Monetary policy expectation and inflation management: DSGE analysis based on news shocks

WANG Xi1 WANG Qian2 CHEN Zhongfei3

(1.Lingnan College, Sun Yat-Sen University)
(2.Guangdong Branch of Postal Savings Bank of China)
(3.College of Economics, Jinan University)

【Abstract】From the perspective of news shocks, this paper distinguishes and studies the effects of both the anticipated and unanticipated monetary policy shocks on China’s inflation in a New Keyesian DSGE model. Furthermore, we analyze the characteristics and mechanism of China’s monetary policy by Sino-US policy effect comparison, and the replacement of parameters and expectation structure. The conclusions are as follows: (1) The impacts of the anticipated shocks are much stronger than the unanticipated ones in China. (2) Compared with the case of the United State, China’s monetary policy has a larger and less persistent effect with a minor over-shooting feature. (3) The above characteristics origin from the incoherency of the monetary policy conducted by the central bank and the short-sighted expectation from the economic agents. The policy implications are derived: (1) To make monetary policy more effective, the central bank should guide the public’s expectations by means of central bank communications. (2) The central bank should try to avoid discretion in order to maintain the consistency of monetary policy. (3) The implementation of monetary policy should keep its deeds with its words. In sum, China’s monetary policy should be more transparent, coherent and credible.

【Keywords】 monetary policy expectations; inflation management; news shocks; DSGE;


【Funds】 National Social Science Fund of China (15ZDA014) High-level Talent Program of Guangdong Province (1414003)

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    [1]. ① Blinder et al. (2008) defines central bank communication as the process that the central bank issues relevant information to the public on monetary policy objectives, operational strategies, economic outlook, and future monetary policy decisions. The central bank communication achieves economic regulation by changing the public’s expectations of monetary policy. [^Back]

    [2]. ② Central banks in various countries have begun to pay more and more attention to the management of inflation expectations. This is also a key area that China’s macro-economic control attempts to get involved in recent years. [^Back]

    [3]. ① Another news shock is sunspot shock, which refers to expected exogenous changes caused by external uncertainties that are not related to the economy itself (such as sunspots, animal spirits, and mood swing). [^Back]

    [4]. ① Due to space limitation, the model solution process is not given in this paper. The details are available upon request. [^Back]

    [5]. ① The time span is from the first quarter of 1996 to the fourth quarter of 2013. In order to match the variables in the model, the variables in the data are processed logarithmically and seasonally. The data are from the website of the People’s Bank of China, CEInet statistics database and the official website of the National Bureau of Statistics of the People’s Republic of China. [^Back]

    [6]. ② Due to space limitation, the paper does not list all news maturity combinations, which are available upon request. [^Back]

    [7]. ① The intensity of regulation is defined as the absolute value of the “peak of the variable (bottom of the variable) / time to peak (bottom).” The greater the value is, the greater the effect of monetary policy on the economic variables is. [^Back]

    [8]. ① Due to space limitation, the paper does not provide detailed empirical results of multiple news shock model. Please refer to the working paper in the website of Economic Research Journal for details. [^Back]

    [9]. ① Due to space limitation, the paper does not provide detailed construction and empirical results of the extending model. Please refer to the working paper in the website of Economic Research Journal for details. [^Back]

    [10]. ② After the expansion of the DSGE model, the horizontal interpretation level of various types of shocks will be reduced, which is also a common feature of the DSGE analysis. However, Figure 5 shows that the time characteristics of the two types of shocks on monetary policy remain basically unchanged. In fact, the impulse response mainly considers the horizontal impact of the shock changes, and the inflation variance decomposition of the extending model is carried out, which takes into account the effect of the second moment. We find that the results of variance decomposition basically remain unchanged compared with the results in Table 4. In other words, whether to expand the model has basically no effect on the interpretation of inflation fluctuations. Detailed results are available upon request. [^Back]

    [11]. ① This corresponds to the case of h = 0 in Table 1. [^Back]

    [12]. ② Wen Jiabao said, “The central government has issued ten measures to expand domestic demand and promote economic growth . . . The general requirement is that we act fast and be forceful.” See Beijing Evening News (北京晚报), (2008-11-11). Later Zhou Xiaochuan also proposed the same requirements for monetary policy operations. [^Back]

    [13]. ① The selection of US parameters is completely in accordance with Milani and Treadwell (2012). [^Back]


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This Article


CN: 11-1081/F

Vol 51, No. 02, Pages 16-29

February 2016


Article Outline


  • 1 Introduction
  • 2 Theoretical sources and research progress
  • 3 Benchmark model construction
  • 4 Parameter estimation and optimal news maturity choice
  • 5 Model performance and empirical results
  • 6 Inflation management: functions, mechanisms, and improvements
  • 7 Conclusions
  • Footnote