Hot Money and Business Cycle Volatility: Evidence from China

Abstract

This paper investigates the link between hot money and business cycle volatility in China from January 1997 to December 2009. Using the structural vector error correction model, we find a considerable degree of long-run cointegration and bidirectional causality effects between hot money and business cycle volatility. The speculative shocks are found to temporarily promote China's economic growth, but also to exacerbate business cycle volatility. The liquidity shock stemming from hot money is shown to be the primary factor responsible for the significantly enhanced fluctuation in business cycles during the most recent global financial crisis period. This could be detrimental to the smooth operation of financial markets. Therefore, in forming future policies, it is critical for policy-makers to take precautions against the speculative factors. © 2010 The Authors China & World Economy © 2010 Institute of World Economics and Politics, Chinese Academy of Social Sciences.