Abstract:
Since the 1980s, the monetary policy framework in developed countries and many middle-income countries has realized the transition of the intermediate targets from monetary aggregates to interest rates. During or after this transition, many countries adopted the interest rate corridor. This paper developed several theoretical models to describe the mechanism of interest rate corridor. We found that: (1) A interest rate corridor can reduce the market interest rate volatility by guiding market expectations more effectively; (2) a interest rate corridor can reduce the "hoarding demand" of market liquidity, and reduce the open market operating cost of central banks; (3) the optimal width of an interest rate corridor is a function of interest rate sensitivity, the policy operating cost, as well as the frequency and amplitude of external shocks. We suggest that China should establish an interest rate corridor during the process of the monetary policy framework transition, in order to reduce interest rate volatility, enhance the market acceptance and benchmark of the policy rate in the future, and provide a foundation for the effective transmission of the policy rate.
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