Kaiji Chen, Patrick Higgins, Daniel F. Waggoner, and Tao Zha

Working Paper 2016-9a
Revised October 2017

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We develop a new empirical framework to identify and estimate the effects of monetary stimulus on the real economy. The framework is applied to the Chinese economy when monetary policy in normal times was switched to an extraordinarily expansionary regime to combat the impact of the 2008 financial crisis. We show that this unprecedented monetary stimulus accounted for as high as a 4 percent increase of real gross domestic product (GDP) growth rate by the end of 2009. Monetary transmission to the real economy was through bank credit allocated disproportionately to financing investment in real estate and heavy industries. Such an asymmetric credit allocation resulted in the persistently high investment rate and debt-to-GDP ratio. Our findings provide a broad perspective on a tradeoff between short-run GDP growth and longer-run accumulated debt in response to large monetary interventions.

JEL classification: E5, E02, C3, C13

Key words: asymmetric credit allocation, endogenous regime switching, debt-to-GDP ratio, heavy GDP, heavy loans, real estate, land prices, GDP growth target, nonlinear effects

Comments from Marty Eichenbaum, John Leahy, Chris Sims, Harald Uhlig, Gianluca Violante, and Shang-Jin Wei have helped improve earlier drafts. The authors thank the discussants Kevin Huang, Bing Li, and Kang Shi as well as seminar participants at International Monetary Fund, Hong Kong Monetary Authority, ECB-Tsinghua Conference on China, Chinese University of Hong Kong, and Princeton University for helpful discussions. This research is supported in part by the National Science Foundation Grant SES 1558486 through the NBER and by the National Natural Science Foundation of China Project Numbers 71473168, 71473169, and 71633003. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or the National Bureau of Economic Research. Any remaining errors are the authors’ responsibility.
Please address questions regarding content to Kaiji Chen, Emory University, 1602 Fishburne Drive, Atlanta, GA 30322-2240 and Federal Reserve Bank of Atlanta, kaiji.chen@emory.edu; Daniel F. Waggoner, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, daniel.f.waggoner@atl.frb.org; Patrick Higgins, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, patrick.higgins@atl.frb.org; or Tao Zha, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, Emory University, and NBER, tao.zha@atl.frb.org.
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