Rethinking Financial Repression and Implicit Guarantee in China
80 Pages Posted: 30 Mar 2020
Date Written: February 20, 2020
Abstract
I construct a model that can explain nearly all financial repression phenomena and main financial market equilibria in China. The model gets two insights: Foremost, the “financial repression” in China roots in the repressed household and state-owned enterprise (SOE) sectors rather than the finance sector. Against this background, the implicit guarantee is not the main risk of financial stability: On one hand, the implicit guarantee is an exogenous institutional factor, it already been contained in asset prices; on the other hand, the household and SOE’s repressions alleviate the implicit guarantee risk. If breaking the implicit guarantee, it will cause financial turmoil and households will bear the cost. To stabilize the financial system, the central bank needs to prevent redemption between banks and to recapitalize banks; while the effect of lender-of-last-resort is limited. If keeping the implicit guarantee, through improving liquidity in the inter-bank market and relaxing the SOE repression can raise financial market efficiency remarkably. Therefore, reform coordination between different sectors is more important for today’s China.
Keywords: financial repression, implicit guarantee, financial risk
JEL Classification: E44; E58; G18; O11; O16
Suggested Citation: Suggested Citation