Study On China’s Financial Cycle

The emergence of the financial crisis in 2008 has greatly weakened the foundation of the original theory of economic stability in macroeconomics.Many scholars re-examine the improper neglect of important financial factors such as asset prices in many economic models.And some of them begin to abandon the inherent practice of incorporating only individual financial factors into economic models.Instead,they try to reconstruct the theoretical system of macroeconomics on the premise that financial stability and economic stability are deeply influenced by financial fluctuations.Therefore,the financial cycle has become a new and important theoretical issue that the academic circle focuses on.Since the reform and openness,the general financial conditions in China have been in a cycle of elastic replacement and repetition.The cyclical fluctuations in China’s general financial conditions affect not only financial stability but also economic stability,and may even cause serious financial and economic imbalance.Therefore,to explore the problems of China’s financial cycle can not only enrich the content of macroeconomics but also provide a theoretical basis to maintain the stable running of the economy and the financial security.The financial cycle is defined as the cyclic fluctuation of the overall financial situation of a country(region),compounded by the cyclic fluctuations of a series of financial variables such as monetary quantity,interest rate,exchange rate and asset price.Throughout the existing literature,foreign scholars have carried out abundant studies on the measurement,typical characteristics,economic impacts and formation mechanism of financial cycle.However,these studies are still in the fancy stage,and scholars have obtained remarkable differently conclusions.At the same time,on the basis of learning from foreign studies,domestic scholars have only started research on China’s financial cycle in recent years,and there is a huge space for continuous expansion and deepening.Therefore,this paper focuses on China’s financial cycle and tries to make an in-depth exploration on the measurement,basic characteristics,economic impacts and formation mechanism.The main conclusions are as follows:Firstly,through the evaluation of the existing measurement methods,using a dynamic weighting method based on GARCH model estimation,we synthesize China’s Financial Conditions Index(FCI),based on which a new measurement of China’s Financial cycle is made.The results show that:(1)The combined fluctuations of broad money supply(M2),real estate price,stock price,short-term interest rate and the real effective exchange rate of RMB determine the fluctuation of China’s general financial conditions.(2)The relative importance of the five indicators above in China’s general financial conditions varies with time.China’s FCI,synthesized by the dynamic weighting method based on GARCH model estimation,can reflect well the fluctuation of China’s general financial conditions.(3)From January 1996 to June2021,the fluctuation of China’s general financial conditions experiences a total of eight complete cycles.Secondly,through statistical analysis and empirical tests,four main characteristics of China’s financial cycle are summarized as below:(1)The fluctuation of China’s FCI and the fluctuations of its constituent variables all have high frequency.By dividing the cycles of China’s FCI and its constituent variables,it is found that the average length of each cycle is between 2 and 4 years,equaling to the length of traditional economic cycles.(2)The financial cycle precedes the economic cycle.China’s financial cycle is a good leading indicator for the economic cycle.The optimal prediction periods of China’s financial fluctuation on output fluctuation and price fluctuation are two months and seven months in advance respectively.(3)China’s general financial imbalance is very common and the state transition about China’s financial cycle has the characteristics of asymmetry of more expansion and less contraction,long expansion and short contraction.(4)There is a differential co-activity among the constituent variables of the general financial conditions.Among the fluctuations of the constituent variables,the real estate price fluctuation and almost any other variable’s fluctuation,the exchange rate fluctuation and almost any other variable’s fluctuations all have a high degree of synchronicity and similarity while the money supply fluctuation and other variables’ fluctuations,the stock price fluctuations and some variables’ fluctuations all have a low degree of synchronicity and similarity.Thirdly,through the construction of a new Keynesian DSGE model incorporating financial cycle shocks,we investigate the characteristics and dynamic transmission mechanism of China’s financial cycle on the macro economy.The results show that:(1)Financial cycle shocks can explain about twenty-six percent of output fluctuation,thus an important reason for China’s macroeconomic fluctuation.From interest rate and risk of the financial market to investment and ultimately to output,is the basic mechanism that the financial cycle shocks affect the economy.(2)The macroeconomic effects of financial cycle shocks in different states are quite different.The response coefficient of output to financial cycle has the greatest influence on the macroeconomic effect of the financial cycle shocks,while that of continuity of the financial cycle being the least.(3)Compared with monetary policy rules that do not include financial cycle,monetary policy rules that includes financial cycle are more helpful to mitigate the impact of monetary policy shocks on macroeconomic fluctuation.Fourthly,on the basis of interpreting the complete generation mechanism of the financial cycle,by constructing a theoretical model including risky assets impact as an exogenous variable,this paper discusses the amplification mechanism of China’s financial cycle fluctuation from the perspective of bank risk-taking.The empirical results show that:(1)The increase of bank risk-taking significantly aggravates China’s financial volatility,which means that the mechanism that initial exogenous shocks,such as policy interest rate’s changes,does amplify financial volatility by affecting bank risk-taking.(2)Under different circumstances,the impacts of bank risk-taking on the financial cycle are different.Firstly,compared with those periods without financial crisis,the risk-taking of bank impacts are greater in the financial cycle than in crisis periods.Secondly,the risk-taking of large banks has a greater impact on the financial cycle than that of small ones.(3)The increase of banks’ balance sheet capacity and leverage ratio will amplify the impact of bank risk-taking on financial cycle fluctuation through the superposition of bank risk-taking.In order to ease the financial cycle fluctuation,this paper puts forward the following policy suggestions:(1)Monitoring China’s overall financial situation and its constituent variables in a regular and dynamic manner.(2)Incorporating more financial factors into the current monetary policy framework and giving full consideration to the financial cycle.(3)Taking full account of banks’ general risk-taking conditions to avoid drastic fluctuations in financial markets in the adjustments of monetary policy.(4)Paying attention to weakening the tendency of habitual financial expansion while adhering to flexible monetary policy.(5)Strengthening and ensuring effective the coordination of monetary policies and macro-prudential policies.