The economic fundamental and economic policy uncertainty of Mainland China and their impacts on Taiwan and Hong Kong

The opening-up of Mainland China has significantly increased its economic relationship with Taiwan and Hong Kong. Trade among Taiwan, Hong Kong and Mainland China has registered record highs in recent years, and capital flow has grown exponentially. The paper applies structural vector autoregressive models to the Taiwan and Hong Kong economies to investigate the impacts of the Chinese economy over the past decade. Identification of the structural shocks is based on the fact that Mainland China has a causal effect on Taiwan and Hong Kong, but not the reverse. Our identification scheme generalizes that in Blanchard and Quah (1989) and considers both short-run restrictions and long-run restrictions. Based on a New Keynesian model, a simple model with four domestic variables namely output, interest rate, price level and real exchange rate, as well as two foreign variables namely Mainland China output and the China monthly index of economic policy uncertainty, is constructed. By considering the short-run and the long-run impacts, we attempt to address the following issues: (i) Is domestic output, or some other domestic variables, affected by the uncertain economic conditions? (ii) Is it a long-run effect, or simply a short-run effect?