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Chinese real business cycle (RBC) exhibits a unique pattern, which is characterized by moderate consumption volatility, substantially lower investment volatility, and acyclical trade balance. These features are quite different from business cycles in other emerging markets and cannot be explained by existing emerging market RBC theories. Motivated by the fact that China undertook dramatic and persistent reform on state-owned enterprises (SOE) in the last 30 years, we construct a full-fledged general equilibrium model with SOE sector and show that the model does a fairly good job in accounting for the above features. The two main driving forces are: (1) shock to the share of downstream SOE in manufacturing sectors and (2) shock to upstream SOE's monopolistic position. These two shocks can explain 85 percent of output volatility, 79 percent of consumption volatility, 72 percent of investment volatility, and 57 percent of the volatility of trade balance-to-output ratio. Standard shocks such as permanent productivity shock, credit shocks, country risk premium shocks, and preference shocks are less important in explaining Chinese economic fluctuations. Our results show that Chinese RBC may be affected substantially by domestic policies.
Key Words: State-owned Enterprise; Real business cycle; Vertical structure; Financial friction; Permanent shocks; Bayesian estimation.
JEL Classification Numbers: E3, F3, F4.
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1.INTRODUCTION
With the enhanced importance of China in the global economy, the macroeconomic aspect of the Chinese economy has been extensively investigated recently. However, most studies have mainly focused on economic growth. What factors characterize Chinese real business cycle (RBC)? What drives economic fluctuations in China? The literature has long been mute on these issues.1 In this paper, we document Chinese business cycle from 1978 to 2010 and reveal that Chinese RBC exhibits a unique pattern characterized by moderate consumption volatility, substantially low investment volatility, and acyclical trade balance.2 Table 1 shows that Chinese RBC differs from business cycles in other emerging markets. To explain these features, we construct a full-fledged general equilibrium model exhibiting Chinese characteristics and investigate Chinese RBC using the Bayesian estimation method.
Why shall we consider Chinese characteristics? As shown by Shi, Wu and Xu (2014), current theories on emerging market business cycle, such as those proposed in Aguiar and Gopinath (2007) and Garcia-Cicco, Pancrazi and Uribe (2011), cannot explain...