Research On The Effectiveness Of The Central Bank’s Open Market Operations As A Monetary Policy Instrument

With the improvement of China’s market economy, open market operations are attached with more and more importance by the central bank. It plays an essential role in guiding the market interest rates and imposes a great impact on the financial market and overall economic activities. Meanwhile, the effectiveness of China’s open market operations is still weakened due to lack of independence of the People’s Bank of China, non-sufficient variety of dealing instruments, and the weakness of the market infrastructure. Under the current scenario, an analysis on the effectiveness of open market operations is called upon to provide practical insights for policy makers.This paper reviewed the relevant literature and investigated the effectiveness of open market operations both theoretically and empirically. In the theory section, this paper introduced perspectives on open market operations of the modern monetary theory, and further analyzed the transmission mechanism of open market operations. Furthermore, this paper studied the evolution history of China’s open market operations and conducted a qualitative analysis regarding to its role in monetary policy. In the empirical analysis, this paper employed Granger test and VAR model on the relevant data from year 2003 to 2013. On the one hand, Granger test is used to validate the impact of open market operations on the market interest. On the other hand, VAR model, impulse response function and variance decomposition are applied yto analyze open market operations’ impact on M2, bank loans, CPI and economic growth, in order to assess the effectiveness of open market operations. Moreover, the paper compared the effectiveness of monetary and credit channels.Conclusions from the empirical study are as follows. First, open market operations have a significant impact on both short-term and long-term market interest rates, and the impact on the former surpasses that on the latter. Second, among the dealing instruments of open market operations, the 28 days repo rate and three-month central bank bills issuing rate influence market interest rates most, therefore they can be treated as members of the "money market reference rate family". Third, open market operations can help realize the intermediate target and the ultimate goal of the monetary policy, no matter through monetary channels or credit channels. However, the effect of open market operations is delayed and does not last for a long period. Fourth, it is found that monetary channel of the open market operations has a more significant impact than does the credit channel, based on results from variance decomposition.Based on the empirical results, the paper raised several suggestions as follows. First, it is important to increase the scale of open market operations and create more dealing instruments. Second, the current focus of the open market operation should continue to be adhered to money supply. Third, the regulator should improve the transmission mechanism of the credit channel, putting it into better use. Fourth, the regulator should continue to deepen the market-oriented interest rate reform and reduce its dependence on money supply, in order to prepare for the transformation of the target from money supply to interest rate. Fifth, the regulator needs to strengthen the independence of the central bank.