1 China ’ s Real Business Cycles between 1954 – 2006 : Productivity and Fiscal Policy Changes

We study the real business cycles in China between 1954-2006, and examine the changes after 1978 when China started its market-oriented reforms. To better understand the real business cycle phenomena in China, we develop several estimations to overcome the data problems and improve the business cycle measurement, in particular the consumption, investment, employment and labor hours. We find that the volatility of the Chinese economy is significantly moderated after 1978, but the consumption and labor hours, relative to the output, become more volatile. We then use a standard neo-classical growth model to study the factors generating the economic fluctuations in China and the differences between pre-1978 and post-1978 periods. Our results indicate that the TFP growth rates are the main reason for the economic volatility and the moderation after 1978. However, it cannot explain the relative volatility changes: fluctuations of output and investment moderate much more than consumption in the post-1978 period. We suggest that the policy change in government expenditure, from pro-cyclical to countercyclical, can account for this phenomenon.