The Direction and Intensity of China’s Monetary Policy: A Dynamic Factor Modelling Approach*

Abstract

The recent update of the People’s Bank of China’s monetary policy framework establishes a corridor system of interest rates. We employ a dynamic factor modelling approach to derive an indicator of China’s monetary policy stance. The approach is based on the notion that co‐movements in several monetary policy instruments have a common element that can be captured by a single underlying, unobserved component. To clarify and interpret the derived index, we employ a baseline dynamic stochastic general equilibrium (DSGE) model that can be solved analytically and allows tracing of the expansionary and contractionary on‐and‐off phases of Chinese monetary policy.

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