China’s Institutional Strength, Monetary Policy Coordination and Fiscal Crowding-in Effect

Li Rong (李戎)1* and Liu Lifei (刘力菲)2

1 China Financial Policy Research Center, Renmin University of China, Beijing, China

2 School of Finance, Renmin University of China

Abstract: As two main tools of macroeconomic policies, coordination and conflict between fiscal and monetary policies have been paid considerable attention by researchers. Under a structural vector autoregressive model that incorporates fiscal and monetary policies, this paper analyzes the monetary policy response to fiscal shocks. Our study finds that during the occurrence of a fiscal shock, the growth rate of broad money supply M2 substantially increased, indicating the adoption of an expansionary monetary policy by the monetary authority to fiscal policy expansion. Based on this empirical finding, this paper improves the dynamic stochastic general equilibrium model to investigate the fiscal policy effects under China’s monetary policy coordination. Our analysis shows that monetary policy coordination will significantly boost the economic stimulus effect of fiscal policy, generating a fiscal crowding-in effect. From the perspective of China’s institutional strength, this conclusion offers a theoretical explanation on the empirical fact of the fiscal crowding-in effect uncovered in the research literature, and offers a policy reference for making the proactive fiscal policy more efficient and effective. This paper suggests that China’s policymakers give full play to the country’s institutional strength by coordinating fiscal and monetary policies for high-quality economic development.

Keywords: Fiscal policy, monetary policy rules, monetary and fiscal policy coordination, fiscal multiplier

JEL Classification Code: E62, H50, E60

DOI: 10.19602/j.chinaeconomist.2022.09.06