Working Paper: CEPR ID: DP14065
Authors: Jeremy Lawson; Abigail Watt; Carolina Martinez; Rong Fu
Abstract: Assessing financial conditions in China is challenging given the wide range of conventional and unconventional policy tools the authorities wield to influence economic and market variables. We utilise principal component analysis to construct a new index that captures the most important policy and market dimensions of Chinese financial conditions over time. We then study the relationship between the index and key domestic and international economic variables, as well as asset prices, within a Bayesian VAR framework. We find evidence that exogenous shocks to Chinese financial conditions have strong spillover effects, particularly to global industrial activity, and emerging market bond spreads and equity prices. However, a variant of our model that allows for time-variation in the parameters implies that these spillover effects have been diminishing over time. When compared to the effects of US economic and financial conditions, our results suggest that Chinese economic shocks have weaker spillovers but financial shocks have stronger spillovers, particularly to emerging markets.
Keywords: financial conditions; Chinese economy; macroeconomic spillovers; financial markets spillovers; Bayesian VAR; TVP-Bayesian VAR; impulse responses; variance decomposition
JEL Codes: C11; E32; E42; E44; E47; E51; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Exogenous shocks to Chinese financial conditions (F65) | Global industrial activity (L16) |
| Exogenous shocks to Chinese financial conditions (F65) | Emerging market bond spreads (G15) |
| Exogenous shocks to Chinese financial conditions (F65) | Equity prices (G12) |
| Positive shock to Chinese financial conditions index (F31) | Chinese composite PMI (C43) |
| Positive shock to Chinese financial conditions index (F31) | Emerging market industrial production (L16) |
| Loosening of financial conditions (E44) | Advanced economy industrial production (P19) |
| Loosening of financial conditions (E44) | Emerging market bond spreads (G15) |
| Shock to Chinese financial conditions (F65) | Domestic Chinese activity (N65) |
| Shock to Chinese financial conditions (F65) | International economic activity (F69) |
| Shock to Chinese financial conditions (F65) | Cumulative responses across various variables (C39) |