What Happens in China Does Not Stay in China

Moynihan Institute of Global Affairs and the Trade, Development and Political Economy program is proud to host Eva Van Leemput, Chief, Emerging Market Economies Section, Board of Governors of the Federal Reserve System.

Spillovers from China to global financial markets have been
found to be small owing to China’s limited integration in the global financial
system. In this paper, however, we provide evidence that China constitutes an
important driver of the global financial cycle. We argue that because of
China’s importance for global consumption, stronger Chinese growth raises
global growth prospects, inducing an increase in global risk sentiment and an
expansion in global asset prices and global credit. Two contributions are key
to this finding:

(1) We construct a measure of China’s credit impulse to
identify Chinese policy-induced demand shocks. Our approach takes advantage of
the fact that a primary tool of China’s stabilization policy—encompassing
monetary, fiscal, and regulatory policies—is controlling the amount of credit
in the economy. Without China’s credit impulse, it is difficult to discern
global financial spillovers;

(2) We estimate an alternative measure of Chinese
GDP growth that captures its business cycle given data concerns about the
smoothness of official GDP data. Without China’s alternative GDP measure, it is
difficult to attribute any global cycle movements to economic developments in
China.