Chinese Financial Conditions and their Spillovers to the Global Economy and Markets

Assessing financial conditions in China is challenging given the wide range of conventional and unconventional policy tools the authorities wield to influence economic and market variables. We utilise principal component analysis to construct a new index that captures the most important policy and market dimensions of Chinese financial conditions over time. We then study the relationship between the index and key domestic and international economic variables, as well as asset prices, within a Bayesian VAR framework. We find evidence that exogenous shocks to Chinese financial conditions have strong spillover effects, particularly to global industrial activity, and emerging market bond spreads and equity prices. However, a variant of our model that allows for time-variation in the parameters implies that these spillover effects have been diminishing over time. When compared to the effects of US economic and financial conditions, our results suggest that Chinese economic shocks have weaker spillovers but financial shocks have stronger spillovers, particularly to emerging markets.