An empirical analysis of the interest rate channel of monetary policy transmission in China

With incomplete interest liberalisation, the effectiveness of the interest rate channel of monetary policy transmission in China remains unclear. Using Granger causality test, impulse response functions and variance decompositions, we examine the interest rate channel of monetary policy transmission in China. Results show that money supply and interest rate impact GDP in China, while the change in money supply does not impact the change in interest rate. The impulse response functions indicate that the shock to M2 has significant impact on GDP and CPI, but the interest rate does not impact them. In addition, although the forecast error variance of GDP is mainly explained by the shock to itself, M2's and R's can explain that increasingly over time. These results suggest that efforts need to be done to accelerate the interest rate liberalisation process and reformation of enterprises and financial institutes, and to shorten the time lag of monetary policy transmission.