The development of China’s economy not only contains the commonalities of all countries in the world, which can be explained by existing theories to a large extent, but also presents many development characteristics that are different from other countries, which needs to be explored from a new perspective. Analyzing the data on output, consumption, and investment in the 40 years after the reform and opening up from 1978 to 2018, we can find the following characteristics: (1) The economy of China is more volatile than those of developed countries, and consumption volatility is greater than that of output, a phenomenon in sharp contrast with the rational consumption behavior obtained from the permanent income hypothesis. (2) Since 1978, China’s economic volatility has shown a downward trend, and consumption volatility has declined even faster than that of output. (3) Since 2008, China’s economic growth rate has continued to decline.

The academic circles attribute the miracle of China’s economic development to a series of institutional reforms since the reform and opening up. However, what has been ignored by the academic circles is that since the institutional reforms are the main driver of China’s rapid economic growth in the past 40 years, as a logical corollary, they must also be an important factor that leads to sometimes rapid and sometimes slow performance of China’s economic growth and the formation of several development cycles. Different from the deviation from trend caused by various random shocks, such as government purchases, money and information, and financial and non-financial frictions, a series of institutional reforms such as the transformation from a planned economy to a market one, the development of private enterprises from illegal to mushrooming, and China’s entry into the World Trade Organization impact the trend itself, changing and supporting China’s rapid economic growth, intertwining its trend fluctuations with cyclical fluctuations.

In order to illustrate the above characteristics, this paper constructs a dynamic stochastic general equilibrium model of small open economies with persistent trend shocks and liquidity constraints. The research results show that: First, after the reform and opening up, a series of institutional changes are an important cause for China’s economic fluctuations to be greater than that of developed countries. Second, there is an obvious random trend in China’s economy. Large fluctuations in output, especially in consumption, are caused by both trend shocks and cyclical shocks. Third, these two shocks are not enough to explain large fluctuations in consumption, especially the fact that consumption fluctuations are greater than that of output, but their combination with liquidity constraints explains this feature pretty well. The introduction of trend shocks increases consumption volatility through the permanent income hypothesis, while the introduction of liquidity constraint increases consumption volatility by reducing the inter-temporal substitution of consumption. Fourth, through comparative analysis of the changes in the driving factors of economic fluctuations in the two stages from 1978 to 1999 and from 2000 to 2018, it is found that with the gradual improvement of the market economic system, both the cyclical shock that has a temporary impact and the trend shock that has a persistent impact on economic fluctuations show a gradual attenuation trend, reducing China’s economic volatility. As the impact of trend shocks declines faster, cyclical shocks gradually play a dominant role in China’s economic fluctuations.