China's Interest Rate Pass-Through To Government Bonds And Monetary Independence

The monetary policy has been a main driver of China's economic growth. Strong evidence shows China's monetary policy is designed to support real GDP growth. There are various and complicated monetary transmission channels. This study examines the relation between monetary independence and interest rate pass-through to government bonds in China. The sensitivity coefficients between government bond yields and the People's Bank of China's (PBC) policy rate FR007 are obtained through a series of univariate 200-trading-day rolling regressions between bond yields with different maturities and FR007. The Monetary Independence (MI) is measured as the reciprocal of the correlation of interest rates in China and the United States. 200-trading-day correlations are calculated using daily interest rate data. A simple regressions model is employed to test the relations between sensitivity coefficients and MI. The time period is between January 4, 2013 and November 30, 2016. The empirical results show that China's monetary independence is positively associated with China's interest rate pass-through to government bonds. This relation is also robust to various tests on the presence of outliers and causality. It means that the higher China's monetary independence, the greater China's interest rate pass-through to government bonds. During March 2016 – November 2016, China had been continuously suffering great capital outflows. China's monetary independence had dropped significantly during this period, and at the same time China's interest rate pass-through to government bonds had totally disappeared. The Impossible Trinity theory may provide the answer. In reality, the Chinese authorities have helped establish multiplier mechanisms that jeopardize both monetary autonomy and exchange-rate stability. The Chinese policy-makers such as finance minister Lou Jiwei also conceded that China's monetary tools were becoming less effective. Based on this study's findings, the PBC is suggested to relax its control of the exchange rate regime in order to increase the independence of the Chinese monetary policy. Accordingly, China's interest rate pass-through to government bonds will be improved, and Chinese economic growth will be more sustainable.