The Chinese Guarantee Network and Post-Recession Stimulus
Article: https://arxiv.org/ftp/arxiv/papers/1804/1804.05667.pdf
This recent paper outlines a network analysis of the Chinese guarantee system in the context of the financial crisis of 2008/09 and the Chinese government’s subsequent stimulus program. A guarantee relationship is between two firms, wherein a guarantor firm will pay the debt incurred by a borrower firm if the borrower firm fails to pay its debts and defaults. In this way, Chinese financial institutions are linked together in a ‘guarantee network.’ By analyzing the evolving structure and properties of this network, the author of this study finds that the monetary policy adjoining the economic stimulus program contributed to a more interconnected guarantee network, which undermined the economy’s stability.
A financial guarantee-network consists of firms as nodes and edges as mutual guarantee relationships. Upon analysis, the author finds that the size of the network decreased after the start of the financial crisis but increased after the government stimulus program. Moreover, the clustering coefficient, which measures the extent to which the nodes form triangles, increased rapidly in the wake of the stimulus program (partly due to the new monetary policy) and kept increasing until 2010 when post-stimulus monetary policy reforms took place. A highly interconnected guarantees-network is indicative of systemic risk, wherein the collapse/default of a few nodes can create a cascading effect of failures all around. The guarantees seemed to be in isolated components, however, because the shortest path length started increasing with the stimulus program. Using these shifting network indicators, the author shows that the stimulus program with loose monetary policy essentially accelerated the creation of these guarantee relationships, especially with small businesses, creating a systemic risk due to interdependence. The subsequent decrease in the graph’s interdependence in 2010 post-monetary policy reform suggests that the reforms helped ameliorate such market instabilities.
As a result, the author of this paper concludes by asserting that policies will often have unforeseen implications within the broader network of participants in the economy. He uses basic ideas such as clustering coefficients and the shortest path length to substantiate this claim. In this way, analyzing the macro-level dynamics of a system before making any revitalizing change is crucial.