Macroeconomic Effects Of Local Government Debt:A Systemic Risk Approach

In recent years,China has emphasized the importance of preventing and controlling systemic financial risks.Among them,high local government debt is an important source of systemic financial risks.Local government debt has entered the balance sheet of the financial sector,causing local government debt risk to be closely linked to financial sector risk and having an impact on the macro economy.Understanding the interaction between local government debt risk and financial risk and preventing systemic financial risk are important research issues at the moment.Based on the approach of systemic financial risks(Financial sector risks worsen risks of the real economy,Bernanke,2009;He and Krishnamurthy,2014),this dissertation comprehensively explores the macroeconomic impact of local government debt.This dissertation builds a framework for quantifying local government debt risk and financial sector risk transmission,understanding China's systemic financial risk accumulation and contagion mechanism.Based on the framework of mutual contagion of local government debt risk and financial sector risk,we discuss other potential channels for the impact of this fiscal-financial linkage on macroeconomy:First,we discuss the impact of fiscal-financial linkage on fiscal policy effects;Furthermore,based on the introduction of heterogeneous enterprises based on this framework,the credit misallocation effect of local government debt was discussed;Finally,a multilocal government debt risk model is constructed to examine the dynamic correlation of local government debt risk between regions.First,this dissertation constructs a DSGE model in which the financial sector holds local government bonds with default risk and is subject to leverage constraints,and then conducts a global nonlinear solution to characterize the double-helical risk structure of China's local government debt risk and financial sector risk which are closely interdependent.The paper explores the risk transmission mechanism,quantify the degree of risk dependence and then conduct policy analysis.The research in this paper shows that the local government debt risk and the financial sector risk are mutually reinforcing,local government debt default risk increases financial risk and transmits to the real economy,while financial sector risk passes through direct balance sheet channels and indirect general equilibrium effect channels.Historical decomposition shows that local debt can explain 25.57%of the financial sector risk,of which 5.87%is attributed to default risk,the financial sector risk can explain 78.79%of the local government debt yield spread.The policy analysis shows that the policy of extending the term of debt will amplify the economic recession of the default risk through the financial risk channel when the default risk remains unchanged.Secondly,based on the basic debt-financial framework,I introduce fiscal and tax policies,using data to estimate model parameters and examined the impact of local government debt on the macroeconomic effects of tax cuts.This dissertation finds that:tax cuts can alleviate the downward pressure on the economy.However,tax cuts have also worsened the local government's fiscal state,resulting in rising local government debt and crowding out bank credit resources.On the other hand,the rise in local government debt has caused an increase in default risk,which has damaged the balance sheet of the financial sector and weakened the economic effects of tax cuts;local government debt has amplified its own economic recession effect through financial pressure;counterfactual analysis shows that by digesting the local government's debt stock can effectively improve the macroeconomic effect of tax cuts.Third,this dissertation introduces heterogeneous enterprises based on the basic framework.I develop a new Keynesian DSGE model with state-owned and privateowned firms,financial sectors and local governments to analyze the impact of local government debt accumulation on credit allocations and economic dynamics.I estimate the model and numerically find that:A rise of local government debt crowds out credits to firms,more for private-owned firms,and reduces the total factor productivity;If the local government debt grows 3.9%quarterly as in the 2009-2018 period,on average the credit ratio of state-owned/private-owned firms would increase 24.2%,the TFP would fall 1.7%,and the output would decline 7.2%;Counterfactual policy analysis shows that financial sector reforms,state-owned enterprises reforms,stronger countercyclical monetary policy and loan facilitation policies for private enterprises can alleviate the distortional effects of credit misallocation of local government debt.Finally,a multi-level government consistent with China's reality is introduced into the basic framework,and a dynamic stochastic general equilibrium model including the central government,local governments of two regions,and the interbank market is constructed to quantitatively analyze the regional spillover effects of local government debt risks and their transmission mechanism.The numerical simulation analysis of the model found that:the risk of local government debt in one region will be transmitted to other regions,which will increase the premium of local government debt in other regions;interregional debt risk will affect the balance sheet status of banks participating in the interbank market.Inter-bank market intervention policies and local bank bailouts help alleviate regional debt risk spillovers and reduce the possibility of systemic risks.This dissertation enriches the systemic macroeconomic and financial risk research framework of fiscal-financial linkages and clarifies how local government debt impact the real economy.Specifically,it has impacted the macro economy through channels such as directly increasing credit costs,weakening tax policy effects,deteriorating the efficiency of credit resource allocation,and strengthening regional debt risk spillovers.The potential innovations of this paper include:applying nonlinear solution technology to the research on the risk of local government debt;the assessment of the effect of tax cuts policies considers the relationship between local government fiscal pressure and financial risk;The balance sheet status is linked to the allocation of credit resources,and clarifies the key mechanism of government debt's impact on the efficiency of resource allocation;A dynamic stochastic general equilibrium model of multi-level government,debt,and financial market associations that reflects China's realistic characteristics is constructed.