Abstract: This paper constructs a model of an open economy with the financial accelerator including nominal and real rigidity to study the spillover effects of the Chinese economy and China's policy response to the Fed's interest rate raise. By Bayesian estimation and numerical simulation, we find that after Fed rate raise, domestic interest rates show a "hump" shaped rising, the spot exchange rate depreciates and the exchange rate appreciates lightly in the long-term. Currency devaluation makes a sharp drop in demand for imports and a surge in exports. Domestic inflation spurs. Real interest rates raise makes consumer generate intertemporal substitution and domestic consumption remains in the doldrums. The corporate external financing costs rise and the domestic investment plummets because of the financial accelerator effect. Thus, after the Federal Reserve raised its interest rates, China's total domestic demand, export demand, net output increased while inflation spurred. Further analysis on the performance benefits shows that if the monetary authority implements single optimal monetary rules, it can greatly improve the social welfare. Based on this, we put forward relevant recommendations of monetary policy and exchange rate regime reform.

Key words: interest rate parity, exchange rate appreciation, financial friction, monetary policy rules