Monetary–fiscal policy regime and macroeconomic dynamics in China

Research using structural models to identify monetary–fiscal interactions in emerging economies is still rare. However, it has long been emphasized that monetary and fiscal policies jointly determine macroeconomic dynamics. Using data from China over the period 1993–2017, we estimate the policy regime and shed light on the role of policy shocks in shaping the business cycles in the largest emerging economy. The estimation strongly prefers a passive monetary coupled with an active fiscal policy regime (PM/AF). As confirmed using Chinese data, the transmission mechanisms under this fiscal dominance regime are completely different from those under the commonly assumed AM/PF regime. Moreover, unlike monetary policy shocks, fiscal policy shocks substantially affect inflation and output growth variations in both short- and long-run under PM/AF. Our analysis highlights the importance of scrutinizing the prevailing monetary–fiscal policy regime in understanding macroeconomic dynamics, particularly in emerging economies, which have been largely understudied.