Local debt risk is one of the core variables of systemic financial risk in China, and comprehensive macroeconomic policy responses are essential for achieving economic and financial stability. Research on the cross-sector transmission mechanisms of local debt risk and the consistency of macroeconomic policy orientations is of significant importance for the sustained and stable development of the Chinese economy.

This paper constructs a multi-sector DSGE model incorporating the feature of commercial banks and introduces different financing channels for local debt. The results show: First, as the primary holders of local debt, commercial banks experience net worth deterioration following a local debt default, which reduces corporate investment and exerts an adverse impact on total output. Second, counter issuance of local debt reduces liquidity absorption by banks, thereby enhancing the effectiveness of fiscal expansion policies. Third, compared to single-policy implementation, policy mixes are more effective in mitigating local debt risk. Specifically, combining counter issuance of local debt with fiscal expansion policies more effectively addresses local debt default risk. Additionally, under local debt default shocks, a monetary policy mix of interest rate cuts and reserve requirement ratio reductions also leads to more pronounced economic improvements. Fourth, net interest margin compression in commercial banks, while reducing bank net worth, lowers corporate financing costs and amplifies policy mix effectiveness. Fifth, strengthening the consistency of macroeconomic policy orientations between policy mixes better mitigates the adverse effect of local debt default risk. When fiscal and monetary policy mixes share consistent directions and objectives, their effectiveness is enhanced, leading to improved social welfare.

The marginal contributions of this paper are as follows: First, by incorporating local government debt into the balance sheets of commercial banks, it quantitatively analyzes the cross-sector transmission of local debt risk through commercial banks and its impact on the macroeconomy. Second, it characterizes the counter financing channel for local debt and analyzes how different financing channels affect the effectiveness of fiscal expansion policies and the management of local debt default risk. Third, it quantitatively examines the effectiveness of fiscal and monetary policy mixes under local debt default risk, with a focus on both directional and objective consistency. This analysis is significant for promoting stable economic growth while preventing local debt risk.