How Does China's Tight Monetary Policy Affect the Inflation: A Structural Dynamic Factor Model Approach

For the first time, this paper investigates the impact of China's tight monetary policy on inflation based on 82 monthly macroeconomic and policy indicators from 2000:1 to 2011:3, using a structural dynamic factor model approach. China's macroeconomic and policy indicators include interest rate, money supply, investment, consumption, industry output, foreign trade, prices and stock markets. Main findings are as follows: (1) Tight monetary policies will help China to tame inflation, and the price puzzle is solved by considering a large amount of macroeconomic variables, (2) The increase in interbank offered rate and deposit reserve ratio is more effective to reduce the prices level, (3) Relatively to consumption and industrial output, the influence of tight monetary policy shock on prices lasts longer.