Research On The Evolution Mechanisms And Preventive Measures Of China’s Macro-economic Tail Risk

The 2022 Central Economic Work Conference pointed out that “We should highlight the work of stable growth,stable employment,and stable prices,effectively prevent and mitigate major risks,promote the improvement of economic operation,and achieve high-quality economic growth.” The “stable growth” in China’s "better balance the control of COVID-19 epidemic and the economic development" task,was placed in a prominent position,ranked as the first of "three stable".This change in national focus fully highlights the importance and urgency of maintaining macroeconomic stability.Against the backdrop of demand contracting,supply reduction and expectations weakening,as well as the volatile external environment,the research on the tail risks of China’s macroeconomy can help provide some potential reference and decision-making for government departments and regulators in the process of achieving “stable growth” and preventing significant risks.The reference is a theoretical and practical foundation for China to achieve high-quality development and build a modern socialist country.However,confined to China’s sustained high economic growth,the established domestic studies have failed to pay sufficient attention to macroeconomic tail risks related to the significant economic slowdown,and there are still many doubts about the dynamic evolution mechanism and preventive measures of macroeconomic tail risks in China(Deng et al.,2022).As the core of the modern economy,risks generated within the financial system can have far-reaching effects on the economy(Adrian et al.,2019;Liu et al.,2021).Although few studies have recently begun to focus on the role of financial risks on China’s macroeconomic tail risks,the key question of whether macroeconomic tail risks are more driven by external or internal financial risks is inconclusive in the context of the high financialization of the global economy,the gradual deepening of China’s opening-up process,and the increasing intensity of external uncertainty shocks(Lloyd et al.,2023).The impact mechanism of different sources of financial risks on China’s macroeconomic tail risks is still unclear,and the policy effectiveness of existing policies on China’s macroeconomic tail risks has not yet been analyzed in depth,which poses many theoretical and practical constraints to the management of China’s macroeconomic tail risks.In the dual background of external uncertainty and internal economic structure transformation,this paper takes China’s macroeconomic tail risks as the research object and discusses the following questions:(1)What is the current performance of China’s macroeconomic tail risks? What are the evolutionary characteristics of macroeconomic tail risks in the cross-sectional and time dimensions,respectively?(2)How does China’s financial risk affect macroeconomic tail risk? Is China’s macroeconomic tail risk more driven by external financial risks or internal financial risks? Through which channels or mechanisms do external and internal financial risks affect China’s macroeconomic tail risks?(3)Against the background of frequent internal and external shocks,what is the evolution of China’s macroeconomic tail risk under different stress shocks?(4)Since macroeconomic tail risks involve economic stability and financial stability,how should we prevent and control macroeconomic tail risks in China based on the “two-pillar” regulatory framework? Is the two-pillar policy implementation effective in managing macroeconomic tail risks? How should policy implementation be timed at different stages of financial cycle evolution? How can macroprudential policy and monetary policy be coordinated and matched in the management of macroeconomic tail risks?Based on a brief summary on the theoretical origin and research linkage of macroeconomic tail risk,this paper systematically composes the theoretical basis of macroeconomic tail risk.Based on the multidimensional data of macroeconomic operations and financial markets from January 1992 to September 2022,I construct a forward-looking analytical framework based on conditional forecast distribution by using mixed-frequency dynamic factor models,quantile regression methods,and distribution fitting techniques,I combine the Growth-at-Risk(Ga R)measure,relative entropy,and expected loss indicators to measure the macroeconomic tail risk in China,and analyze its evolutionary characteristics.On this basis,I use the multiple network model to measure China’s external financial risk and internal financial risk,analyze the impact of both on China’s macroeconomic tail risk and explore the mechanisms behind them from the perspectives of social psychological expectations and cross-border capital flows.In addition,I further explore the evolution of China’s macroeconomic tail risks under multiple shock stress scenarios by applying stress testing methods to lay the foundation for policy design.Finally,the paper discusses the macroeconomic tail risk prevention mechanism in China in three modules: policy effectiveness assessment,policy timing,and policy coordination.The main findings of the paper include the following seven aspects:(1)The conditional predictive distribution of economic growth in China changes over time;in terms of location characteristics,the distribution exhibits a gradual leftward shift,while in terms of shape characteristics,the probability density curve exhibits a fattailed posture.(2)China’s macroeconomic tail risk exhibits time-varying characteristics of high volatility and shows a highly consistent evolution across maturities;Notably,although China’s macroeconomic tail risk climbs in an average sense with increasing maturity,the short-term risk will exceed the median and longterm level during major crisis periods(e.g.,the Asian financial crisis,the 2008 financial crisis,and the outbreak of the COVID-19 epidemic).(3)In general,while current economic performance predicts expected growth levels,macroeconomic tail risks are mainly driven by internal and external financial conditions(size and structure),especially internal financial conditions and internal financial structure.Further,the results of the study on the term structure of macroeconomic tail risk suggest that there is an intertemporal trade-off between financial conditions adjustment and macroeconomic tail risk in China;an accommodative financial situation helps to contain macroeconomic tail risk in the short run,but further strengthens macro financial vulnerability in the medium and long run,which leads to an increase in macroeconomic tail risk in the medium and long run.(4)Both external and internal financial risks will contribute to the generation and accumulation of macroeconomic tail risks in China and act through the channels of cross-border capital flows and social psychological expectations.(5)The results of stress tests show that China’s macroeconomic tail risks are affected by shocks to the real economy,shocks to financial conditions,and shocks to the financial structure.Among them,under the same intensity of shocks,the impact of real economy shocks decays with the duration of action and has the strongest negative effect on macroeconomic tail risk in the short term;By contrast,the negative impact of internal and external financial condition,especially domestic financial condition shocks,on China’s macroeconomy tail risk is stronger than the risk effect caused by real economy shocks.In addition,although the finance structural shocks can also lead to a rise in macroeconomic tail risks,their effects are mainly reflected in the medium and long term.It is worth emphasizing that the superimposed effect of internal and external shocks tends to further strengthen the macroeconomic tail risk compared with that of a single shock.(6)As for the management of macroeconomic tail risks,the combination of moderately tight monetary policy and tight macroprudential policy helps to balance the management of macroeconomic tail risks and the maintenance of expected economic growth to a certain extent,demonstrating the effectiveness and importance of the two-pillar policy coordination.In particular,although loosening monetary policy can reduce macroeconomic tail risks in the short run,it will further enhance macroeconomic vulnerability in the medium and long run,thus strengthening macroeconomic tail risks in the medium and long run;while tight macroprudential policy can effectively control the level of macroeconomic tail risks,it may lead to a certain degree of lower expected economic growth rate.(7)Countercyclical implementation of the two-pillar policy framework helps reduce macroeconomic tail risks in the short run.Specifically,the counter-cyclical implementation of macroprudential policy can further strengthen the effectiveness of macroprudential policy in managing macroeconomic tail risks in the short run,but it has no significant benefit for the management of macroeconomic tail risks in the medium and long run.In contrast,although the counter-cyclical implementation of monetary policy in China has hardly reduced macroeconomic tail risks,it has been able to strengthen the level of expected economic growth rate to a certain extent.The contributions of this paper are as follows:(1)By portraying the internal and external financial operating conditions in China from the scale and structure dimensions,this paper expands the analysis dimension compared with studies such as Zhang and Liu(2020)and Deng et al.(2022).This study provides a more accurate indicator basis for the construction of the forecast distribution of China’s economic growth.In addition,this index division makes it possible for this paper to further compare and analyze the potential effects of scale(status)factors and structural factors,internal and external factors,and short-term and long-term effects,thus laying a foundation in preventing major economic and financial risks.(2)Unlike Zhang and Liu(2020),who focus on the impact of financial risks on future economic growth expectations without an in-depth analysis of macroeconomic tail risks and their impact mechanisms,this study expands the Ga R analysis framework to examine the impact of China’s financial risks on future macroeconomic tail risks and further refine financial risks into the external financial risks and internal financial risks.This will provide some theoretical and practical references for China to achieve the long-term balance between "risk prevention" and "stable growth," as well as the major strategic objectives of high-quality economic development.(3)This study draws on the Ga R framework of Adrian et al.(2019)and extends the existing framework based on the mixed-frequency dynamic factor model.I integrate the risk information in different types and frequencies of economic and financial indicators from the dimensions of scale and structure and overcome the problems brought about by non-flush,fragmented-tail,missing informationomission,and insufficient-sample features of data.I further introduce the construction of stress scenario distance indicators based on relative entropy,forming the basis for quantitative analysis of macroeconomic tail risks.(4)Based on the Suarez(2022)framework,this study further extends to the context of two-pillar policy,evaluates the effectiveness of macroprudential policy and monetary policy for macroeconomic tail risk management,verifies the importance of different operating stages of the financial cycle in macroeconomic tail risk management,and provides references for the timing problem of policy implementation.This paper provides a reference for the policy formulation of the prevention and resolution of macroeconomic tail risks in China.Although this paper has conduct a comprehensive and detailed analysis of the evolution mechanism and prevention countermeasures of China’s macroeconomic tail risks,the following shortcomings still exist:(1)This paper only conducts an empirical analysis of China’s macroeconomic tail risk.This paper has not yet incorporated the empirical evidence and typical facts obtained in the evolution of China’s macroeconomic tail risk into the existing macroeconomic theoretical model,which is subject to further in-depth discussion.(2)Due to the availability of data,the selection of external financial conditions and financial structure-related indicators in this paper is still limited,and further exploration is needed in the construction of the indicator system and index synthesis methods.(3)This paper only considers the coordination mechanism of monetary policy and macroprudential policy and does not further explore the coordination between the two-pillar regulatory framework and other types of policies(e.g.,fiscal policy).This work will also be interesting in the future.