A Study On Fiscal Decentralization,Bank Credit And Inflation

In this study, based on the background of China’s fiscal decentralization reforms and structural changes of inflation, I have made use of provincial panel data in China from 1985 to 2012 to study and compare the impact of fiscal decentralization and bank credit in inflation of China, in order to assess the overall and regional relationship among fiscal decentralization, bank credit and Chinese Inflation.In this regard, this paper is focused on previous studies, constructing theoretical framework and using a panel data of 29 provinces of China.I aim to make further analyze of the internal mechanism of fiscal decentralization reform’s practice, investigate the impact of fiscal decentralization and bank credit in inflation and promote the theory of fiscal decentralization in China. Eventually,In the end, I hope to provide the necessary theoretical and empirical support for the full positive effect of fiscal decentralization reforms.The main contents include:(1) Make theoretical comparisons between research at home and abroad in recent years, fiscal decentralization;(2)From the perspective of institutional level, monetary economy and the real economy to make path research of fiscal decentralization,bank credit and inflation;(3)Elaborate the status quo of fiscal decentralization, bank credit and inflation in China running our country and give necessary evaluation;(4)Based on Chinese Provincial Panel Data, using a variety of empirical methods for the measurement of fiscal decentralization and bank credit on the mechanism of inflation,the introducing of dummy variables, making the overall and regional regression;(5)Put forward policy recommendations to ease inflation based on the fiscal decentralization reform.A. The conclusions of this paper:a.There is significant correlation between China’s fiscal decentralization, bank credit and inflation from 1985 to 2012.In the context of the 1985 fiscal decentralization reform, state-owned bank credit of government-led exacerbated the rise of China’s overall inflation rate, it shows that the inappropriate behavior of local governments will have a serious negative impact on the macroeconomic.While fiscal decentralization could enhance the rights of local governments’investment and resources, under pressure from the central government’s evaluation of economic development, so local governments have to take aggressive financing measures, set guidance for state-owned banks to give credit support, which will become one of the important causes of inflation. After the 1994 tax reform, the impact of government financial intervention in inflation rate becomes smaller,the main reason relies on that centralization effect is gradually offset by extra financial expenditure means of local governments, and with the deepening of China’s financial reform, China make efforts to coordinate the relationship between central and local finances, providing a more stable environment for regions’ developments therefore the impact of financial interventions on inflation becomes smaller.b.There is difference between state-owned banking sector credit and non-state-owned banking sector in the impact of inflation.In the practice of fiscal decentralization reform of China.as the implementation of monetary policy department, the banking sector plays an important role in the prosperity of local economy, the allocation of credit resources, attracting investment and so on.After the empirical analysis of heterogeneity bank credit from 1985 to 2012,it shows that:the state-owned bank credit has significant and positive impact in inflation,while non-state-owned bank credit has negatively correlated with inflation.The main reason may be that the local commercial banks are under administrative guidance of local government,so local bank has taken measures to support economic development in the credit area and to meet the requirements of the central government’s incentives, thus increasing the supply of money in circulation. Instead the state-owned banking sector are less affected by the government.c.There are various factors affecting inflation and regional differences are significant.Overall, in addition to openness and urbanization in inflation is not significant, the rest of variables have a significant role in inflation. Fiscal decentralization index, the state-owned bank credit,cross-term coefficients of fiscal decentralization and the state-owned bank credit,utilization of foreign investment, economic growth are all tested positive correlation with inflation. But there is a significant negative correlation between non-state-owned bank credit and inflation.From a regional perspective, effects of eastern, central and western regions are different.The coefficients of fiscal decentralization in three regions are positive, but in the west region it is the most significant. The cross-term coefficients of fiscal decentralization and the state-owned bank credit in eastern and central regions are significantly positive, but not significant in the western region.As the extent of the governments’financial intervention in eastern and central regions, it will further exacerbate the degree of inflation.After the introduction of 1994 dummy variables, the affecting in three regions are not the same, in which the coefficients in eastern and western regions are not significant, only in the central region,the coefficient is significantly positive,reflecting after the 1994 tax reform, the government’s intervention in banks and other financial institutions will cause inflation in the central region.Openness, urbanization and the utilization of foreign investment in eastern region are not significant,but these above variables and economic growth in central region are significant, the control variables are significant in the western region. Especially Especially there is positive impact between economic growth and inflation in three regions and the eastern region has the strongest effect.B. Policy suggestions:a.Change the central government’s incentives method to local government and introduce a comprehensive performance evaluation system.Fiscal decentralization is the root cause of inflation in China, fiscal decentralization system go through investment and bank credit to expand the size of fiscal expenditure,increasing the aggregate demand and exacerbating the extent of inflation.In local government’s term, in order to pursue short-term economic development,they tend to develop a mixed policy of infrastructure investment, although fiscal decentralization can play a role in stimulating the local economic development,which can not be ignored is that there is a deviation of the central government’s incentives to local governments,local governments pay too much emphasis on the speed of economic development, while ignoring the quality of economy, resulting in a distortion of economic behavior.It is necessary to re-establish a comprehensive, sustainable local government evaluation system,enhance the financial assessment of local government and introduce other macroeconomic indicators of healthy operation.b.Improve the positive interaction of the relationship between central government and local government, to achieve the unity of property rights and powers.Under the fiscal decentralization system, "common pool" problem between the local government and the central government is even more significant, leading to the expansion of the transfer payments scale in central government. While the beneficiary is the provincial local government, the next level of government can not obtain sufficient financial resources, resulting in uneven debt of local government, which led to the expansion of deficit.Inflation is buried under the risk.Therefore, we must combine with different levels of local governments’reform, coordinate property rights of the provincial, the county (city) and township (town) local governments, optimizing the financial system.At first,we should pay attention to the legislative level,make the division of power clear between the central government and local governments,between local governments. It is vital to refine specific duties and assume the proportion of multiple levels of governments, which will be institutionalized and legalized, rebuilding the central taxation system and local tax system.c.Improve fiscal decentralization mechanism to strengthen budget oversight.Fiscal decentralization system should be combined with China’s national conditions and absorb the contents of the Western fiscal decentralization theory critically.The central government should control fiscal powers of local government in accordance with the specific needs of the local government, especially provide supervision mechanism for investment behavior beyond the local ability,while fiscal decentralization should be advancing with improving financial oversight functions at the same time.Strengthen extent of public the budget, so that local government’s financial are fully under the supervision of public opinion.Although China’s "budget law" has made provision of balance the local budget,but the local government remains dependent on higher levels government in the administrative and financial aspects,thus leading imbalance budget of government. People’s Congress should play a supervisory role in the budget and gradually form a hard budget constraint places.d.Enhance the independence of local commercial banks.Fiscal decentralization system empowered local governments interfere rights of commercial banks,local governments are more susceptible to performance evaluation of central government to give administrative guidance of these banks, so the local government could obtain the credit support through a variety of means from commercial banks, for the development of infrastructure or large enterprises,resulting in the expansion of local government investment change into investment demand, accelerating the expansion of the credit scale.On the other hand, the financial risks of local commercial banks continue to accumulate. Some project with investment risk, poor benefits obtain the credit funds,so local commercial banks’ non-performing loan rate has improved, thus increasing the economy’s internal currency.Therefore, we must continue to accelerate China’s financial reform, promote innovation of local financial system and reinforce the independence of the commercial banks, making it legal to operate independently. At the same time, the need for reconstruction of the central government and local government’s financial relations is urgent, we should re-division of the central and local governments’financial stability responsibilities, allowing local governments to resolve fully responsibility for this area of financial risk.