Bubble Economics: How Big a Shock to China's Real Estate Sector Will Throw the Country into Recession, and Why Does it Matter?

67 Pages Posted: 30 May 2016

See all articles by Bryane Michael

Bryane Michael

University of Oxford

Simon Zhao

The University of Hong Kong - Department of Geography

Date Written: May 27, 2016

Abstract

How far do China’s property prices need to drop in order to send the country into a recession? What does this question tell us about the way Bubble Economies work? In this paper, we develop a theory of Bubble Economics - non-linear and often “systemic” (in the mathematical sense of the word) forces which cause significant misallocations of resources. Our theory draws on the standard elements of most stories of Bubble Economics, looking at the way banking, construction, savings/investment, local government and equities sectors interact. We find that Bubble Economies’ GDP growth can depend on property prices changes differently at different times - depending on risks building up in the economy. We argue that a tacit, implicit Bubble Risk Factor might provide a way of understanding a key variable academics and practitioners omit when they try to explain how economies (mis)allocate resources during bubbles. A 15%-20% property price drop could cause recession, if China’s economy resembles other large economies having already experienced property-related asset crises. However, a 40% decline would not be out of the question.

Keywords: China recession, bubble economics, DSGE models, fragility, systems of nonlinear differential equations

JEL Classification: D58, N15, L85, G01

Suggested Citation

Michael, Bryane and Zhao, Simon, Bubble Economics: How Big a Shock to China's Real Estate Sector Will Throw the Country into Recession, and Why Does it Matter? (May 27, 2016). Available at SSRN: https://ssrn.com/abstract=2785503 or http://dx.doi.org/10.2139/ssrn.2785503

Bryane Michael (Contact Author)

University of Oxford ( email )

South Parks Road
Oxford, Oxfordshire OX1 3QY
United Kingdom

HOME PAGE: http://users.ox.ac.uk/~scat1663/

Simon Zhao

The University of Hong Kong - Department of Geography ( email )

Pokfulam Road
Hong Kong
China

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