Banking and the Macroeconomy in China: A Banking Crisis Deferred?

The downturn in the world economy following the global banking crisis has left the Chinese economy relatively unscathed. This paper develops a model of the Chinese economy using a DSGE framework with a banking sector to shed light on this episode. It differs from other applications in the use of indirect inference procedure to test the fitted model. The model finds that the main shocks hitting China in the crisis were international and that domestic banking shocks were unimportant. However, directed bank lending and direct government spending was used to supplement monetary policy to aggressively offset shocks to demand. The model finds that government expenditure feedback reduces the frequency of a business cycle crisis but that any feedback effect on investment creates excess capacity and instability in output.