Abstract: This article investigates the response of monetary policy to financial instability in China. We estimate a forward-looking Taylor rule model with a constructed comprehensive financial stress index using the time-varying coefficient method. Empirical results suggest that financial stability has always been a main concern for China’s monetary authorities even in periods with low financial pressure. Moreover, China’s central bank tends to lower the policy interest rate in response to financial instability, but the size of policy responses varies substantially over time. Although the proportion of policy interest rate change due to financial stability concern is less relative to developed countries, financial stability is increasing in importance for monetary policymaking in China. We also find that banking stress and stock-market stress are two main concerns for China’s central bank, while little evidence supports that exchange-market stress can drive the reaction of China’s central bank.
https://www.tandfonline.com/doi/full/10.1080/13547860.2020.1790156
