The debate on the effectiveness of monetary policy has been going on for long. The real business cycle theory, which assumes a complete market and completely flexible prices, considers the monetary policy neutral, because it affects the nominal price only, with no effect on the real economic variables such as output and interest rate. However, the New Keynesian theory, which assumes an incomplete market and nominal rigidities, considers the monetary policy no longer neutral, and as affecting several real economic variables and leading to economic fluctuations in the short run. New Keynesian economics modified real business cycle method and add nominal rigidities, various shocks and frictions to construct the new Keynesian model, which is called Dynamic Stochastic General Equilibrium (DSGE) model. For the efficient implementation of monetary policy, it is important to understand the spillover effects of monetary policy to the real economy. To this end, this study investigates the effects of monetary policy on each part of the Chinese real economy. This paper estimates a closed medium-scale dynamic stochastic general equilibrium (DSGE) model and presents the dynamic monetary policy shock effects on the Chinese economy. We estimate some important parameter values by applying the Bayesian approach to quarterly data of three Chinese macroeconomic variables, output, consumption, and inflation, for the period from 1992:1 to 2018:4. The closed medium-scale DSGE model shows that a positive monetary policy shock has negative effects on the output, consumption, investment, labor, inflation, wage, and government consumption, whose values go down in the first period but then rise and finally revert to the steady-state values. Conversely, a negative monetary policy shock has positive effects on the output, consumption, investment, labor, inflation, wage, and government consumption in the short run. Our results are consistent with the findings of Smets and Wouters (2003, 2007) and Christiano, Eichenbaum, and Evan (2005).
2. Literature Review
3. The Dynamic Effects of Monetary Policy
3.1 Medium-scale DSGE model economy
3.2 Steady state
3.3 Parameters estimation
3.4 Impulse responses