Impacts of Monetary Stimulus on Credit Allocation and Macroeconomy: Evidence from China

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
I. INTRODUCTION In the aftermath of the 2008 global financial crisis, central banks around the world (Federal Reserve System, European Central Bank, Bank of Japan, and People's Bank of China) [...]