Sectoral shocks, production linkages, and business cycles in China1

Abstract

This paper develops a dynamic multisector model to examine the contribution of sectoral productivity shocks and input-output linkages to the dynamics of the Chinese economy. Our baseline simulations replicate the volatility and comovement in the data fairly well. More importantly, we show that the idiosyncratic components of sectoral productivity shocks together with the production linkages are the primary drivers of volatility and comovement, while the common components of sectoral productivity shocks mainly result in resource reallocation across sectors through substitution effects. The sensitivity analysis highlights the importance of elasticity-of-substitution parameters. Finally, the share of state-owned enterprises in each sector is shown to have significant impact on the aggregate volatility.