China's Financial System and Economic Imbalances

Xi Li, Yikai Wang and Tong Zhang
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Xi Li: Department of Accounting , The Hong Kong University of Science and Technology
Tong Zhang: Department of Economics, University of Zurich, Switzerland

No 2018-53, HKUST IEMS Working Paper Series from HKUST Institute for Emerging Market Studies

Abstract: In this paper, we study how the financial market frictions in the Chinese economy, especially the interest rate policies, lead to inefficient resource allocations and economic imbalances. First, the repressed low interest rate for household savings induce them to increase saving in order to prepare for future necessary expenditures. Consequently consumption share is low and the economic imbalance of consumption and saving emerges. Second, the government provides explicit or implicit guarantees for state firms, so banks prefer to lend to state firms which are less productive. Private firms get less financial resource and operate at sub-optimal levels. The lower aggregate productivity implies the lower household income and consumption and worsen the imbalance. Due to the financial market frictions, traditional consumption stimulating policies, e.g., reducing the interest rate, may actually results in the opposite: even lower consumption and a more imbalanced economy. Reforms towards market-determined interest rates can help to rebalance the economy.

Pages: 28 pages
Date: 2018-02, Revised 2018-02
New Economics Papers: this item is included in nep-cna, nep-fdg and nep-tra
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