Demand Boosting and Inflation Control : Policy Choices Facing Increased Labor Income Volatility in China

Boosting private demand and curbing inflation are two major targets set by China’s policymakers. This paper studies China’s policy choices when faced with increased labor income volatility. Using a multi-sector DSGE model, we analyze the negative impact of labor income volatility on China’s economic growth and financial stability. Then we evaluate a combination of counter-cyclical and cross-cyclical policy choices to achieve the dual targets of demand boosting and inflation control. Our results suggest that: (1) Increased labor income volatility leads to an abnormal business cycle with more uncertainties. (2) Technological innovation, salary grade system, and some other factors may cause a discrepancy between the marginal product of labor and labor income. (3) After integrating cross-cyclical policies, counter-cyclical policies become more effective to boost consumer and investment demand while curbing inflation at the same time