Monetary policy in mainland China : frictions in financial intermediaton and the cost of sterilization

This paper implements frictions in financial intermediation into a small open economy DSGE model. The model is designed to recreate key aspects of the Chinese economy during the financial crisis of 2008 and the ensuing worldwide economic contraction caused by the crisis. Simulations of external foreign interest rate shocks show a significant reduction in the aggregate deviation from monetary policy targets when financial intermediation is introduced. The reduction is further enhanced when current Chinese macroprudential regulations are taken into account. The assessment of the simulations suggests that the Chinese financial sector and its relationship to the central bank could play a major role in enhancing the sustainability of the current monetary policy stance adopted by Mainland China.


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