The local government bond channel of China's monetary policy

China's economic development and change are significantly influenced by local governments. By affecting the cost of borrowing for local governments, monetary policy can have an impact on their fiscal policies and, eventually, the actual economy. After providing empirical evidence to support the existence of the local government bond channel of monetary policy in China, this paper builds a DSGE model with a multi-region and multi-level government structure in order to quantitatively analyze the impact of the local government bond channel of monetary policy. The findings indicate that local government borrowing costs have a major impact on the transmission of monetary policy. The stimulus impact of monetary policy is significantly increased when local governments may borrow at the risk-free rate, resulting in an output response that is more than twice as large as that of the baseline model. With some cross-regional financial spillovers among local governments, the output response at the average response is lower than in the benchmark model, but the output response at the 75th percentile bond rate is more than twice as large. Since local government borrowing costs respond differently to monetary policy, there are notable geographical consequences of monetary policy. Competition among local governments reduces the impact of monetary policy transmission. This paper's quantitative analysis offers a fresh analytical viewpoint on how China's monetary policy is transmitted during periods of transition.