A dynamic financial applied general equilibrium model of the Chinese economy

This thesis describes a recursive-dynamic computable general equilibrium (CGE) model of the Chinese economy which allows explicit policy analysis to be conducted on the financial sector. The motivation for the development of this model is to address the shortcomings of current large-scale CGE models with regard to their implementation of the financial sector, and to subsequently investigate the role of monetary and fiscal policy within this framework. We apply our Financial Applied General Equilibrium (PAGE) model specifically to the Chinese external accounts. China’s rapid accumulation of foreign reserves and large external imbalance has raised some questions as to how they could best restructure their economic policy in order to reduce their reliance on exports and achieve more sustainable growth. Three different sets of simulations are conducted using the PAGE model. The first confirms the ‘impossible trinity’ hypothesis whereby central banks cannot simultaneously i) allow free capital movement, ii) adopt a fixed exchange rate, and iii) have independent monetary policy. The second finds that further appreciation of the Chinese currency would not correct China’s external imbalance as some analysts suggested, but may in fact lead to an even larger trade surplus in the short run. The final set of simulations tests two rebalancing packages for the Chinese economy and finds that an increase in domestic consumption combined with an expansionary monetary policy would yield the most favourable outcome. The thesis includes a number of other contributions including some back-of-the envelope (BOTE) equations allowing easier interpretation and analysis of simulation results, and the derivation of a suitable capital supply and investment function within the context of the model’s financial sector framework.