The Impact of Economic Policy Uncertainty on China’s Regional Economy and Its Dynamic Effects —A theoretical analysis based on TVP-FAVAR

Abstract

Through a review of prior literature, we can conclude that average consumption in developed regions is generally lower than less developed regions and the economic policy uncertainty (EPU) has differently negative effects on China’s investment, consumption, price levels, and output in the short term. This paper intends to divide further China’s provinces and cities into consumption-led areas, moderate areas, and investment-led areas. Then this paper adopts the time-varying parameter factor-augmented vector autoregression (TVP-FAVAR) model to conduct a theoretical analysis of macroeconomic response under China’s economic policy uncertainty. Using the transmission mechanism of interest rate channel, credit channel, and exchange rate channel, we predict that the increase in policy uncertainty will have a more significant negative impact on regions with a low proportion of consumption, manifested in a higher degree of decline in consumption, investment, and output. However, the price level is significantly consistent across regions. As for the nonlinear issue, as China’s economic environment changes, major economic indicators in various regions have shown obvious time-varying characteristics.