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Economic policy uncertainty, financial development, and financial constraints: Evidence from China

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  • Ma, Huanyu
  • Hao, Dapeng

Abstract

Financial frictions are important transmission mechanism of the adverse effect of policy uncertainty on economic output. We use Chinese listed firms’ data to verify the mechanism directly by empirically examining whether economic policy uncertainty (EPU) exacerbates corporate financial constraints and whether financial development can mitigate the impact of policy uncertainty on financial constraints. We find that economic policy uncertainty causes a significant increase in the firm financial constraints level. We further find that financial development mitigates the adverse impact of EPU on financial constraints. Financial development also relieves the increase in cost of capital and the significant decrease in cash flow caused by rising EPU through which EPU affects financial constraints. Further analysis shows that the moderating effect is much stronger when the firm is credit constrained, (e.g., small firms and non-state-owned enterprises).

Suggested Citation

  • Ma, Huanyu & Hao, Dapeng, 2022. "Economic policy uncertainty, financial development, and financial constraints: Evidence from China," International Review of Economics & Finance, Elsevier, vol. 79(C), pages 368-386.
    • Handle: RePEc:eee:reveco:v:79:y:2022:i:c:p:368-386
    DOI: 10.1016/j.iref.2022.02.027
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    Keywords

    Economic policy uncertainty; Financial constraints; Financial development; Cost of capital; Cash flow;
    All these keywords.

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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