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| Stock Price Fluctuaions and Optimal Two-pillar Policy Regulations |
| XU Zhenyang, GONG Liutang, DONG Feng, XU Zhiwei
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School of Economics and Management, Tsinghua University;
The Institute for Advanced Studies, Wuhan University;
Key Laboratory of Mathematical Economics and Quantitative Finance, Peking University;
School of Economics, Fudan University; Shanghai Institution of Internatinal Finance and Economics |
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Abstract As China accelerates the construction of a modern central banking system and emphasizes the bottom line of preventing systemic financial risks, stock price fluctuation have emerged as one of the core challenges to macroeconomic stability. To address such risks, China is actively constructing a “two-pillar” regulatory framework that coordinates monetary policy with macroprudential policy. However, a fundamental question demands an urgent answer: In an economic environment with stock price fluctuation, how should the “two-pillar” policies optimally respond to economic shocks from different sources？ Traditional research mostly relies on fixed linear policy rules, often leading to generalized conclusions of “leaning against the wind”. Yet, these conclusions diverge significantly from the complex, discretionary practices of real-world policymakers.
To bridge the gap between theoretical models and policy practices, the core methodological innovation of this paper lies in employing the Ramsey optimal policy framework. Unlike the traditional approach of optimizing parameters for “optimal simple rules”, the Ramsey method takes the equilibrium equations of the entire economy as constraints and solves directly for the policy path that maximizes social welfare. The resulting optimal policy response functions are fully flexible and nonlinear, unconstrained by any preset structure, thereby revealing the truly optimal policy choices under different economic states and providing a robust theoretical foundation for “going beyond the Taylor rule”.
We construct a dynamic stochastic general equilibrium (DSGE) model that incorporates equity market and two-pillar policy tools. Stock prices can generate self-fulfilling fluctuations through collateral channels. Through parameter calibration and Bayesian estimation with the characteristics of the Chinese economy, we obtain four main findings.
Firstly, the choice of optimal two-pillar policies is not static but highly dependent on the nature of economic shocks. We overturn the conventional “leaning against the wind” paradigm and point out that when the economy faces positive fundamental productivity shocks, the optimal policy is a “tailwind” approach of “dual easing”, involving simultaneous interest rate cuts and relaxation of leverage ratios to encourage investment and fully seize growth opportunities. Conversely, when the economy faces positive sentiment shocks originating from non-fundamentals, the optimal policy is a “headwind” approach of “dual tightening”, raising rates and resolutely curbing excessive investment and protecting the real economy from irrational exuberance.
Secondly, compared to a single monetary policy, the two-pillar framework can significantly enhance social welfare. Its advantage lies in achieving an effective division of tasks among policy tools: macroprudential policy primarily regulates investment levels and maintains financial stability, while monetary policy can focus more on stabilizing inflation. This coordination breaks the difficult trade-off between “stabilizing growth” and “mitigating risks” faced by a single policy, enabling the economy to operate closer to the socially optimal state when facing shocks.
Thirdly, through comparative analysis, we find that the main flaw of optimal simple rules lies in their one-size-fits-all “leaning against the wind” approach, which erroneously suppresses investment under productivity shocks, resulting in welfare losses. To address this, we innovatively propose a “dual simple rules” scheme that is both optimal and operational, suggesting that policymakers switch between different simple rules under “productivity-dominated” and “non-productivity-dominated” modes based on the current economic environment, serving as a practical guide for approximately achieving Ramsey-optimal policies.
Lastly, in an extended model that more closely resembles Chinese reality by incorporating a large number of non-bankable firms, we find that rising stock prices in credit-accessible firms can generate positive “spillover effects”, thereby amplifying total investment. This mechanism necessitates that optimal two-pillar policies exercise greater caution during pro-cyclical easing and adopt more forceful measures during counter-cyclical tightening.
The research in this paper holds significant theoretical and practical value for the construction of China's modern central banking system. We not only provide a clear roadmap for the discretionary coordination under the two-pillar policies but also reveal the complex, dual role of equity bubbles in the economy. They are both sources of risk and potential tools for alleviating financial frictions. Our conclusions support the view that policymakers should construct a decision-making framework that goes beyond traditional rules and relies on in-depth macroeconomic analysis, harnessing rather than suppressing the energy of equity market prosperity through precise monitoring, expectation guidance, and differentiated regulation to serve high-quality economic development. Meanwhile, the “shock-dependent” policy paradigm proposed in this paper also holds profound implications for understanding and addressing asset price fluctuations in other key sectors like real estate.
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Received: 10 February 2025
Published: 13 October 2025
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