Reserve financing and government infrastructure investment: An application to China

This paper proposes a novel financing scheme, reserve financing, for government infrastructure investment in China. A two-sector open economy model explores the consequences and policy implications of a surge in infrastructure investment financed by international reserves. The results show that reserve financing, coupled with a managed float exchange rate system, can maintain the country's fast growth rate while mitigating fiscal pressure on local governments. Productive infrastructure capital stimulates domestic demand, reducing the country's dependence on exports. To promote growth and maintain price stability, three factors are critical: return on infrastructure, swift fiscal adjustment, and rapid infrastructure financing.