Financial Frictions,financial Risks And Economic Fluctuations

To confront with the global financial crisis,Chinese government had stimulated the economy by enlarging both money supply and government purchase from 2008.During that period,the growth rate of M2 had skyrocketed to finance infrastructure building projects.Due to this kind of massive liquidity injection to the economy,the debt level has experienced rapid increase over the past decade,and the debt to GDP ratio in the real sector has increased 100 percent point from 141.2% in 2008 to 241.2% in 2017.However,the bank loan distributed disproportionally among different sectors in the economy and the heavy sector has received a larger amount of loans compared to the light sector industry.The increase in leverage threatens our economy since it can amplify the effects of exogenous shocks through financial accelerating effect.The risk of financial turmoil is more prominent since China,as a developing economy with poor financial system compared to the US,is also facing challenges from abroad.As has been documented by many researches,the capital flows caused by changes in foreign countries is a main reason for financial instability in emerging economy.So,to prevent systematic financial risks,we have to limit the growth pattern in debt,and this is what our country had done in the past several years.This research project provides a systematic analysis about financial risks and economic fluctuation in China economy.Within this paper,we build three models to explain some typical features of our economy and provide some useful suggestions to improve the immunity of our economy to external shocks.In three different macroeconomic frameworks,this paper discusses three main issues faced by China economy:(1)the idiosyncratic in financial frictions and its impact on economic fluctuations;(2)the effectiveness on stabilize economy of deleverage policy conducted by government in recent years;(3)the financial risks caused by variations in capital flows.I perform the analysis in three DSGE models featured with financial frictions,and these models utilize three different modeling methods for financial frictions respectively.I also give a literature review about financial frictions before our study,we introduce the technics to incorporate borrowing behavior into standard New-Keynesian model and give some examples of the applications of financial frictions in explaining some stylized facts in business cycles.The first part of this research concerns business cycles in China.I embedded the financial accelerator mechanism into a New-Keynesian model with heterogeneous entrepreneurs that represent heavy sector and light sector respectively.These two sectors differ in their monitoring costs and thus have different level of financial frictions.I estimate this model using Chinese macroeconomic data and the result shows that heavy sector has smaller monitoring cost.As a result,entrepreneurs in heavy sector has higher leverage ratio than their light sector counterpart.When central bank inject liquidity into the economy by lowering interest rate,the loan to heavy sector grows more quickly than to light sector,so this model can explain the credit misallocation in China over the past decade.and my study attributes the main driven force of China business cycles into the monetary shock,the unexpected fluctuation in risk-free rate can explain fluctuations in those main variables.In addition,the idiosyncratic productivity shocks also account for a large part of the fluctuations in loans and capital holdings of the two sectors.However,this study show that risk shock only plays a minor role in China economy,which is considered to be very important in US.My second model studies the effect of deleverage policy on macroeconomy.This model also considers heterogeneous in financial frictions.The two entrepreneurs are constrained in their borrowing capacity by the value of collateral,but they have different loan-to-value ratio.When this difference appears,technology shock has asymmetric effects on two sectors.and the model interprets deleverage policy as lowering loan-to-value ratio.The Government can decrease LTV ratio of two sectors simultaneously or only adjust one of them.Deleverage will decrease the long run output level,but it can also stabilize the economy by limit the financial accelerating effect.Compared with deleveraging both sectors,structural deleverage,which means only limit the borrowing capacity of the sector with higher LTV ratio,can lessen the financial friction of entrepreneurs with lower LTV ratio and thus can increase the efficiency in capital allocation.The third part of this paper incorporates financial intermediaries within a small open DSGE model and studies the effects of bank runs on economic activities.Shocks to the world interest rate induce capital outflows and asset price reduction,and the decline in asset prices weakens intermediaries' balance sheets,making them vulnerable to bank runs and leading,in turn,to a more severe and persistent recession.Our model is successful in generating some key properties observed in emerging market business cycles.We also asses the stabilization effect of capital control policy,numerical experiment suggests that countercyclical tax on capital flows is effective in absorbing the disturbance from external financial shocks and reducing the probability of bank runs.