Impacts of financial decentralization on economic growth and inflation in China

Abstract

Fiscal decentralization and promotion incentives are main elements that inspire local governments in China to compete for economic growth with each other; but this regime is only part of reason that local governments in China have more effects on economic cycle than their counterparts in other countries. The authors think that financial decentralization should be taken into account. Empirical results indicate that excess financial decentralization would cause high risk of inflation and economic overheating. After tax-sharing reform in 1994, the central government could adjust the boundary of financial decentralization and the local governments may borrow more money during the economic downturn. The authors suggest that a two-tiered financial supervisory system should be set up in the new round of financial reform and financial decentralization should be adjusted to the changing market economy in China.