An Analysis of Financial Stress in the Chinese Economy: A TVAR Approach

University essay from Lunds universitet/Nationalekonomiska institutionen

Abstract: In this paper, we look to develop understanding of the nature and potential impact of financial stress and fiscal shocks in the Chinese economy, examining how such stress spreads through the economy and how monetary policy can exaggerate or mitigate the resultant effects. In order to do so, we construct a TVAR model on Chinese quarterly data. To achieve that we develop a financial stress index comprising of four distinct sub-indices, each covering a key sector of the domestic economy and designed with the specificities of the Chinese economic landscape in mind. The model shows that China experiences apparently cyclical periods of financial stress, resulting from both exogenous and endogenous sources, and the shock impulse analysis provides a dynamic illustration of how our chosen dependent variables of GDP growth, Inflation and CHIBOR react to shifts in the economic environment. We demonstrate how shocks which occur during the high stress regime typically produce a greater impact on the economy and discuss how policy responses to the occurrence of such shocks can be better guided.

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