A Study On The Business Cycle Fluctuations And Monetary Policy In China During The Transition Period

Since the reform and opening up from 1978, China has been experiencing wild economic fluctuations. Meanwhile, money is playing an increasingly important role in the economy. The correlative dependence and interplay between the business cycle and the credit cycle has become the salient feature of the economy. In the face of these phenomena, it’s natural to ask: As the biggest transition economy in the world, what’s the regularities and characteristics of China’s business cycles? What’s the main driving force behand it? Furthermore, what’s the causal relationship between the business cycle and the credit cycle? Does the change in the money supply cause the business cycle or in the opposite direction? Answering the above questions are the main task of the paper.In the first part, the paper examines the empirical relationship during the reform and opening up period in China between the aggregate business cycle and various aspects of the macroeconomy, and documents the main stylized facts of macroeconomic fluctuations using the macroeconomic data of China from 1978 to 2013. We find that there are two main features of China’s business cycle. Firstly, the transitional period falls into two stages, the first stage is from 1978 to 1990, in which the economic fluctuations are attributable to supply shock, while in the latter stage beginning from 1991 to present, the volatility of the output becomes smaller and mainly be driven by the demand shock; secondly, the ratio of the employee in the first industry over that in the second and tertiary industry is strongly counter-cyclical, which shows the phenomenon that the rural surplus labor force flow into the city when the economy is prosperous, otherwise return back to the countryside.Based upon the anylsis in the first part, the paper examines the relationship between the business cycle and the credit cycle in China using a SVAR model, which integrates monetary policy behavior with the banking system, demand for money aggregate, and the real economy. Different from the existing research, we distinguish between the ‘required reserve rate’ and the ‘open market operation’, and identify the impacts of the two policy instruments simultaneously. The empirical results show that the PBC’s responsibility for controlling inflation and stabilizing the aggregate demand is mainly represented by the adjustment of the required reserve rate, and the ‘open market operation’ accounts for the monetary authority’s concern on the liquidity management of commercial banks. Furthermore, we find that monetary policy shock is not the main driving force for the business cycles in China, whereas a large fraction of the variation in monetary policy is attributable to the systematic reactions of policy authority to the state of the economy.Finally, we summarize some issues and directions for further research on China’s business cycle. To provide a guidance for the policy analysis and decision making, it’s necessary to construct a quantitative macroeconomic model that incorporates the key features of the business cycle. Needless to say, it’s a challenging task both for the researchers and policy makers, and much remains to be done.