China's Easily Overlooked Monetary Transmission Mechanism: Monetary Reservoir

TL;DR

This paper identifies China's real estate sector as a non-traditional monetary reservoir influencing monetary policy effectiveness, asset bubbles, and long-term growth through fiscal and financial interactions.

Contribution

It constructs a dynamic general equilibrium model revealing how China's real estate acts as a monetary reservoir affecting policy and growth.

Findings

Real estate sector functions as a monetary reservoir in China.

The mechanism influences asset prices and policy effectiveness.

Crowds out long-term growth factors like human capital.

Abstract

The traditional monetary transmission mechanism usually views the equity markets as the monetary reservoir that absorbs over-issued money, but due to China's unique fiscal and financial system, the real estate sector has become an "invisible" non-traditional monetary reservoir in China for many years. First, using data from Chinese housing market and central bank for parameter estimation, we constructs a dynamic general equilibrium model that includes fiscal expansion and financial accelerator to reveal the mechanism of monetary reservoir. An asset can be called a loan product, which worked as financed asset for local fiscal expansion, as long as it satisfies the following three conditions: leveraged trading system, balance commitment payment, and the existence of the utility of local governments. This paper refers to this mechanism as the monetary reservoir that will push up the premium of loan product, form asset bubbles and has a significant impact on the effectiveness of monetary policy. Local governments leverage the sector of the loan product to obtain short-term growth by influencing the balance sheets of financial intermediaries through fiscal financing, expenditure and also investment, but this mechanism undermines the foundations of long-term growth by crowding out human capital and technological accumulation.