The Effects Of Energy Supply Shocks And Interest Rate Liberalization In China

Supply-side shocks are an important factor affecting macroeconomic fluctuations.For example,the oil crisis in the 1970 s is considered one of the main causes of economic stagnation in the Western world;China’s supply-side structural reforms in recent years,with "removing production capacity and reducing costs" as the core,have also had an important impact on macroeconomic performance;the new crown epidemic(Covid-19)since 2020 has led to Supply chain disruptions and declining labor force participation rates since 2020 have posed challenges to macroeconomic policies;energy and food shortages from the Russia-Ukraine war starting in February 2022 have also exacerbated the volatility of the world economic situation.Energy price volatility causes changes in output and inflation by affecting production costs,consumption,and the expectations of economic agents.And the response of monetary policy plays a crucial role in the transmission of energy supply shocks.New Keynesian theory suggests that in the case of sticky prices,changes in the level of interest rates affect the effect of energy shocks through the real interest rate.Faced with a negative supply shock,in the case of an elastic interest rate(e.g.,Taylor rule),inflation increases while output declines;in the case of a fixed interest rate(e.g.,the lower bound of the zero interest rate),a negative supply shock leads to an increase in output rather than a decline.The key mechanism that produces this result is the real interest rate: in a period of flexible interest rates,the Taylor rule allows the real interest rate to increase with inflation,which causes output to fall,while in a period of fixed nominal interest rates,the real interest rate decreases with inflation,which causes output to increase.That is,compared to the flexible interest rate period,in the case of a fixed interest rate,output falls less or even increases in the face of a negative energy supply shock,a result that contradicts the flexible interest rate period,and the response of inflation is even greater than in the flexible interest rate period.In China,it has been nearly thirty years since the market reform of interest rates was launched in 1996.At the beginning of the market reform,interest rates were regulated by the state and were relatively "fixed".As the marketization of interest rates progressed,interest rates gradually became more elastic,which provided the conditions for us to study the response of economies to energy shocks at different interest rate levels.So,do different interest rate elasticities have an impact on supply-side shocks? Does a negative supply-side shock have an expansionary effect in the case of a fixed interest rate?To address the above questions,this paper focuses on two levels of theoretical and empirical evidence:(1)On the theoretical side,this paper models the interest rate marketization in China as an evolution from fixed to flexible interest rates and constructs a New Keynesian model incorporating fixed interest rates and energy supply shocks to explore the impact of interest rate elasticity changes on energy shocks before and after interest rate marketization in China.The theoretical analysis demonstrates that in the face of a negative supply shock,output declines less or even increases with a fixed interest rate compared to an elastic interest rate.The main mechanism is that a fixed nominal interest rate makes the real interest rate change in the opposite direction with expected inflation,thus changing the propagation mechanism of the model for energy shocks.(2)In terms of empirical tests,this paper focuses on the impact of energy supply shocks represented by coal,oil,and natural gas on the Chinese economy under different interest rate regimes.First,we test the findings of the theoretical model by constructing the Divisia energy index using Chinese data(based on Kilian’s(2009)method to construct an SVAR model to identify supply shocks and Jorda’s(2005)local projection method to obtain the response to shocks of the variables)..In the fixed interest rate case,output increases rather than decreases in the face of a negative energy supply shock,and inflation levels are higher than in the flexible interest rate case.Second,we use the coal data to make further tests and find that output increases but decreases less in the fixed rate case than in the flexible rate case,and inflation is significantly higher than in the flexible rate case.The results of the empirical tests are generally consistent with the theoretical predictions of the model.