Commitment or Discretion? An Empirical Investigation of Monetary Policy Preferences in China

Despite the fact that China has become the second largest economy in the world, its monetary policy is yet to be understood by the outside observers. In this paper we estimate the policy preferences of China's central bank by confronting a small-scale microfounded New Keynesian DSGE model in which monetary policy is described by commitment or discretion with the Chinese macroeconomic data over the period from 1992Q2 to 2017Q4. Bayesian model comparison reveals that the data favours discretionary monetary policy. Estimates of the loss function weights under both cases show that the leading policy goal is price stability, followed by output stability and then interest rate smoothing. Finally, through counterfactual analyses we assess how macroeconomic outcomes might improve had the Chinese central bank been able to commit