it is being tightened, but chanages in the rrr have larger effects on loan rates when monetary policy stance in being tightened than when it is loosened. In addition, changes the market interest rates have larger effect on loan size when being loosened than when it is being tightened The rest of the paper is organized as follows. The next section briefly reviews the institutional background of the Chinese monetary policy framework and the banking sector. Section 3 develops a simple theoretical model and discusses its predictions Section 4 describes the specifications of empirical models and the estimation strategy Section 5 describes the data and discusses sample selection. Section 6 reports the estimation results and discusses two caveats. Section 7 concludes the paper 2. Institutional Background 2.1 The monetary policy framework in China According to the Law on the People's Bank of China, "the aim of monetary policies shall be to maintain the stability of the currency and thereby promote economic growth. Thus the pbc has a dual mandate. similar to that of the us Federal reserve. Even though it is not explicitly stated in the law, there is also an understanding that the PbC has the mandate to maintain the stability of the Chinese financial system, reflecting its role as the lender of last resort. The policy implementation framework has evolved since the mid-1990s from relying on quantity-based instruments into a mixture of both quantity and price-based instruments. (He and Pauwels, 2008) Key to a good understanding of China's monetary policy framework is the"dual-track interest-rate system: on the one hand, bank deposit and lending rates are regulated by the central bank (i. e, the imposition of a deposit-rate ceiling and a lending- rate floor ) on the other hand, interest rates in money and capital markets are market-determined. At the same time, the ceiling or the floor may not necessarily be binding in practice. The deposit-rate ceiling is generally considered binding while actual lending data since 2004 suggests the lending- rate floor is generally not binding(He and wang, 2012) Price distortions (rates ceiling and floor)in the banking system mean that the pbc m also rely on quantity-based instruments to achieve its targets. For example, a lower Qust deposit rate ceiling(compared to its equilibrium level) causes the loan supply curve of commercial banks to shift to the right(Graph 1, S1>S2), where Si is the loan supply curve without the deposit rate ceiling. The shifted loan supply curve(S2)means that banks are willing to lend to firms at lower loan rates because the funding cost of banks (deposit rate) is lower than it should be(P2<Pl). Meanwhile, firms' loan demand is higher than its equilibrium level due to cheaper rates( Q2>Q1). This means that both commercial banks and firms benefit from lower loan rates but at the expense of depositors in the economy who receive lower rates on their deposits However, the new equilibrium under the deposit rate ceiling(P2, Q2)means that there will be more credit(Q2>Q1)in the economy compared to its original equilibrium(Pl4 it is being tightened, but chanages in the RRR have larger effects on loan rates when monetary policy stance in being tightened than when it is loosened. In addition, changes in the market interest rates have larger effect on loan size when monetary policy stance is being loosened than when it is being tightened. The rest of the paper is organized as follows. The next section briefly reviews the institutional background of the Chinese monetary policy framework and the banking sector. Section 3 develops a simple theoretical model and discusses its predictions. Section 4 describes the specifications of empirical models and the estimation strategy. Section 5 describes the data and discusses sample selection. Section 6 reports the estimation results and discusses two caveats. Section 7 concludes the paper. 2. Institutional Background 2.1 The monetary policy framework in China According to the Law on the People’s Bank of China, “the aim of monetary policies shall be to maintain the stability of the currency and thereby promote economic growth.” Thus, the PBC has a dual mandate, similar to that of the US Federal Reserve. Even though it is not explicitly stated in the law, there is also an understanding that the PBC has the mandate to maintain the stability of the Chinese financial system, reflecting its role as the lender of last resort. The policy implementation framework has evolved since the mid-1990s from relying on quantity-based instruments into a mixture of both quantity￾and price-based instruments. (He and Pauwels, 2008). Key to a good understanding of China’s monetary policy framework is the “dual-track” interest-rate system: on the one hand, bank deposit and lending rates are regulated by the central bank (i.e., the imposition of a deposit-rate ceiling and a lending-rate floor); on the other hand, interest rates in money and capital markets are market-determined. At the same time, the ceiling or the floor may not necessarily be binding in practice. The deposit-rate ceiling is generally considered binding while actual lending data since 2004 suggests the lending-rate floor is generally not binding (He and Wang, 2012). Price distortions (rates ceiling and floor) in the banking system mean that the PBC must also rely on quantity-based instruments to achieve its targets. For example, a lower deposit rate ceiling (compared to its equilibrium level) causes the loan supply curve of commercial banks to shift to the right (Graph 1, S1
S2), where S1 is the loan supply curve without the deposit rate ceiling. The shifted loan supply curve (S2) means that banks are willing to lend to firms at lower loan rates because the funding cost of banks (deposit rate) is lower than it should be (P2<P1). Meanwhile, firms’ loan demand is higher than its equilibrium level due to cheaper rates (Q2>Q1). This means that both commercial banks and firms benefit from lower loan rates but at the expense of depositors in the economy who receive lower rates on their deposits. However, the new equilibrium under the deposit rate ceiling (P2, Q2) means that there will be more credit (Q2>Q1) in the economy compared to its original equilibrium (P1