asse prices o fall by abou 4.8%, and loans by 4%, bu neiher CPI inflaion, invesmen nor oupu go down. Only household consumpion drops. This implies ha he required reserve raio is a poor insrumen for sabilizing oupu or he price level, bu a good one for sabilizing asse prices and loans, and hence has an absolue advanage as a financial sabiliy insrumen.

25 Figure The Effecs of Required Reserves Raio (% increase).4 rrrha rha.4 piha 5 qha yha cpha ciha iha lha dha The Effecs of Macroprudenial Policy Shocks The wo macroprudenial insrumens we consider are he required reserve raio, and he loan-o-value raio (LTV). The effecs of hese wo ypes of shocks are shown in Figure and Figure 2 respecively. In Figure, a posiive LTV shock cus asse prices and loans sharply, implying ha LTV is a powerful financial sabiliy insrumen. Furhermore, from Fig 2, we may infer ha including a required reserve raio shock enhances moneary sabiliy in our experimen suggesing ha his macroprudenial device can enhance moneary policy. So macroprudenial policy complemens o he moneary policy.

26 Figure he Effecs of Loan-o-Value Raio Shocks.2 rha.2 piha.5 qha yha cpha ciha iha niha neha lha dha viha Figure 2 shows ha he increase in RRR by a posiive shock decreases he price of asses significanly, reduces he volume of loans a lile, and reduces oupu and CPI inflaion. So he RRR could be used as eiher a macroprudenial policy insrumen or a moneary policy insrumen.

27 Figure 2 The Effecs of Required Reserve Raio (RRR) Shocks (RRR as a macroprudenial insrumen).5 rha.5 piha.2 qha yha cpha ciha iha niha neha lha dha viha.5 rrrha

28 5.2.3 The Comparisons of Price Sabiliy Objecive and Financial Sabiliy Objecive To compare, we se.5. We conduc he following four policy y l q experimens: Experimen I: No LTV Rule. Here we suppress equaions (35) and (36), and freeze he LTV insrumen a he seady sae values. The RRR is auned o he moneary policy arge only. Experimen II: As I, bu wih LTV inroduced, and auned o macroprudenial objecives. Only equaion (36) is suppressed; (35) now applies. Experimen III: As I, bu wih (36) replacing (34), so he RRR responds o macroprudenial aims only, and no longer o moneary aims; and he LTV insrumen is idle. Experimen IV: As III, bu wih LTV reinroduced, and direced o macroprudenial objecive. When he PBOC's moneary policy is concerned solely wih price sabiliy, he loss resuls are given in Table 2. Table 2 he Resuls under Price Sabiliy Objecive (Experimen I) Policy Rae Rule Required Reserve Raio Rule PS Table 2 indicaes ha he policy rae (ineres rae) is a beer insrumen for price sabiliy han he required reserve raio in our Experimen I. Table 3 presens he resuls for Experimen II, III, and IV.

29 Table 3 he Resuls under boh Price Sabiliy and Financial Sabiliy Objecives Experimen II Experimen III Experimen IV Moneary Policy Macropru. Moneary Macropru. Moneary Macropru. Policy Policy Policy Policy Policy R* RRR (LTV) R RRR R LTV RRR PS / FS FS PS / FS / PS *R denoes policy rae rule, RRR: required reserve raio rule, LTV: loan-o-value rule. PS / FS denoes he loss by price sabiliy policy given financial sabiliy is concerned. The resuls of Experimen II show ha when he PBOC chooses required reserve raio as is moneary policy insrumen and LTV as is macroprudenial policy insrumen, macroprudenial and moneary policies are complemenary. Oherwise, if he ineres rae is aken as he insrumen of moneary policy, he implemenaion of macroprudenial policy increases he wealh loss of price sabiliy, so may conflic wih he effecs of moneary policy. So, as row (6) reveals, pursuing financial sabiliy desabilizes he price level. In Experimen III, he policy rae is auned o price sabiliy (moneary policy) and he required reserve raio is chosen for financial sabiliy (macroprudenial policy). The loss resuls show ha he required reserve raio is a beer choice of he macroprudenial policy

30 insrumens, bu he macroprudenial policy operaion enhances he loss in price sabiliy. This porrays macroprudenial and moneary policy in conflic. In Experimen IV, moneary policy relies on he ineres rae, and macroprudenial he LTV. RRR is deployed for boh purposes; and conflic again appears On he basis of he above resuls, our suggesions for policy combinaion are: When he PBOC aims solely a price sabiliy, he ineres rae is a beer choice for he implemenaion of moneary policy han he required reserve raio. If he PBOC is responsible for boh he price sabiliy and financial sabiliy, he beer combinaion of policy insrumens is: required reserve raio for moneary policy and he loan-o-value raio for macroprudenial policy. Or The required reserve raio is aken as he ool for boh moneary and macroprudenial policies, while he loan-o-value raio is chosen as he insrumen for he macroprudenial policy. The laer wo suggesions ensure ha he macroprudenial policy complemens he moneary policy The Effecs of Oher Shocks We now consider he oher hree disurbances: a echnology shock, a cos-push shock and a ne asse shock. The effecs of hese shocks are presened in Figure 3, 4, and 5 respecively.

31 Figure 3 he Effecs of Technology Shocks rha piha qha yha cpha ciha iha niha neha lha dha viha A posiive shock o echnology increases consumpion, invesmen and hereby increasing oupu and propery; he jump in echnology reduces raes of ineres rae and inflaion, and simulaes he oupu. (Figure 3)

32 Figure 4 he Effecs of Cos-Push Shocks.2 rha.2 piha qha yha cpha ciha iha niha neha lha dha viha Figure 4 shows ha a posiive cos-push raises raes of inflaion and ineres, and hus lowers he invesmen and oupu.

33 Figure 5 he Effecs of Ne Asse Shocks.2 rha.2 piha 2 qha yha cpha ciha iha niha neha lha dha viha In Figure 5, a propery service shock causes a rise in he price of asse, reducing consumpion; he rise in he price of asses increases invesmen and hence oupu. 6. Concluding Remarks Using a DSGE model feauring China s unique moneary policy and financial regulaions, we analyse he ineracions beween moneary and macroprudenial policies in China. Our policy experimens show ha moneary policy and macroprudenial policy could be eiher

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