Dual-pillar Framework for Monetary and Macropr

China’s Dual-pillar Framework for Monetary and

Macroprudential Policy: An Analysis Based on TVP-

FAVR and MF-VAR Models*Changchun PanLong ZhangLong Jiang**Abstract: Following the 2007-2008 financial crisis, China’s “dual-pillar” framework for monetary

and macroprudential policy has become the primary means through which China’s central bank

regulates price stability and financial stability. This report measures China’s financial conditions index

using a time-varying parameter factor-augmented vector autoregressive model, conducting a mixed-frequency Granger causality test to measure the causality between this FCI and China’s consumer

price index, and further analyzing the dual-pillar framework using a constructed

financial volatility

index (FCIF) and price volatility index (CPIF). Results reveal a marked difference in the fluctuations and

trends of the gaps in the financial variables of the synthetic FCI. It is found that FCI has a leading effect on

economic growth as well as inflation, and that the causal relationship between FCI and CPI is ds: Financial Stability; Macroprudential Policy; Monetary Policy; Price uctionEver since the “New Consensus” monetary policy framework was established in the late

1970s, many countries have adopted both conventional and unconventional monetary policies

to regulate and control macroeconomic development as per their respective policy objectives.

A rule of enacting monetary policy aimed at stabilizing currency inflation took shape as a

result (Taylor, 1993; Fève et al., 2010). Specifically, the primary objective for monetary policy

in most countries before the recent 2007-2008 economic crisis was to stabilize prices and

　*Funding Programs: Key Program of National Social Science: Research on the Forming Mechanism of National

Economic New Normal, Tendency Features and Corresponding Monetary Policy (15AZD&001). Major Program of

National Social Science: Research on the Market Foundation, Systematic Mechanism, and Development Model Which

Leads the New Normal of Economic Development (15ZDC008). Major Program of National Social Science: Property

Price and Monetary Policy Regulation: Theoretical Simulation and Calculation Research (2018M631856).　** Changchun Pan, Research Assistant at School of Economics at Jilin University; Long Zhang, Business College at Jilin

University; Long Jiang, Business College at Jilin University.

China’s Dual-pillar Framework for Monetary and Macroprudential Policy:An Analysis Based on TVP-FAVR and MF-VAR Models· 139 ·promote economic authority would consider financial risk only in the condition

that the latter has a negative impact on forecasting currency inflation and economic growth.

The Jackson Hole consensus opposes making financial stability the primary objective of

monetary policy. (Bernanke and Gertler, 2001; Posen, 2006). The outbreak and spread of

the worldwide financial crisis in 2007 made economic theorists, academic communities,

and financial authorities realize that some fluctuations during the economic cycle cannot

be effectively controlled by monetary policy alone. Countries are now paying much more

attention to financial stability as a result (Li, 2009; Singh and Pattanaik, 2012).

Financial stability is critical for preventing financial risks and “gray rhinos” from

emerging in an economic system. It is also a strong guarantor for the healthy and stable

economic development of a nation on the whole. For a long time, the objectives for monetary

policy in China were economic growth, price stability, high rates of employment, and

financial stability, among others. However, a regulation and control model that uses a single

tool for multiple objectives often generates unpredictability in policy signals, and regulation

can be ineffective. Macroeconomic objectives have some time-phased features, and for

various economic goals sought at different stages of economic cycles, specific policy tools

would bring about different results. Some objectives demand the use of monetary policies,

while others require macroprudential policies. Some others need both (Liu and Zhang,

2018). However, in general the target for monetary policies would be the resolution of

economic problems on the whole, economic growth and price stability. Macroprudential

policies are most often utilized to sustain financial stability, in order to prevent or resolve

systematic financial risk. Note however, that these two policies are not independent of

one another, but rather have a mutual influence on each other (Zhang and Ji, 2017). Thus,

the establishment and refining of China’s dual-pillar framework for monetary policy and

macroprudential policy could be very useful for preventing systematic financial crises.1 Literature Review and Research DevelopmentThe outbreak and spread of the international economic crisis in 2007 made the monetary

authorities of every country realize that their policies should not only focus exclusively on

currency inflation and economic growth, but also take financial stability into consideration.

Many scholars have conducted theoretical and empirical studies on problems related

to price stability, financial stability, and monetary policies. The focus of those studies

is constructing dual-pillar framework through the financial stability indices and

macroprudential policy rs have analyzed the development of China’s dual-pillar framework of monetary