Macro Regime and Economic Growth in China

In this paper, we investigate the relationship between Chinese macroeconomic policy and economic growth, and examine how the choice of macroeconomic regime affects economic performance in China. An open-economy model is developed for this purpose. It is a three-sector “almost small" open-economy macroeconomic model, with asset markets and forward-looking agents. This open-economy model is then adopted to analyse the implications of both domestic and external growth shocks to the Chinese economy under two alternative macroeconomic policy regimes. These policy regimes have two extreme assumptions on the exchange rate, with differing degrees of financial capital mobility. The simulation results show that greater flexibility in the exchange rate regime allows the central bank to conduct independent monetary policy in the Chinese economy, the benefit from which increases as financial capital becomes more internationally mobile. Most growth shocks cause an expansion in the real GDP level, and there is a deflation in the price level and depreciation in the real exchange rate when the economy operates a floating exchange rate regime with high financial capital mobility. Overall, the expansionary effects in this macroeconomic environment will be beneficial to the Chinese economy.