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Borrowing constraint, heterogeneous production sectors and policy implications: The case of China

Ren Wang, Jie Hou, Xiaobei He and Hui Song

International Review of Economics & Finance, 2017, vol. 49, issue C, 568-581

Abstract: It is well known that the financing capacity of China's private firms is negatively impacted by the discriminatory borrowing constraints imposed on them, but not on state-owned firms. In this paper, we aim to quantify the implication of the borrowing constraints on the transmission mechanism of monetary and fiscal policy, using a DSGE model with a heterogeneous production side of private and state-owned sectors. We fit our model to China's quarterly data from 2005 to 2014 and conduct several experiments. The main findings are as follows. First, a monetary policy shock interacts with private firms' borrowing constraint, thus having an additional effect on real variables, named reallocation effect. This is a deviation from the standard New Keynesian framework, where the real effect comes from the price rigidity. Second, intensified borrowing constraints of the privates firms reduce the efficacy of a tax rate cut shock for private firms and lessen the tightening effects on the state-owned firms of such shock. Third, intensified borrowing constraints on the privates firms reduce the efficacy of an expansionary monetary policy shock for private firms and enhance its effectiveness for the state-owned firms. The model can be easily extended to other developing economies in a similar environment.

Keywords: Borrowing constraint; Heterogeneous production sectors; Monetary policy; Fiscal policy (search for similar items in EconPapers)
JEL-codes: E20 E44 E52 E62 (search for similar items in EconPapers)
Date: 2017
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Handle: RePEc:eee:reveco:v:49:y:2017:i:c:p:568-581