Monetary policy in China and Egypt: Can Egypt play the Chinese game?

Abstract

Despite the similarity between the Chinese and Egyptian monetary policies, the outcomes of the policies are profoundly diverse. China's inflation rate was always lower than Egypt's, while its growth rate totally surpassed it. This study attempts first, to compare the monetary policy transmission mechanisms in China and Egypt; second, to evaluate Egypt's readiness to replicate the Chinese paradigm by examining the main monetary policy instruments responsible for China's relatively low inflation and high growth. The paper uses Granger causality tests, a variance autoregressive (VAR) model, impulse response functions (IRF) and variance error decomposition (VDC) analyses to test for the main monetary policy instruments affecting growth and inflation in China and Egypt. Results prove that in the short run, replicating China's policy in Egypt would not be fruitful to Egypt. IRFs have shown that appreciation of the yuan immediately slows down growth, while appreciation of the Egyptian pound increases GDP for two years before it starts decreasing again. Increasing the interest rate decreases growth in China and Egypt as well; but the effect of interest rate on output is much weaker in China than in Egypt. However, the Chinese paradigm, focusing on low exchange and interest rates, may be may be fruitful in Egypt if the long run effect is targeted, since such policy would boost output without significantly affecting inflation. With respect to inflation, results indicate that the interest rate as a monetary policy transmission mechanism is weak in both countries. The exchange rate in China was still the most dominant factor affecting prices, while in Egypt both the exchange rate and interest rate contributions to price changes were modest. If the significance of interest rate as a monetary policy transmission mechanism in Egypt is weak in affecting inflation but crucial in influencing growth, then probably the growth target rather than the inflation target, should receive priority by Egyptian policy makers when shaping this policy instrument. EuroJournals Publishing, Inc. 2011.