Accounting for China’s business cycles: a quantitative analysis of the post-reform era

This paper analyzes China’s macroeconomic fluctuations over the post-reform period from 1979 to 2019 using a small open economy business cycle accounting framework. It estimates four wedges and quantifies their contributions to economic fluctuations during three major slowdown episodes: the late 1980s, the Asian Financial Crisis, and the post-Global Financial Crisis period. The results show strong heterogeneity across episodes. In the late 1980s and during the Asian Financial Crisis, movements in the efficiency wedge account for most of the declines in output, while the labour wedge primarily drives fluctuations in hours worked. A novel finding is that in the post-2011 slowdown, output and consumption dynamics are explained predominantly by the bond wedge, with the efficiency wedge playing a negligible role. The investment wedge contributes little to aggregate fluctuations throughout the sample. The paper further links the estimated wedges to China-specific institutional factors, including credit misallocation towards state-owned enterprises, wage rigidity and labour market segmentation associated with the hukou system, and evolving external financial conditions shaped by external debt composition, foreign reserve accumulation, and exchange rate management.