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December 2015 issue
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Interest Rate Determination in China: Past, Present, and Future

by Dong He,a Honglin Wangb and Xiangrong Yub

Abstract

How should we think about the determination of interest rates in China after interest rate liberalization? Would effective deposit rates, lending rates, and bond yields move higher or lower? We argue that interest rates in a liberalized environment would need to be anchored by monetary policy. To achieve price and output (or employment) stabilization, the policy rate should be set close to China’s equilibrium or natural rate. We sketch three preliminary approaches to estimation of the natural rate. Based on this analysis, we argue that interest rates on large deposits and short-term money-market rates would likely move higher following liberalization. The effect on effective lending rates is somewhat ambiguous, as the contestability of the banking sector and the competition from the bond markets are likely to increase. We leave the determination of the curvature of the yield curve to future research.

JEL Codes: E43, E52, O53, P24.

 
Full article (PDF, 23 pages, 1270 kb)


a International Monetary Fund
b Hong Kong Monetary Authority