Trends and Cycles in China’s Macroeconomy

Abstract

The cyclical patterns uncovered in this paper, an issue silent in SSZ, constitute an integral part of our model mechanism. The key to accounting for these important cyclical patterns is the presence of bank lending frictions in our model, which interacts with the aforementioned collateral constraint to deliver a negative externality on the light sector from credit injections into the heavy sector. In response to the government’s credit injection, the expansion of credit demand by the heavy sector tends to crowd out the light sector’s demand for working capital loans by pushing up the loan rate for working capital. In an economy absent such lending frictions, a credit injection into the heavy sector tends to push up the wage income and therefore household consumption due to the imperfect substitutability between output produced from the heavy sector and output produced by the light sector, a result that is again at odds with what we observe in China (fact [C2]).5 Specifically, a shock to credit expansion generates the following counterfactual predictions: