The Post-COVID-19 Economic Policy Uncertainty and the Effectiveness of Monetary Policy: Evidence From China

Abstract

The outbreak of the COVID-19 pandemic has caused an upsurge economic policy uncertainty (EPU). Study on the time-varying effect of EPU is of substantial implication for the central bank in implementation of monetary policy. To empirically investigate the time-varying effect of EPU, the paper considers the shock of the monetary policy implemented by China's central bank on different economic variables including interest rate, output gap, and inflationary gap using the latent threshold time-varying parameter vector autoregressive model (LT-TVP-VAR Model). Data period is chosen to be January 2015 through April 2021. Our findings show that (i) EPU has a significant threshold effect on the shock of quantitative monetary policy instrument and the shock of price-based monetary policy, and that the two types of policy are positively correlated; (ii) the price-based monetary policy instrument has a significant counter-cyclical effect on both output gap and inflationary gap; (iii) relative to the quantitative monetary policy instrument, the price-based monetary policy instrument has a more significant counter-cyclical effect on output gap; and (iv) a higher level of EPU is associated with a more significant monetary policy effect on output gap and inflationary gap.

Keywords: China; EPU; LT-TVP-VAR model; counter-cyclical; monetary policy.