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China’s Gradualistic Economic Approach and Financial Markets (Brunnermeier, Sockin, Xiong, AER P&P, 2017)

"A key approach successfully employed by China to reform its economy in the past 30 years is the so-called "crossing the river by touching the stones" approach, a gradualistic method that optimizes policy through experimentation. The government will start with an initial (usually small) policy change, and gradually modify the policy based on the reaction from the economy to this change." BUT, "Can China continue to use its gradualistic approach in the presence of active financial markets?"

In Brunnermeier, Sockin, Xiong, (AER P&P, 2017), they provide the theoretical rationale for potential ineffectiveness of gradualistic policy approach with the existence of an active financial market. In align with the well-known time-inconsistency problem (Kydland and Prescott (1977) and Barro and Gordon (1983) ), incentives of front-run by private agents in expectation of ex post non commitment of the policymaker renders the gradualistic approach ineffective. 

The po…
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