China financial stability and asymmetric implications for economic stability

This paper selects indicators from the macro-risk surface and incorporates them in the time-varying parameter factor augmented vector autoregression model to construct a financial stability index for China. It further uses the Bayesian Markovian switching vector autoregressive model to explore the asymmetric effect of financial stability on economic stability. This study shows that China’s financial stability has gradually improved over the past nearly two decades and is characterised by two regimes’ shifts between financial volatility and stability. Furthermore, the effects of financial stability shocks on economic stability variables are all significantly asymmetric. The financial stability period plays a stable and sustained role in promoting economic stability variables, while the stabilising effect of the financial volatility phase on economic variables is weakened. In addition, financial stability contributes more significantly to consumption stability than output, price and investment stability. This paper provides valuable references for policymakers to maintain financial and economic stability.