Does local government debt replacement affect macroeconomics? Evidence from China

Abstract

Utilizing the quasi-natural experiment of local debt replacement from 2015 to 2019, this paper employs the intensity difference-in-difference method to investigate the impact of debt replacement on macroeconomics. The findings reveal that local debt replacement significantly increased fixed asset investment, increased industrial output, and reduced financial sector growth, demonstrating its importance in optimizing macroeconomic resource allocation. Simultaneously, local debt replacement improved commercial banks' liquidity risks, slowed stock trading growth, and reduced insurance density, indicating a financial sector constraining effect. Furthermore, local debt replacement significantly stimulated real estate markets by increasing capital availability, increasing newly started construction areas, and accelerating commercial housing sales. Consequently, the fiscal policy space created by such initiatives should be strategically utilized to prioritize investments in major technological advancements, industrial structure optimization, and high-quality development. Second, policymakers must monitor the potential disruptions to financial institutions' operations caused by significant policy changes and promote fiscal–monetary policy synergies. Finally, the stimulative effects of local debt replacement on the real estate sector must be carefully managed to avoid countercyclical policies that unintentionally amplify procyclical distortions.