Journal
REVIEW OF ECONOMIC STUDIES
Volume 89, Issue 6, Pages 3115-3153Publisher
OXFORD UNIV PRESS
DOI: 10.1093/restud/rdab098
Keywords
Government intervention; Financial stability; Price efficiency; G18
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China and the West have different approaches to managing financial markets, with China prioritizing financial stability while the West values market freedom. Research shows that under certain economic conditions, China's intensive government intervention leads investors to focus on policy noise rather than fundamentals.
China's economic model involves regular and intensive government interventions in financial markets, while Western policymakers often refrain from substantial interventions outside crisis periods. We develop a theoretical framework to rationalize the approaches of both China and the West to managing the financial system as being optimal given the differences in their respective economies. In this framework, a government leans against trading of noise traders but at the expense of introducing policy noise to the market. Our welfare analysis shows that under certain underlying economic conditions, the optimal government policy induces a government-centric equilibrium, in which government intervention is so intensive that all investors choose to acquire private information about policy noise rather than fundamentals. This policy regime characterizes China's approach with financial stability prioritized over other policy objectives.
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