The effects of short-term interest rates on output, price and exchange rates: recent evidence from China

Abstract

This paper utilizes VAR techniques to examine the relationship between a policy related variable and selected macro-variables in China. Johansen’s cointegration tests fail to find a moving equilibrium among the related variables. Based on a VAR model in first differences, we find that an unexpected temporary one-off shock to the change in the seven-day money market interbank borrowing rate does not have significant influence on GDP changes but a significant influence on price level changes in a “wrong” direction. Empirical testing demonstrates that the seven-day Repo rate has an insignificant influence on both GDP changes and on the price level changes. Furthermore, the relationships between monetary aggregate (M2) and short-run money market interest rates suggest that the short-run interest rates do not have significant influence on the monetary aggregate. Therefore, we have determined that short-run money market interest rates are ineffective as a monetary policy-operating objective.