Finance in a global CGE model: the effects of financial decoupling between the U.S. and China

Abstract

We add to the GTAP model a financial module built around an 18-region asset-liability matrix. A financial agent in each region takes account of expected rates of return in allocating the regions financial budget between domestic capital and financial assets in each other region. Using GTAP with the financial module in place, we simulate financial decoupling between the U.S. and China. The results show that the U.S. would gain by limiting its financial flows to China, leading to a redirection of finance to the domestic economy. This would stimulate investment in the U.S. with favorable effects on employment, capital stocks, real GDP, wealth, and real wage rates. At the same time investment in China would decline with negative effects on the Chinese economy. Similarly, China would gain by limiting its financial flows to the U.S. and the U.S. would lose. In a tit-for-tat situation in which each country reduces its financial asset holding in the other country by x per cent, the winner would be China. We conduct additional simulations to compare the effects of trade decoupling with those of financial decoupling.