The effects of capacity reduction policy under the interest rate peg in China

Bing Tong

Journal of Asian Economics, 2021, vol. 74, issue C

Abstract: Capacity reduction has been a recurrent theme in China's economic policy. The central government takes various administrative measures to remove excess capacity, accumulated mainly due to underpriced production factors and distorted incentives. I evaluate the de-capacity policy in a series of models and prove that its effects depend critically on its persistence and monetary policy regime. Under an interest rate peg, a transient policy that changes markup temporarily is ineffective and even expansionary, whereas a persistent policy is effective due to a negative wealth effect. A permanent de-capacity policy can lead to over-reactions in macro variables because the interest rate peg adds positive feedback to the economy. Therefore, the de-capacity policy has greater uncertainty under the interest rate peg. As a policy tool, it easily deviates from its target and brings about excessive volatility. However, long-run price stability and a gradually advanced de-capacity policy are conducive to the achievement of policy targets.

Keywords: Chinese economy; Capacity reduction; De-capacity; New Keynesian model; Supply shock; Interest rate peg (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S1049007821000403
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:asieco:v:74:y:2021:i:c:s1049007821000403

DOI: 10.1016/j.asieco.2021.101311

Access Statistics for this article

Journal of Asian Economics is currently edited by C. Wiemer

More articles in Journal of Asian Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().