Working Paper: NBER ID: w23194
Authors: Markus K. Brunnermeier; Michael Sockin; Wei Xiong
Abstract: China’s gradualistic approach allowed the government to learn how the economy reacts to small policy changes, and to adjust its reforms before implementing them in full. With fully developed financial markets, however, private actors’ may front-run future policy changes making it impossible for the implement policies gradually. With financial markets the government faces a time-inconsistency problem. The government would like to commit to a gradualistic approach, but after it observes the economy’s quick reaction, it has no incentive to implement its policies in small steps.
Keywords: No keywords provided
JEL Codes: E5; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government policy changes (O24) | Private investment decisions (G11) |
| Government's gradualistic approach (H10) | Private investment decisions (G11) |
| Presence of financial markets (G19) | Earlier investment decisions by private agents (G11) |
| Government's inability to commit to gradualism (E65) | Faster rise in leverage and instability in financial markets (F65) |
| Government's gradualistic approach (H10) | Learning and adjustment based on economic reactions (E70) |
| Private agents anticipating policy changes (D84) | Breakdown of the gradualistic approach (B52) |
| Government's optimal policy choice diverging from initial gradual policy (E63) | Ineffectiveness of gradualism (P39) |