The declining effectiveness of China’s monetary policy in recent years has attracted considerable attention. Current literature predominantly focuses on the zero-interest rate environment where policy space is exhausted, neglecting its impact under conventional (non-zero rate) conditions. To address this gap, this paper systematically investigates how narrowed monetary policy space affects policy effectiveness during conventional (non-zero rate) periods. Using the monetary policy space index of the macro policy trinity database from Q1 2000 to Q4 2022 and nonlinear local projection (LP) methods, it empirically examines the impact of monetary policy space on monetary policy effectiveness and also identifies the transmission mechanisms.

Benchmark regression shows that the effectiveness of monetary policy is significant when policy space is ample, but becomes negligible when space contracts. Mechanism testing confirms two core pathways: the policy strength mechanism, wherein narrowed space reduces the strength of monetary operations, thereby attenuating effectiveness; and the confidence mechanism, whereby space contraction weakens confidence of market participants, further impairing policy transmission. The results imply that policymakers should prioritize growth-stabilizing measures during economic downturns rather than excessive space preservation. Concurrently, bolstering market confidence is essential when policy space is constrained.

This paper makes two contributions to the literature: The first contribution lies in extending the analytical scope beyond the zero-interest rate paradigm—the exhausted policy space scenario predominantly examined in prior studies. This paper pioneers systematic investigation into how monetary policy space contraction affects monetary policy effectiveness under conventional (non-zero rate) conditions, elucidating underlying transmission mechanisms and enriching the existing literature. The second innovation addresses methodological limitations. Whereas extant research focuses mainly on price-based instruments (e.g., interest rates), this paper introduces the monetary policy space index of the macro policy trinity database, which is a comprehensive metric integrating both quantitative and price-based tools. This advancement delivers improved alignment with China’s monetary operations in practice.