The impact on the Australian economy of exogenous or policy shocks to China has yet to be quantified, despite increasing public perception of a link and a growing trade relationship between the two countries. An empirical measure of this effect is important for policymakers, as well as others exposed to the Australian economy to develop appropriate responses to such shocks. Although some literature describing Australias business cycle synchronization exists, historically it has focused on shocks emanating from the U.S. and currently the only studies including China use correlation analysis or a DSGE model. Moreover, all previous research is focussed on the effects on Australian output measures, whereas this research measures the effect on a more relevant measure for the open economy, purchasing power. Further, it is likely that this relationship has changed over time, a feature that such time invariant models will not capture.
This thesis will attempt to address this deficiency in the literature. It will examine the response of Australian variables to Chinese demand and money supply shocks and attempt to quantify how these responses have evolved. This will be achieved using a TVP-SVAR model with Bayesian estimation and stochastic volatility in the parameters.
Contrary to popular opinion, the results of this research indicate that despite increasing trade and price linkages between China and Australia, idiosyncratic shocks to the Chinese economy have an insignificant effect on Australian purchasing power and other macroeconomic variables.