Macroeconomics

Monetary policy

China

Economics

Deflation

Dynamic stochastic general equilibrium

Politics

Debt financing

Political science

Monetary economics

Debt

Finance

Investment (military)

International Review of Economics & Finance

This paper studies how monetary policy uncertainty (MPU) propagates to real economic activities in China, and suggests that debt financing cost plays a pivotal role. Our empirical analysis, based on firm-level panel data, indicates that the rise in MPU leads to a significant increase in debt financing cost, which further reduces firm investment. The interacted VAR model based on macro-level data also suggests that the deflationary effect of MPU is intensified when debt level is high. Moreover, we present a theoretical framework of DSGE analysis to formalize how the rise in MPU depresses economic activities. Simulations featuring default risks and uncertainty shocks support evidence that MPU is transmitted to the real sector through debt financing cost channel.

Monetary policy uncertainty, debt financing cost and real economic activities: Evidence from China