Mixed Monetary–Fiscal Policies and Macroeconomic Fluctuations: An Analysis Based on the Dynamic Stochastic General Equilibrium Model

• Published date: 01 March 2022
• Author: Xi Wang,Jiayang Li,Guangbin Zhang
• Date: 01 March 2022
• DOI: http://doi.org/10.1111/cwe.12414

©2022 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 167–196, Vol. 30, No. 2, 2022 167

Mixed Monetary–Fiscal Policies and Macroeconomic

Fluctuations: An Analysis Based on the Dynamic

Stochastic General Equilibrium Model

Xi Wang, Jiayang Li, Guangbin Zhang*

Abstract

The existing literature on macroeconomic policy research is mainly concerned with the

impact of a single monetary or fi scal policy on China’s macroeconomic fl uctuations in

a closed economy. However, the effect of a mix of monetary and fi scal policies has been

neglected. This paper addresses this issue with an open economy dynamic stochastic

general equilibrium model. It applies impulse-response and welfare analyses to explore

the stabilization effect of various mixes of monetary and fi scal policies. The results show

that the optimal monetary policy and fi scal policy mix varies in different cases. When

government spending shocks happen, the aggressive fi scal policy and passive monetary

policy would be the best choice. In contrast, for domestic interest rate shocks, foreign

interest rate shocks, and foreign consumption shocks, the passive fiscal policy and

aggressive monetary policy are more applicable. This article explains China’s economic

fl uctuations and highlights the importance of mix of monetary and fi scal policies in the

face of different shocks.

Keywords: fi scal policy, macroeconomic fl uctuations, monetary policy, policy mix

JEL codes: E63, F41, F62, O23

I. Introduction

In recent years, frequent financial crises (such as the Asian financial crisis in 1997

and the 2007–2008 global fi nancial crises) have led to economic downturns that have

severely tested many countries. Unemployment, inflation, abnormal fluctuations in

exchange rates, and economic stagnation are more common than before. During the

*Xi Wang, Professor, Lingnan College, Sun Yat-Sen University, China. Email: Lnswx@mail.sysu.edu.cn;

Jiayang Li, PhD candidate, Lingnan College, Sun Yat-Sen University, China. Email: lijiay23@mail2.sysu.

edu.cn; Guangbin Zhang (corresponding author), Professor, School of Economics and Management, Yunnan

Normal University, China. Email: 673076750@qq.com. This study is sponsored by National Natural Science

Foundation of China (Nos. 72133006 and 71903204) and the Youth Fund Project of Ministry of Education

(No. 19YJC790137).

Xi Wang et al. / 167–196, Vol. 30, No. 2, 2022

©2022 Institute of World Economics and Politics, Chinese Academy of Social Sciences

168

Asian fi nancial crisis, China promoted domestic economic recovery through proactive

fiscal policies and prudent monetary policies (Feng et al., 2021). From September

2008 to December 2008, the People’s Bank of China lowered the deposit reserve

ratio four times. However, due to the insignificant effect of the policy stimulus, the

Chinese government implemented the “four trillion” plan in November 2008 to

curb the downward trend in the domestic economy. Even now, the negative impact

of the global financial crisis on China’s economy has not ended. COVID-19 and

the trade conflicts between China and the US have exacerbated global economic

uncertainty (Song and Zhou, 2020) also kept the RMB exchange rate under constant

pressure. In the early days, countries worldwide generally used the money supply

as the main tool for macroeconomic regulation and control. However, with the

continuous development of the economy and finance in the 1980s, Britain, the US,

Germany, Switzerland, and other countries found that the correlation between monetary

policy and the money supply as the main tool and the ultimate goal of economic

development weakened. The measurability and controllability of the money supply also

decreased gradually. These countries are turning to interest rates as the main tools of

macroeconomic manipulation. Since the global fi nancial crisis in 2008, the central banks

of many countries have realized that it is impossible to achieve their expected goals by

relying only on monetary policy to regulate the real economy, and a single policy cannot

effectively smooth fl uctuations in the operation of the economy. People also begin to

pay more and more attention to the impact of the economic policy mix on a country’s

macroeconomic stability. Indeed, fi scal policy and monetary policy – two major policy

systems of macroeconomic regulation – usually have better effects when coordinated.

As the main means of macroeconomic regulation, fi scal and monetary policies have

also experienced a tortuous development process in China. From 1949 to 2019, China’s

economy experienced a transformation from a planned economy to a market economy,

and then to the current “new normal.” Accordingly, the government’s regulatory means

have changed greatly. One of the main manifestations is the continuous improvement in

the coordination between fi scal and monetary policy.

China has entered the “new normal” in recent years. The investment growth rate has

dropped markedly. Structural problems such as overcapacity, economic downturn, low

infl ation, and asset price bubble have become more prominent. Under the “new normal”

of China’s economy, the acceleration of structural adjustment, the transformation of

development mode, the promotion of a new round of opening-up strategy, and the

control of systemic risks in the financial system all require the overall stability of

macro economy. The mix of fi scal policy and monetary policy is becoming increasingly

important.