The Nonlinear Relationship Between Financial Stability And The Macro-prudential Policy

By the influence of the global financial crisis, macro-prudential policy becomes ahot topic in contemporary economy. Many scholars have done researches on this issue.In fact, before the financial crisis, some foreign scholars gave preliminaryrepresentations about the definition, objectives, tools, effectiveness and mechanism ofthe macro-prudential policy and so on. After2008, however, people began to reflectthe lessons of the financial crisis, and creatively looked for a variety of solutions,especially lack of regulatory issues that the crisis exposed, the theoretical advocatesshould strengthen financial supervision, and implementation of macro-prudentialregulation becomes a consensus. In recent years, with the development of financialsystem reform, the mechanism of each variable in the economic system also existscorresponding changes, many studies use dynamic stochastic general equilibriummethod to study the mechanism of the macro-prudential policy, but there is noanalysis of the specific tools in the regulation of financial stability. Therefore, thisarticle receives the thoughts of early papers, using Markov-switching vectorautoregressive model, dividing the data into two regimes, then we study the nonlinearrelationship between macro-prudential policy, the economic growth and financialstability respectively.The article establishes a MS-VAR model using GDP growth, financial stabilityindex and macro-prudential policy tools. First, we fit financial stability index (FSI),selecting the deposit and loan ratio, stock price-earnings ratio, national real estateindex, M2/GDP, foreign currency loan/total loans, Shanghai composite index andcompositional index of Shenzhen stock market and so on, based on13indicators byprincipal component analysis to get our country’s financial system stability index FSI.Its graph is consistent with China’s economic development prospects, which showsthat financial stability index built by this article has certain representativeness. Second,we make stationary test to the financial stability index FSI and macro-prudential policy tools: loan-to-value ratio (LTV), domestic credit/GDP, the deposit reserve rate(DR) and provision for coverage (PRC), results show that domestic credit/GDP, thedeposit reserve rate and provision for coverage are not smooth, this is mainly becausethat central banks control the deposit reserve rate and the provision for coverage, andthese changes do not have a smooth time-varying characteristics. Althoughcredit/GDP manifests the non-stationary, there is a long-term cointegrationrelationship credit/GDP and GDP, so we can use it to establish the VAR model. Inaddition, the examples of the subprime crisis show that excessive credit expansionand real estate price bubble will make a lasting impact on financial stability andeconomic activity, so this article chooses loan-to-value ratio (LTV) and domesticcredit/GDP as macro-prudential regulation tools to measure its regulatory influenceon the financial stability and economic growth.Then based on the results in this study, we use FSI, GDP growth rate andmacro-prudential policy tools to build MS-VAR model, the sample into two regimes:financial stability and financial fragility. And then in two zones, this article studies therelationship respectively. Finally we choose impulse response function to describe themechanism of variable changes.The empirical results indicate that, first of all, whether both in the financialstability regime and in the financial fragility regime, the change of loan-to-value ratioand the domestic credit/GDP will make a significant adjustment to the stability of thefinancial system, which manifests that these are effective macro-prudential tools.Second, in the financial crisis period, in views of the reaction degree of financialstability changes, the response of domestic credit/GDP is more intense, which showsthat when the financial system fragility is higher, the government and the monetaryauthorities should pay more attention to the change of domestic credit/GDP, also tendto implement macro-prudential regulation from the total view. Finally, to point out,although both tools play a role in regulating financial stability, these also have asignificant inhibitory effect on economic growth in the short term, which means thatthe use of macro-prudential tools to control the financial stability will face thetrade-offs of economic growth and financial stability. Therefore, when the government and the monetary authorities use macro-prudential tools to control thestability of the financial system, they should attach great importance to thedouble-edged effects of macro-prudential tools, so ensuring the safety running of thefinancial system and smooth development of macro economy.