The Impact of Financial Risk Factors on Chinas Real Economy

As the worlds second largest economy, China has accounted for around one-third of global GDP growth over the last decade while, at the same time, Chinas economy faces a dramatic increase of economic uncertainty and financial risks in the recent years, preventing financial risk has been made a top economic priority for the next years of Chinas government work.This study employs dynamic factor model with time-varying coefficients to build three factors associated with financial risk derived from extensive financial and macroeconomic data in China. Subsequently, this paper investigate the non-linear impacts of these financial risk factors on China's real economy. Our findings reveal that financial risk shocks have the potential to transmit to the real economy, inducing a contractionary effect on both output and inflation rates. Notably, these spillover effects are significantly magnified during periods of economic recession. The most important policy implication of this paper is that: other than monitoring and preventing the financial risks in financial system, Chinas government should also reduce its policy uncertainties to better promote financial stability.