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The binary transmission mechanism of China’s monetary policy—A research on the “two intermediaries, two targets” model

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The research, using VAR model and economic and financial data starting from January 1998 and expiring by June 2006, by econometric methods and theoretical analysis, examines the intermediate target and transmission channel of China’s monetary policy. The results are as followings: (1) Monetary supply M2 is a good indicator for China’s monetary policy, its prediction ability to economic variables is far above other monetary variables; (2) M2 is China’s monetary intermediate target because M2 reacts systematically to the industrial added value and CPI, and M2 innovation is made by the People’s Bank of China (PBC); (3) Monetary transmission channel does not exist in China basically, the main transmission channel is bank loans, credit quota is a de facto intermediate target, which regulates macroeconomy directly and induces the changes in M2, so there are two intermediate targets—credit quota and M2, which is fundamentally the same as the situation before 1998; (4) The two intermediate targets function in different fields—credit quota for real economy and M2 for the financial market, which is a realistic choice and PBC has successfully coordinated them. These conclusions are meaningful for the practices of China’s monetary policy, which indicates that we should pay more attention to the credit quota and take it as the core variable to regulate macroeconomy. Of course, this monetary transmission mode is only effective temporarily because there are many limitations in it. In the future, it is necessary to adopt the interest rate, which is more informative, as the intermediate target, which takes the marketization of the interest rate and exchange rate as the preconditions.


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