Abstract: On June 13, 2023, the People's Bank of China lowered the 7-day OMO (Open Market Operation) rate by 10 basis points, and simultaneously reduced the 7-day SLF (Standing Lending Facility) rate by 10 basis points. This adjustment is a manifestation of the interest rate corridor mechanism. Since the 1990s, central banks of major economies have often utilized interest rate corridor mechanisms to regulate short-term interest rates. Since 2015, China has gradually developed its own interest rate corridor mechanism, with the 7-day reverse repurchase (OMO) rate in open market operations serving as the short-term policy rate, and the 7-day SLF rate acting as the ceiling, while the excess reserve interest rate serves as the floor.
In general, the short-term market interest rate, DR007, has operated within the corridor range, and there has not been a breach of the ceiling or the floor of the corridor. However, the effectiveness of the interest rate corridor in stabilizing DR007 near the 7-day OMO rate is not particularly evident. This is mainly manifested in three aspects: (1) The volatility of market interest rates has decreased compared to the past but remains relatively high internationally. (2) When policy rates and corridor width remained unchanged, there was a notable sustained deviation of the average DR007 rate from the 7-day OMO rate. (3) When policy rates and corridor ranges remained unchanged, there was a tendency for unilateral adjustments in the DR007 rate.
Excessive volatility in short-term market interest rates can lead to issues such as blurred signals in monetary policy. Therefore, drawing on international experiences and domestic conditions, this paper systematically examined the fundamental elements of China's interest rate corridor and arrived at the following conclusions:
(1) A symmetrical model of the interest rate corridor is more suitable for China. First, the liquidity in China's financial system is reasonably abundant. Second, the symmetrical model has been proven effective through verification in numerous countries over an extended period and is more easily understood by the market. (2) The interest rate corridor in China is too wide. It is recommended to initially reduce it to a width of 200 basis points and gradually narrow it further based on the development of the interbank market to reach a desirable level. (3) The SLF and excess reserve interest rates conform to the operational principles of the interest rate corridor and do not exhibit significant frictional factors. They are appropriate tools for setting the upper and lower limits of the corridor. (4) The trading counterparties of the interest rate corridor in China are limited to depository financial institutions. This aligns with the current state of development in China's financial markets and is consistent with using the DR007 rate, which does not reflect the risk of non-bank institutions, as the market benchmark interest rate. The current scope of trading counterparties is deemed appropriate.
In sum, it is recommended to optimize China's interest rate corridor mechanism as follows: adopting a symmetrical interest rate corridor mechanism, with the 7-day OMO rate as the short-term policy rate, the 7-day SLF rate as the ceiling and the excess reserve interest rate as the floor, with a width of 200 basis points (gradually narrowing if necessary). For ease of communication and adjustment, the ceiling and floor of the interest rate corridor should be concurrently adjusted when modifying the OMO rate in the future, with proper explanations provided. Other key policy tool rates, such as the Medium-term Lending Facility (MLF), should also be adjusted in response to changes in the interest rate corridor. Meanwhile, the central bank should establish a more effective communication mechanism with the market.
