Undergraduate Honors Theses

Thesis Defended

Spring 2016

Document Type

Thesis

Type of Thesis

Departmental Honors

Department

Economics

First Advisor

Robert McNown

Second Advisor

Martin Boileau

Third Advisor

William Wei

Abstract

The Taylor Rule effectively describes the relationship among nominal interest, inflation rate and output gap in the United States, assuming the country has a closed economy. This paper positively analyzes the efficiency of the Taylor Rule in China through historical analysis. I evaluate the responsiveness and effectiveness by estimating the Taylor Rule and its modifications, using quarterly data in the period 1987Q1 to 2015Q3. The original Taylor Rule does not work well based on the current Chinese monetary policy. However, adding a lagged nominal interest rate in the previous period can help the model to work better. The nominal interest rate responds actively to both the inflation rate and the output gap. Using a specific information set can help to forecast the change in the nominal interest rate. The exchange rate also plays an important role in improving the model.

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