The Nonlinear Character Research Of China’s Monetary Policy Based On DSGE Model

The monetary policy follow a certain rule, other than discretionary, is not only helpful tolimit the rapid rise of price, but also beneficial to promote a steady growth of economy.Currently most central bank operates the monetary policy staring to the interest rate andmoney supply, which means that the adjustment of interest rate and money supply is basedon the inflation gap and output gap. The typical monetary policy includes Taylor rule andMcCallum rule. To illustrate the problem we will propose, we take Taylor rule as example.The basic Taylor rule implies the adjustment of interest rate as a linear function of output gapand inflation gap, which is not consistent with observations of market agents. In contrast,central bank does not control the interest rate based on a constant rule, but on a nonlinear onewith structure variance. To illustrate the monetary policy of central bank as a nonlinear ruleis better for market agents to form their expectations, and better for administration sector toregulate the macro-economy. This paper focuses on the Taylor rule, and defines two newKeynesian dynamic stochastic general equilibrium models. In one model, monetary rule isset constant, but another is set Markov regime switching. To incorporate the regimeswitching probability into the rational expectation function, we transform the nonlinearMarkov regime switching model to a linear one. Then we estimate parameters with MCMCmethods based on Metropolis and Hastings sampling. To compare the two models, wecalculate the marginal likelihood, which shows that the latter is more fit to the data in China.In other words, two different monetary regimes, called “active” and “passive”, exist in theChina’s monetary policy operation.