Financial Condition Index And The Analysis Of Monetary Policy Rules In China

Since the end of last century, financial liberalization, financial globalization, andfinancial innovation has been accelerating the development of national capital markets,the global financial system has been more closely connected, and the asset pricevolatility has been becoming challenges of economic development. The outbreak ofthe international financial crisis in2008has led to global macroeconomic volatility,caused profound negative impact on the global real economy.Monetary authorities allaround the world has paid more and more attention to asset price factors when makingmonetary policy.With the great improvement of China’s financial system, asset prices willgradually increase the predictive power of information on future macro economy.Based Goodhart&Hofmann’s (2000) idea, using the state-space model, this paperconstruct a time-varying financial condition index (FCI). Including interest rates,exchange rates, real estate prices and stock prices, the time-varying FCI effectivelyreflects China’s economic and financial structure changes. The empirical results showthat, as a comprehensive measure of asset price variables, the FCI includes the futuremacro-economic information. With monitoring the FCI, the central bank could taketimely measures to control price fluctuations and maintain stable economic growth.Then, as a indicator of accommodative level of the overall financial situation, weadd the FCI into the monetary policy reaction function, and find that:(1) including theFCI, the reaction of policy instruments in the two rules to FCI gap variable shows theprocyclical characteristic, which exacerbates the instability of financial markets;(2)the GMM estimates show that the adjust R2of McCallum and Taylor rule are0.084and0.744, compared to McCallum rule, Taylor rule’s fitting results is better;(3)Although the coefficient of the FCI in the Taylor rule suggest a certain amount ofinstability, but the response coefficients of inflation and output are positive, indicatingthat with the deepening of market-oriented reform, the Taylor rule can be a bettercharacterization model of China’s monetary policy.Finally, after pointing out some main problems in china’s monetary policysystem, this paper advise taking the FCI as an important reference variable ofmonetary policy, and in the medium term when monetary policy transforming toprice-based, we could construct “double target” system, including both the inflationtarget and money supply target, but in the long run, should steadily push forward market-oriented interest rate and exchange rate system reform, continue to strengthenthe building of financial markets, rationalize the monetary policy transmissionmechanism, and ultimately realizing the monetary rule change to price-based fromquantity-based.