Evaluating McCallum rule as a policy guideline for China

Abstract

Economists have reached a consensus that central bank can improve their policy efficiency by following a monetary policy rule. Given that money supply is the principal policy instrument of the People's Bank of China (PBC) and its monetary targeting regime, this paper utilizes the counterfactual simulation method to evaluate the feasibility of the McCallum rule as a policy guideline for China in two simple macroeconomic models. The simulation results show that following the McCallum rule could significantly reduce China's nominal GDP fluctuations. The analysis shows that a rule-specified path for monetary base changes could be used as a benchmark for PBC's policy decision. Therefore, we strongly advocate that the PBC adopt the McCallum rule as its policy guideline in future policymaking.

Keywords:

• McCallum rule
• PBC's policy guideline
• counterfactual simulation method

JEL classifications:

• E42
• E52

Notes

1. The simple policy rules refer to a simple feedback instrument rule, which is derived from the first order conditions of the central bank's welfare maximization subject to the economic situation in which the monetary policy rule operates (Kalin 2002).

2. In Macroeconomics, the word “path” describes the locus of a variable changes over time.

3. NGDP and MB stand for nominal GDP and monetary base in level.