When Can Macroeconomic Policy Smooth Business Cycle Fluctuation? A Demand-Side Mechanism Story in Post-Opening-Up and Pre-COVID China

This paper investigates the timing characteristic of the fluctuation-mitigating effect of macroeconomic policy using aggregate variables from the demand side of a country as functionary channels. By formulating and applying a two-variable nonlinear Markov Switching Causality model to the Chinese economy from 1993 to 2019, i.e., from the year of China’s full implementation of the opening-up policy to the year when COVID imposes a sudden stop to the Chinese economy, we find time-varying and regime-switching relationships between various policy tools and demand-side macroeconomic indicators that drive business cycles. This finding supports the implementation of only the best-fit policy to smooth fluctuations in specific periods and macroeconomic indicator causality regimes, aiming to solve for stable transition pathways to a green Chinese economy.