Working Paper: NBER ID: w23377
Authors: Kaiji Chen; Jue Ren; Tao Zha
Abstract: We estimate the quantity-based monetary policy system in China. We argue that China's rising shadow banking was inextricably linked to banks' balance-sheet risk and hampered the effectiveness of monetary policy on the banking system during the 2009-2015 period of monetary policy contractions. By constructing two micro datasets at the individual bank level, we substantiate this argument with three empirical findings: (1) in response to monetary policy tightening, nonstate banks actively engaged in intermediating shadow banking products; (2) these banks, in sharp contrast to state banks, brought shadow banking products onto the balance sheet via risky investments; (3) bank loans and risky investment assets in the banking system respond in opposite directions to monetary policy tightening, which makes monetary policy less effective. We build a theoretical framework to derive the above testable hypotheses and explore implications of the interaction between monetary and regulatory policies.
Keywords: Monetary Policy; Shadow Banking; China; Banking System
JEL Codes: E02; E5; G11; G12; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Contractionary monetary policy in China from 2009 to 2015 (E52) | Nonstate banks increased their engagement in shadow banking activities (F65) |
| Contractionary monetary policy tightening (E52) | Significant increase in entrusted lending through nonstate banks (G21) |
| Contractionary monetary policy tightening (E52) | Decrease in entrusted lending by state banks (G21) |
| Contractionary monetary policy tightening (E52) | Nonstate banks increased their ARIX holdings (G21) |
| Contractionary monetary policy tightening (E52) | Decrease in ARIX holdings by state banks (G21) |
| Rise of ARIX holdings (G34) | Undermining effectiveness of monetary policy on total bank credit (E51) |
| Regulations (LDR and safe-loan regulation) (G28) | Mediators in causal relationships (C32) |