How does China’s macro-economy response to the world crude oil price shock: A structural dynamic factor model approach

Abstract

This paper investigates how does China’s macro-economy response to the world crude oil price shock, applying a structural dynamic factor model approach based on 71 China monthly macroeconomic indicators from January 1997 to August 2011. Main conclusions are the following. First, China’s prices are raised, and moreover, the responses of China’s crude oil price, import price index, producer price index, retail price index and consumer price index to the WTI crude oil price shock weaken gradually, which accords with price transmission mechanism. Second, because there are probably China’s high demand for import products, lower added-value or technology of China’s export products and many venture capital in China’s stock market, foreign trade and stock market have sensitivities to price, and then the responses of China’s foreign trade and stock market are larger than one of investment, consumption and industrial production to the WTI crude oil price shock. Finally, after the WTI crude oil price shock, China’s interest rates and interbank offered rates are raised, the growth rate of Money supply (M1) does not immediately fall and begins to decrease after 3months due to time delay, and furthermore there is RMB real effective exchange rate appreciation.