Structural news shock, financial market uncertainty and China's business fluctuations

Abstract

This paper investigates whether and how financial uncertainty affects economic activity and business fluctuations, especially effects which occur through expectations. First, we find that China's business fluctuations are significantly affected by the anticipated uncertainty, while unanticipated uncertainty is limited. Second, short-term anticipated uncertainty shocks have the greatest impact on business fluctuations, followed by long-term shocks and medium-term anticipated uncertainty shocks. All the anticipated uncertainty shocks have a “smiling curve” character. Third, anticipated uncertainty, in the short term, suppresses economic growth, while it has the opposite effect in the long term, indicating that agents' behavior changes from overreaction to rational choice. Fourth, the major driving force of China's business fluctuations has gradually shifted from monetary policy to expectation management, which has reduced the policy costs of the monetary authority. It also shows that uncertainty, especially anticipated uncertainty, will play an increasingly important role in future business fluctuations.