Les effets des chocs de la politique monétaire de la Chine de 1997 à 2005 : des données désagrégées, les variations provinciales et le marché boursier, The effects of monetary policy shocks in China 1977 to 2005 : disaggregated data, provincial variations and the stock market

University of Aix-Marseille Ⅱ
Department of Economics
Thesis
By Ying Liu
The Effects of Monetary Policy
Shocks in China 1997 to 2005
Disaggregated data, provincial variations and the stock market
Defended in September 2010 in front of the committee composed of the following

Supervisor: Eric GIRARDIN, Professor, GREQAM and the University of
Aix-Marseille Ⅱ (France)
Members: Aaron MEHROTRA, Senior Economist, Institute for Economies in
Transition BOFIT, Bank of Finland (Finland)
Duo QIN, Senior Lecturer, University of London (UK)
Anne PEGUIN-FEISSOLLE, Professor, GREQAM and the
University of Aix- Marseille Ⅱ (France)
__________________________________________________________________
GREQAM
Groupement de Recherche en Economie Quantitative d'Aix-Marseille
UMR CNRS 6579
Centre de la Vieille Charité- 2, Rue de la Charité
13002 Marseille Cedex 02 The Effects of Monetary Policy
Shocks in China 1997 to 2005
Disaggregated data, provincial variations and the stock market
Ying Liu
September, 2010
Abstract
This thesis studies the effects of monetary policy shocks on the Chinese
economy from 1997 to 2005 based on a VAR framework with monthly data. We
find that China‟s output and price decrease significantly following a
contractionary policy shock, suggesting the presence of an interest rate channel.
Our results are reinforced by a Factor Augmented VAR (FAVAR), which
extracts information from a large number of economic series. We also find that
heavy industries and privately-owned enterprises respond much more
profoundly to monetary policy shocks than light industries and state-owned
enterprises, respectively. We then explore the provincial variations of the
responses to monetary policy shocks. In general, we find that output and prices
are more sensitive to monetary policy shocks in coastal provinces than in inland
provinces. Cross sectional analysis of these provincial variations suggests that
provinces with a higher growth rate and a higher level of construction activities
are more likely to respond strongly to monetary policy shocks. Finally, we
investigate the effects of monetary policy shocks on China‟s stock market and
its sectoral indices. We conclude that monetary policy has little effect on the
overall stock market, but certain sectors do respond more strongly to monetary
policy shocks than others.




1
Table of Contents

Chapter 1 The Effects of Monetary Policy Shocks in China 1997 to 2005: A VAR
and FAVAR analysis ................................................................................................... 16
1.1 Introduction .... 16
1.2 Monetary policy in China .............................................................................. 24
1.2.1 Open market operations ...... 25
1.2.2 Reserve requirements .......................................................................... 26
1.2.3 Rediscount rate .................... 29
1.3 Econometric models ....................................................................................... 32
1.3.1 VAR .................................... 32
1.3.2 Impulse Response Functions (IRFs) and Identification ...................... 35
1.3.3 FAVAR ............................................................................................... 37
1.3.4.Data ..................................................................... 41
1.4 Results ............................................ 43
1.4.1 Stationarity and cointegration ............................................................. 43
1.4.2 VAR in levels ...................................................... 45
1.4.3 Parameter stability .............................................. 47
1.4.4 Diagnosis tests .................................................... 50
1.4.5 Impulse response functions ................................................................. 57
1.5 Sectoral responses .......................................................... 60
1.5.1 Light industries versus heavy industries ............................................. 61
1.5.2 State-owned enterprises versus privately-owned enterprises ............. 62
1.6 Factor-Augmented VAR (FAVAR) ............................................................... 64
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1.7 Conclusion ..................................................................................................... 69

Chapter 2 The Provincial Effects of Monetary Policy Shocks in China ................... 72
2.1 Introduction .................................................................................................... 72
2.2 Chinese regions and Chinese regional studies ............... 77
2.3 Model specification ........................................................................................ 82
2.4 Regional effects of monetary policy .............................. 84
2.5 Aggregation bias .......................................................................................... 104
2.6 Channels of monetary policy in China ......................... 108
2.7 Cross-sectional analysis with political economy variables .......................... 121
2.8 Conclusion ................................................................................................... 126
Chapter 3 Stock market responses to Monetary Policy in China - a Sectoral
Approach .................................................................................................................... 128
3.1 Introduction .................................................................................................. 128
3.2 Overview of China‟s stock market .............................. 134
3.3 Data .............................................................................................................. 137
3.4 Model ........... 153
3.5 Results .......................................................................................................... 155
3.5.1 Overall stock market responses ........................................................ 155
3.5.2 Results from sectoral analysis ........................... 161
3.6 Conclusion ................................................................................................... 177
General Conclusion .... 180
Appendix A: Unit root tests and VECM specification ...................................... 184
Appendix B: Structural VAR (SVAR) .............................................................. 189
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Appendix C: Bayesian VARs with MCMC
techniques……………………….192
Appendix D: Alternative policy shock and flow of funds variables .................. 196
Appendix E: Sub-sample periods ....................................................................... 203
Appendix F: Results of NormalityTest and IRFs of Existing Literature ........... 211
Appendix G: Variables Included in the Principal Component Analysis for
FAVAR
…………………………………………………………..……………222
Appendix H: Provincial Output Responses to Stock Market Shocks………… 224
Bibliography .............................................................................................................. 228

4
Introduction
The rapid development of the Chinese economy has drawn enormous attention to the
country‟s economic policy making. A great deal of interest has been focused on the
ability of its central bank to maintain a stable and sustainable pace of development. With
an almost entirely state-controlled banking sector, underdeveloped financial markets
and (until recently) a fixed exchange rate, China‟s monetary policy operates in an
environment highly different from those of most developed countries and faces
enormous challenges. Since the banking reform of the mid-1990s and an increased
emphasis on the interest rate policy, the People‟s Bank of China (PBC) has been more
and more active in using benchmark policy variables in an attempt to affect the real
economy. For example, it raised interest rate six times in 2007 and lowered it five times
in 2008. Such active interventions using the interest rate have been unprecedented and in
many ways resemble policy actions conducted by central banks in the industrialized
world.

The purpose of this thesis is to investigate the effects of these monetary policy moves on
the overall economy, the provincial economies and the stock market. We conduct an
empirical analysis of the transmission mechanism of China‟s monetary policy in the
period 1997 to 2005. The sample period in question is highly relevant, because it covers
both deflationary (1997 to 2002) and inflationary (2002 to 2005) periods. It also
witnesses a large inflow of foreign exchange since the end of 2000. The resulted large increase in foreign currency reserves creates a great challenge for the PBC, which must
strive to sterilize the impact of such capital inflows on the monetary base, if it wants to
maintain an autonomous monetary policy. Also, since 1996, the PBC has put more and
more emphasis on the interest rate policy. In some sense, the conduct of monetary policy
in China is converging to that in developed countries. This thesis provides a timely
analysis of the functioning of the interest rate channel of the transmission of China‟s
monetary policy.