Financial Stability, Inflation And Economic Growth

Ever since financial crisis, central banks all over the world have realized that it is not sufficientto ensure macroeconomics stability only through economic growth and price stability by inflationmanagement, as a stable status of all the key functions of the financial system effectivelyimplemented, the coordinated development between financial market and real economy, the efficientprocession in financial market of key partition such as resource allocation, risk management,settlement and so on, the shock-absorbing and interference resistance ability from exogenousuncertainty, financial stability has gradually become the primary policy objective of central banks.Since the accession of WTO, Chinese financial system has faced massive risk and challenge,aside with price stability and economic growth, maintaining financial stability has become a criticalpolicy target from monetary authority, the enhancement of Chinese financial stability systemdemands immediate attention. The report of the18th National Congress of CPC clearly implied thatone of the key tasks from next4years’ development plan of the country is to improve financialsupervision, promote financial innovation, activate the banking, securities, insurance and otherindustries competitiveness and safeguard financial stability. At present, China’s economy isexperiencing a critical period of transition, facing severe and complicated international economicenvironment, the research of “financial stability, inflation and economic growth” will provide usefulreference to the balance, coordination and sustainability of China’s economy development. Inaddition, in current situation, the foundation of China’s “financial stability” theoretical system juststarts, with many areas to be explored, and has not yet formed a sound framework. Thus, thetheoretical and empirical research based on financial stability is a useful supplement to thetheoretical system of financial stability, having important theoretical and practical significance.In this dissertation, we present the main theory of financial stability, build the China FinancialStability Index (FSI) based on IMF financial soundness indicators and other studies, analyze theindex according to actual facts happened in China, and study the relationship between financialstability and price stability, the monetary policy rule integrated with financial stability factor, therelationship between financial stability and macroeconomic performance, and the relationshipbetween financial stability and economic growth with different kinds of econometrics methods.Firstly, in this dissertation, according to the actual situation of china, we build the ChinaFinancial Stability Index, and analyze the status and trend of Chinese financial stability. From the overall trend, the stability of China’s financial system showed a trend of steady improvement from2004; from volatility point of view, in the period from2005to2006and from2007to the end of theinterim period during2009, China’s financial stability shows obvious volatility; from the horizontalvalue point of view, China’s financial system stable state is divided into the following three phases:first phase, from early2004to mid-2007, China presented the overall financial stability of the bettertrends; second phase, from early2007to mid-2010, the Chinese financial stability appeared violentfluctuations, which showed trough in mid-2009and peak at the end of2007; third phase, from2010to late2013, China continued steady improvement of financial stability, volatility was quite small.Secondly, in this dissertation, based on FSI built before, we use markov regime switchingmodel to analyze the relationship between China’s financial stability and price stability. Researchshows that in China, financial stability not only helps price stability, financial stability can also beexplained by price stability; price stability and financial stability is commonly in moderate negativecorrelation, as in low levels of inflation is prone to financial stability. At the same time, the impacton prices of financial stability has significantly reduced during time; it not only helps to reduce thelevel of inflation values, but also helps in reducing its volatility.Thirdly, in this dissertation, based on the standard linear interest rate rules, we introduce theterm of financial stability gap to the rule to examine whether China’s central bank concerning aboutthe financial stability factor while implementing monetary policy. Through interest rate rules modelparameter estimation of the interest rate rule integrated with financial stability factors, we find thatthe interest rate adjustment parameters to financial stability gap is not significant, suggesting that themain attention of implementation of monetary policy with financial stability in China’s central bankis not high. This is mainly because the low level of China’s interest rate market openness, thetransmission mechanism transferred monetary policy signals to financial market is not complete,which is main direction for financial system regulation in future. With the accelerating process ofChina’s market-oriented interest rates, the use of market-based instruments in the financial marketsfor financial regulation and supervision is the key to future financial market stability.Fourthly, in the dissertation, we estimate a simple economic system using VAR model andTVP-VAR model to analyze the relevance of financial stability, inflation and broad money supply.Studies have shown that compared to the VAR model, TVP-VAR model is more robust; during thesample period, although the impact of inflation and the money supply do not produce structuralchanges in affecting the financial stability mechanism, but in the wake of the financial crisis, theperiod of positive money supply shock negatively impacting on the financial stability index issignificantly shortened, and the dependence of financial stability and inflation is also weakened, which is conducive to the government and monetary authorities to treat both goals separately withmacro-control in order to achieve multiple macro-control goals.Finally, in this dissertation, we analyze the impact mechanism of economic growth on thefinancial stability using fixed parameter and time-varying parameter state space model, and usemarkov regime switching model for robustness test. Estimation results for fixed parameters modelindicate that the economic growth to financial stability have significant inhibitory effect; while thatfor time-varying models indicate the model fitting results is improving and note the apparenttime-varying characteristics on the impact of economic growth on the financial stability. In thesample period, the impact of economic growth on financial stability shows a gradual upward trendduring2004-2007, and inhibitory effect is decreasing; during2007-2012, the impact of economicgrowth on financial stability transfers from negative to positive for the first time, but then quicklyturns negative again; after2012, as China’s economic growth rate began to decrease, the impact ofeconomic growth on the financial stability shows an obvious pull effect. Robustness test resultsfurther confirmed the previous conclusion.