On The Transmission Mechanism Of China's International Real Business Cycles

In closed economies real business cycle (RBC) theory has done a pretty good job in explaining volatility and fitting the data. Its performance, however, is hardly satisfactory when the theory is extended to open economies. One of such dissatisfaction is that, in the data, cross country correlations of output are higher than that of the consumption, but the theory stubbornly predicts just the opposite. What's more, the overprediction of international correlation of consumptions can not be eliminated by rescricting the risk sharing abilities of complete markets (even under total autarky), which gives rise to an interesting question whether openness greatly changes the models' behavior.This paper gives a thorough analysis to China's international real business cycles and its trasmission mechanism in a dynamic stochastic general equilibrium framework. It intends to make clear the following questions:first, what are the stylized facts of fluctuations in China's open economy? Are there any of them are China specific? Secondly, Can a theoretical model developed for China's open economy give satisfactory explanations with respect to its volatility properties? If yes, what is exactly the transmission mechanism?Thirdly, what are the welfare effects of economic fluctuation to individuals? What kind of policy implications can we derive from the theoretical cognitions of fluctuation mechanism? To answer these questions, this paper summarizes the empirical stylized facts of China's open economy fluctuations, builds two-country two-good models of open economies and calibrate them according to featured properties of China in order to quantify whether the artificial time series obtained by simulating the model under specific parameterized preferences and technology resemble the behavior of the observed series. The paper also calculates the welfare cost of volatility by conducting a simple thought experiment to give answers regarding the individual welfare consequences and its policy implications.The innovations of this paper lie in the following three aspects:first, contribute to a robust summary of stylized facts by extracting the fluctuation components applying four kinds of high pass or band pass filter techniques that each stresses a specific technical aspect. It reveals that the negative cross-country correlation of investment is the specific property that distinguishes China from other economies, which deserves particular attention in modeling considerations. Secondly, this paper demonstrates that, according to the model's specification, asymmetric preferences, incomplete financial markets and term of trade shocks yield a pretty good prediction to China's volatity properties. Specifically, the theoretical analysis starts from a benchmark with symmetric preferences and complete markets, and extends in order by being equipted with asymmetric preferences that characterizing zero elasticity of leisure to income, non-state contingent bonds, and terms of trade shocks. Such extension reveals that the most important transmission mechanism which leads to much improvement of explanation lies in the zero wealth effect of leisure that enables positive comovements of labor supply, and thus outputs are also internationally positively correlated. The incomplete markets help to reduce the over predicted correlation of investment across counties while the terms of trade shocks adjust net exports to make it more consistent with the acyclical fact. Thirdly, this paper calculates that the welfare costs of China's economic volatility are approximately 0.32% of average consumption, which corresponds to 24.24 Yuan of real consumption in 2009. By extending the discussion to incorporate the considerations such as asymmetric risk distribution among heterogeneous individuals, the percentage amount of fluctuations that can be attributed to policy changes, the paper argues that it has reasons to justify this calculation as the right magnitude of China's economic fluctuations. Thus the welfare cost of volatility is quite low, even the most "perfect" stabilization policy can only bring about very limited welfare gain.The policy implications conveyed by the transmission mechanism and the welfare calculations are that the long-run supply management (provide incentives for the individuals to work more) is much reliable than the short run demand management. The loss of inappropriate policies can be much greater than the improvement of pertinent policies. In any way, the main social gains from a deeper insight of business cycles will be in helping us to avoid severe mistakes with policies that have minimally inefficient side effects, not in devising ever more subtle policies to remove business cycle risk.