Abstract:
The paper empirically analyzes the effect of positive oil price shocks on China's economy, having special interest
in the response of the Chinese interest rate to those shocks. Using different econometric models, i) a time-varying
parameter structural vector autoregression (TVP SVAR) model with short-run identifying restrictions, ii) a
structural VAR (SVAR) model with the short-run identifying restrictions, and iii) a VAR model with orderingfree
generalized impulse response VAR (GIR VAR), we find that the response of the Chinese interest rate to the
oil price shocks is not only time-varying but also showing quite different signs of responses. Specifically, in the
earlier sample period (1992:4–2001:10), the interest rate shows a negative response to the oil price shock,
while in the latter period (2001:11–2014:5) it shows a positive response to the shock. Given the negative
response of the world oil production to an oil price shock in the earlier period, the shock is identified as a negative
supply shock or a precautionary demand shock as suggested by Kilian (2009), thereby the negative response of
the interest rate to the oil price shock is deemed as economy-boosting. The positive response of the interest rate
to the oil price shock in the later period, given that this shock is identified as a positive world oil demand shock,
gives evidence that stabilization of inflation is one of the main objectives of China's monetary authority, even
though the current main objective of the monetary policy is characterized as “maintaining the stability of the
value of the currency and thereby promoting economic growth.” Finally, the variance decomposition results
reveal that the oil price shock becomes an increasingly important source in the volatility of China's interest rate
