How trade drives fluctuations in macroeconomics in China – A multi-level dynamic factor approach

Abstract

Investigating how international trade with different regions and in different indus- tries affects the macroeconomy is crucial for policymaking and economic forecasting, particularly in the context of trade frictions. Using a dynamic hierarchical factor model (DHFM) and factor-augmented vector autoregression (FAVAR) model, we extract factors from extensive trade data to explore their impacts on and interactions with the macroeconomy.

Our findings reveal three key aspects. First, a positive shock to the overall trade factor generates positive macroeconomic effects, though with notable regional varia- tions. The OECD factor triggers inflationary pressures and monetary tightening in both China and the US, whereas the ASEAN factor leads to policy divergence—China opts for monetary easing against US tightening—accompanied by improved foreign direct investment (FDI) inflows and stock market performance. Second, in the in- dustry dimension, positive shocks to the medium-tech and high-tech manufacturing sector demonstrate sustained industrial growth and positive FDI trends, despite some financial market uncertainties. Third, regarding policy interactions, we find a contrac- tionary US monetary policy shock significantly impacts China's trade and macroeco- nomic cycles,whereas a contractionary Chinese monetary policy shock shows relatively ambiguous effects.