By Wei Wang. University of California, Berkeley
This study investigates the relationship between developing stock markets and the real economy by examining the effect of stock market crashes on macroeconomic variables in China in recent years. I determine periods of stock market crashes in China and estimate a panel Vector Autoregression model to assess the impulse responses of provincial GDP, interest rate, consumer confidence index and consumer price index to stock market crash shocks. The impulse response functions reveal a statistically insignificant response of GDP to stock market crashes, yet significant negative responses of consumer confidence index to stock market crashes. A robustness check indicates a positive reaction of fixed investment to crash shocks. I speculate that as the Chinese economy is investment-driven, it is resilient to wealth effects while the increase in fixed investment in response to financial crash offsets consumption changes to produce an overall insignificant net effect in GDP.
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