Soft budget constrait and inflation cycles: A positive model of the macro-dynamics in China during transition

Abstract

In this paper we develop a positive, general equilibrium model consistent with China's institutional and political environment to explain the growth and inflation cycles during transition. Central to our explanation is the government's use of the monetary and financial system to support the state sector, and the growing tension between a long-running commitment to the sector and economic decentralization. Given this commitment, we show how the cycles emerge as a product of the government's imperfect control over credit allocation under decentralization and the high costs of implementing administrative credit control. © 2001 Published by Elsevier Science B.V.