Abstract
AbstractThis paper examines how the risky lending activities of the state‐owned enterprises (SOEs) affect the effectiveness of monetary and fiscal policy in China with a shadow banking sector. We develop a dynamic stochastic general equilibrium (DSGE) macroeconomic model with two production sectors, where the SOEs have access to low cost funds from the commercial banks (also mainly state‐owned) and on‐lend to the private sector in the form of entrusted loans. The Bayesian estimation results show that higher restrictions on bank credit push SOEs to engage in more shadow banking in this form which dampens the effectiveness of contractionary monetary policy. Expansionary fiscal policy increases output, but crowds out private investment, which can further drain the financial market and exert a detrimental effect on the Chinese economy.
Highlights
China's shadow banking has grown dramatically since the 2007–2009 financial crisis
The total stock of entrusted loans in the first half of 2016 was estimated to be 2.1 trillion RMB, which accounted for the largest component of the Chinese shadow banking system and became the second after the rapid growth of wealth management products (WMPs)1 later (Allen, Qian, Tu, & Yu, 2019)
Our goal is to answer the following research questions: (a) Does the existence of the shadow banking system reduce the effectiveness of monetary policy in tightening credit constraints faced by state-owned enterprises (SOEs)? (b) Does an increase in government spending add to the conventional crowding out mechanism by worsening the credit conditions of private-owned enterprises (POEs)?
Summary
China's shadow banking has grown dramatically since the 2007–2009 financial crisis. Moody's estimation in 2017 shows that by the first half of 2016, the size of the shadow banking assets reached approximately 82% of Chinese GDP. The Chinese shadow banking system takes the form of credit intermediation involving entities and activities outside the regular banking system that serves to provide liquidity and credit transformation (People's Bank of China, hereinafter PBoC, 2013). It is “shadow” because it lacks a strong safety net and operates at a lower level of regulatory oversight, it could be a potential source of regulatory arbitrage and systemic risk. The total stock of entrusted loans in the first half of 2016 was estimated to be 2.1 trillion RMB, which accounted for the largest component of the Chinese shadow banking system and became the second after the rapid growth of wealth management products (WMPs) later (Allen, Qian, Tu, & Yu, 2019)
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