On The Causes And Welfare Cost Of Business Cycle In China

Economic growth and business cycles are two equally important aspects in macroeconomics. Since the adoption of reform and open policy, the Chinese economy experiences thirty years of high growth, which is a remarkable achievement. Along with high growth, there are also large fluctuations during this period. For instance, the GDP growth rate reached 15% in 1984 and 1992, while it plummeted to 4% in 1990. The gap exceeds 11 percentage points. Facing fluctuation of this extent, a natural question is:what is the main cause of Chinese business cycle? How large is the welfare cost of business cycle in China?These are some studies conducted by Chinese scholars attempting to find the cause of Chinese business cycle. However, some of these studies may lack depth and also overlook several important factors. Many Chinese economists hold different views on the cause of business cycle in China. For example, some scholars argued that Chinese business cycles are caused by the exogenous stochastic shocks such as technology, monetary and government spending shocks, etc,. Others argued that some characteristics of Chinese economy such as low level of financial development, soft budget constraint in state owned enterprises, inefficient allocation of scarce resources, political business cycles and so on are the main causes of business cycles in China.This paper attempt study the cause of Chinese business cycles from the perspective of news shocks. With the development of Chinese economy, the uncertainty and risk faced by economic agent (households, firms and government) is increasing. We believe that the deeper cause of the short-term demand and supply fluctuations is change of expectation formed by economic agents (households, firms and government) on future economic situations. We take notice that Lin(2007) and Lin, Wu and Xing (2009) share similar view. Lin (2007) first proposed that Chinese macroeconomic fluctuation could be caused by the change of expectation formed by economic agents on the prospect of certain industries. However, Lin (2007) didn't give a proper theoretical explanation from a macroeconomic perspective. This study will fill this gap. We first review the relevant literature in chapter 2, and define the business cycle caused by news shocks (news driven business cycle or NDBC). NDBC has following characteristics: business cycle co-movement among consumption, hours, investment, and output under news shocks. Then we construct a structural model in which news shocks could generate NDBC. Since the RBC model is the workhorse model in business cycle, we construct an extended RBC model by introducing news shocks into standard RBC model in chapter 3. The main purpose of chapter 3 is to study how to incorporate expectation shocks into business cycle model. Our analysis shows that news shocks cannot generate NDBC in RBC model, which is a main drawback of chapter 3.Taking the drawback in chapter 3 into account, we first build a simple DSGE model with news shocks in chapter 4. We introduce two kinds of real frictions, namely habit persistence in consumption and adjustment cost in investment, since both of them are the main factors that news shocks can generate NDBC. Then we use Bayesian method to estimate how much of predicted aggregate fluctuations since the adoption of reform and open policy could be explained by news shocks. We find that news shocks are the main force driving the business cycles in China. News shocks could account for over two thirds of predicted aggregate fluctuations in china. Finally we build a large DSGE model without nominal frictions based on the simple DSGE model in order to check the robustness of conclusion of the simple model. We find that the conclusion of simple DSGE model is robust.After the discussion of the cause of Chinese business cycles, we turn to question of welfare cost of business cycles in China, which is a natural extension of our study on business cycles. If economic fluctuations are not a social problem, it is unnecessary for economists to study the cause of business cycles. To ensure integrity of the structure of this paper, we consider the welfare cost of Chinese business cycles in chapter 5.In contrast with the view that the welfare cost of business cycles in China is very small held by many Chinese scholars, we show that the welfare cost of business cycles in China is very large in chapter 5. This is due to the fact that almost all other Chinese scholars employ the Lucas model and its extended models to study it. However, in the spirit of Barro (2007,2006) and Salyer (2007), our model assumes that the consumers face not only the economic fluctuation in usual sense which could be described by second momentum of consumption, but also the low probability "disaster" events such as the great depression and financial crisis.