A Game-Theoretical Study of Alternative Policies in China: Can Locally Initiated Investment Expansion Be Regulated?

Abstract

Investment competition between local governments is a well-reported phenomenon accompanying the stage of economic take-off in China. Thus it is of important practical significance to investigate how the central bank can effectively realise its objectives in the context of such a competition when the approach to monetary policy evolves from a reliance on direct controls to a mix of direct and indirect regulations. This paper is a theoretical attempt to construct an interregional investment competition model framed in three different financial settings, and then to compare these alternative financial policies in terms of macroeconomic stabilisation. It is found that administrative controls and indirect regulations each has its strengths and weaknesses due to the existence of investment competition. This perhaps explains why it is unwise for China to jump in one step to the position that the central bank basically applies indirect monetary instruments to achieve macroeconomic management.