The hybrid monetary policy rule in China’s transition period

Abstract

This paper conducts a comprehensive analysis of China's monetary policy rule during its transition period. We theoretically demonstrate the equivalence between quantity-based and price-based monetary policy rules. On this basis, we propose a novel quantity-price-hybrid monetary policy rule that aligns with China’s monetary policy practices, offering significant theoretical and practical contributions to understand the monetary policy operations in China’s transition period. Our theoretical framework yields two pivotal insights: First, when interest rate was below the equilibrium level under China's historical interest-rate control circumstances, the existence of the quantity-price-hybrid monetary policy rule explains how excess money supply coexisted with price stability without hyperinflation. Second, we derive a modified Taylor principle, demonstrating that monetary authorities can achieve price stability through interest rate adjustments smaller than inflation fluctuations. Empirical analysis for China strongly supports these theoretical propositions. Now, as the interest-rate liberalization have been largely promoted and the liquidity landscape has been reversed, our findings underscore the growing necessity for China to transition towards price-based monetary policy management. This research provides critical analytical tools and policy implications for economies navigating similar transitional challenges.