Financial cycle and the effect of monetary policy

Using a time-varying parameter vector vector autoregressive model with stochastic volatility (TVP-SV-VAR), this study evaluates the effect of quantitative and price-based monetary policies on China's financial cycle, which is represented by a dynamic financial condition index (FCI) constructed with a time-varying parameter factor-augmented vector autoregressive (TVP-FAVAR) model. Results reveal that quantitative monetary policy boosts the financial cycle slightly and swiftly, whereas price-based monetary policy has slower but stronger long-term negative effect to restrain boom and control financial risk. Moreover, the effects of both monetary policies are compromised in periods of strong financial fluctuation.

Automated summary

This study uses TVP-SV-VAR and TVP-FAVAR models to evaluate the impact of quantitative and price-based monetary policies on China's financial cycle. The results show that quantitative monetary policy boosts the financial cycle, while price-based monetary policy has a stronger long-term negative effect to restrain boom and control financial risk.