Monetary policy uncertainty, debt financing cost and real economic activities: Evidence from China

This paper studies how monetary policy uncertainty (MPU) propagates to real economic activities in China, and suggests that debt financing cost plays a pivotal role. Our empirical analysis, based on firm-level panel data, indicates that the rise in MPU leads to a significant increase in debt financing cost, which further reduces firm investment. The interacted VAR model based on macro-level data also suggests that the deflationary effect of MPU is intensified when debt level is high. Moreover, we present a theoretical framework of DSGE analysis to formalize how the rise in MPU depresses economic activities. Simulations featuring default risks and uncertainty shocks support evidence that MPU is transmitted to the real sector through debt financing cost channel.

Automated summary

This paper investigates how monetary policy uncertainty affects real economic activities in China, highlighting the role of debt financing cost. The empirical analysis shows that an increase in MPU leads to higher debt financing costs and subsequently reduces firm investment, particularly when debt levels are high. The study also presents a theoretical framework and simulations to demonstrate how MPU is transmitted to the real sector through debt financing costs.