Rethinking Financial Repression and Implicit Guarantee in China
80 Pages Posted: 30 Mar 2020
Date Written: February 20, 2020
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