Financial Stress and Its Impact on the Business Cycle in China

Abstract

Financial stress is the state of the financial system when it is affected by its own vulnerability, uncertainty and various external shocks. Rationally measuring financial stress and exploring the impact of financial stress on the business cycle, is one of the core issues in the new economics” theory which is based on financial stability, and it is also a hot topic that academia and decision-making departments pay close attention to. However, in the related research on financial stress, domestic and foreign scholars have always faced two problems: Firstly, how to accurately measure financial stress under the complex and volatile economic and financial situation? Secondly, how to reasonably portray the relationship between financial stress and the business cycle in different periods? In recent years, with the continuous advancement of economic globalization and financial integration, the potential stress of the financial system has gradually emerged, and has been continuously accumulating and spreading through the financial accelerator effect and pro-cyclical effect of the financial system. Financial stress not only has a significant impact on the operation of the macro economy, but also poses serious challenges to macro-prudential supervision and financial risk prevention and control. Therefore, solving the above two problems not only helps to understand the operating laws of China’s macroeconomic and financial systems from the perspective of financial stress, but also has an important practical significance for improving the foresightedness and effectiveness of the macro-control policies.　　In view of this, this paper measures financial stress of China from exchange market pressure, bankingsystem pressure and financial bubble pressure respectively, incorporates all financial sub-markets into a unified framework, and then synthesizes China’s financial stress index （CFSI） based on the dynamic CRITIC method. The analysis shows that the CFSI constructed in this paper is highly coupled with the operation of China’s financial system and can reasonably reflect the stress conditions of the financial system. On this basis, this paper analyzes the typical differences in the evolution of CFSI during different periods, especially before and after the financial crisis. The empirical results obtained by using the MSAR model show that after the crisis, China’s financial stress changes show a series of asymmetric features such as rapid accumulation and slow release. Furthermore, based on the TVP-VAR model, this paper empirically explores the nonlinear impact of financial stress changes on the business cycle in China from the perspectives of the financial sub-market and the entire financial system. The results show that: firstly, the suppression effect of financial stress accumulation on the business cycle is more significant than the promotion effect of financial stress relief on the business cycle; secondly, the time lag and the limitation of monetary policy may lead to a pro-cyclical” phenomenon of financial stress and the business cycle, and then may amplify the impact of financial stress on the business cycle; finally, the suppression effects of all sub-markets’ financial stress on the business cycle show different time-varying dynamics, but all show obvious state-dependent characteristics.　　These findings not only help to further understand China’s macroeconomic and financial system operating conditions in the new era, but also provide useful empirical references and policy implications for the perfection of the financial regulatory system and macroeconomic control policies. This paper argues that, on the basis of paying close attention to the evolution of China’s financial stress, on the one hand, policy-makers should improve the framework of regulation underpinned by monetary policies and macro-prudential policies, and give full play to the role of macro-prudential policies in suppressing the pro-cyclical volatility of the financial system and preventing cross-market infections of risks. On the other hand, they should innovate means of macro control, use various policy tools in a flexible and appropriate fashion to carry out timely and moderate pro-cyclical fine-tuning of key areas and weak links, so as to achieve key targets for the dual stability of economics and finance.