We exploit the unique institutional features of Chinese bond markets to estimate the causal effect of collateral-based monetary policy on asset prices and the real economy. A policy change allowed certain bonds to be used as collateral for the Medium-Term Lending Facility in the interbank market, while the same bonds in the exchange market remained ineligible. This change reduced the spreads of the newly eligible bonds by 37-53 basis points, or 10%-15% of the average spread in the secondary interbank market, with a strong pass-through rate of 67 to over 100% to the primary interbank market.
