2024-07-30
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Huang Yiping: Macroeconomic Policy Framework with Chinese Characteristics
Characteristics of China's macroeconomic policy framework: 1. There are some non-price or even non-market policy tools in the macroeconomic policy framework; 2. The positions of the finance and central bank departments are very clear, which sometimes affects policy coordination; 3. Local governments have an amplifying effect on macroeconomic regulation.
If the goal of "preserving policy space" is affected at the expense of achieving "macroeconomic stability", it may be a bit of putting the cart before the horse.
Structural reform is a long-term measure, while macroeconomic policy is a short-term response. In fact, both are indispensable. If the economy collapses in the short term, there will be no sustainable growth.
Instead of helping with expansion, local governments actually did a lot of austerity things, such as exaggerating "living a tight life."
The current economy is "easy to cool but difficult to heat up", and if it really falls into the "low inflation trap", the consequences will be serious.CPIA growth rate of 2%-3% is clearly defined as a rigid policy target.
Huang Yiping is a member of the Economic 50 Forum, Dean of the National School of Development at Peking University, and a member of the Monetary Policy Committee of the People's Bank of China.
Huang Yiping's main research areas are macroeconomics, financial policy and digital finance. In the 415th Chang'an Forum, Huang Yiping was invited to give a speech on the theme of "Macroeconomic Policy Framework with Chinese Characteristics".
Huang Yiping believes that compared with developed countries, my country's macroeconomic policies are unique. For example, there are non-price policy tools, the positions of finance and the central bank are very clear, and local governments have an amplifying effect on macroeconomic regulation.
Huang Yiping believes that current macroeconomic policies are facing new challenges, such as the lack of policy stimulus, the weakening of the amplifying effect of local governments on macroeconomic regulation, the risk of low inflation due to weak prices, and the risk of balance sheet recession for households and businesses.
His policy recommendations include paying attention to guiding market expectations, the central government andCentral BankAssume the main responsibility for macroeconomic regulation, etc. In terms of short-term policies, he also suggested that CPI growth of 2%-3% be clearly defined as a rigid policy target, and fiscal measures to support consumption growth be adopted.
The following is the full text of Huang Yiping’s opinion:
Since the end of the COVID-19 pandemic, investors and entrepreneurs have often complained about my country's "lack of macroeconomic policy strength." Recently, the Ministry of Finance decided to issue ultra-long-term special government bonds, and some self-media at home and abroad interpreted it as a policy of "loosening water" and "China's version ofQuantitative easingAre these claims justified? The report to the 20th CPC National Congress clearly proposed to “improve the macroeconomic governance system”.[1]
However, the "macroeconomic governance system" here is a broad definition, which includes three aspects of goals:That is, to enhance the momentum of economic growth, maintain macroeconomic stability and promote social justice.These three goals correspond to corresponding policy tools. The macroeconomic policy discussed in this article is a narrow concept, which mainly uses monetary and fiscal countercyclical policy tools to balance total demand and total supply, promote price stability and full employment, and achieve reasonable labor income growth and corporate profit growth.
Today, I would like to share my personal observations on the macroeconomic policy framework. I have added the words "Chinese characteristics" because this framework is indeed special compared to general macroeconomic policy theory and practice. However, the purpose of this discussion is not to propose a new economic theory. my country's policy framework has its own characteristics, mainly because some structural or institutional characteristics in the economy have an impact on the choice of macroeconomic policy tools, policy transmission and its effects. These characteristics can still be analyzed within the general theoretical framework, but some restrictions may need to be changed or added.
In addition to a brief review of the formation and development of macroeconomic policies, this sharing also attempts to answer three questions:
First, compared with traditional market economies, what are the characteristics of my country's traditional macroeconomic policy framework?
Second, my country's macroeconomic policies in the past were known for their vigorous and immediate results. Why do market players generally feel that the policy efforts have been lukewarm recently?
Third, if we want to improve the effectiveness of my country's countercyclical regulation, what kind of adjustments should be made to macroeconomic policies?
Macroeconomic policies are strategies and actions taken by the government to control and influence the overall economic situation. Macroeconomic policies have specific goals, generally including maintaining economic stability, achieving sustainable growth, reducing unemployment, controlling inflation, etc. In certain circumstances, macroeconomic policy goals sometimes also include some structural and industrial dimensions, but this practice is not common.
The most important macroeconomic policies are fiscal policy and monetary policy. Fiscal policy is the government's way of influencing economic activity by changing spending and tax levels. If the government increases spending and increases the deficit rate, it actually increases aggregate demand, and economic activity will become more active. On the contrary, if the government reduces spending, economic activity will slow down. Monetary policy is controlled by the central bank and generally includes managing the money supply and interest rate levels. A very important feature of macroeconomic policy is that it focuses on aggregate indicators, including aggregate demand, aggregate supply, aggregate price levels, aggregate unemployment levels, etc., and some structural practices have also been formed in the process of development.
It is generally believed that the macroeconomic policy system was gradually formed after the Great Depression of 1929. Before that, governments were not proactive in intervening in economic activities. Keynes should be the most important contributor to early macroeconomic policy thinking [2]. He mainly focused on fiscal policy. The so-called Keynesian view can be summarized in three sentences:
First, aggregate demand is determined jointly by the private and public sectors.The composition of aggregate demand is consumption, investment and exports, which are the "three carriages" that drive economic growth. These three variables have an important and decisive role in the level of economic activity. The level of aggregate demand is determined by both the private and public sectors. Households determine consumption, enterprises determine investment, and the government determines public spending.
Second, prices, especially wages, respond slowly to supply and demand.
Third, expected and unexpected changes in aggregate demand have a huge impact on output and employment in the short term.
In simple terms, total demand determines total supply, so economic activities can be stabilized through government intervention. When the economy is in a downturn, the government can increase the level of total demand through deficit policies, thereby making economic activities more active.
Over the past 100 years, Keynesianism has laid the academic foundation for macroeconomic policies in various countries. Of course, Keynesian economic thought is also constantly evolving. There was once a joke that Keynes told people after attending a seminar that everyone at the meeting was a Keynesian, except himself.
The Monetary History of the United States, co-authored by Friedman and Schwartz, once had a significant impact on many macro-finance scholars. Friedman and his collaborators found that during the four years of the Great Depression from 1929 to 1933, the U.S. money supply M2 continued to decline (Figure 1). [3] When the economy falls into a serious recession, if the money supply continues to decrease, it will make the situation worse and cause the economy to shrink further. Friedman believed that this data showed that the Federal Reserve did nothing during the Great Depression.
Bernanke's academic career began with reading this book. He accepted the views of the two authors, which probably laid the academic seeds for his later adoption of extraordinary monetary policies during the subprime mortgage crisis as Chairman of the Federal Reserve. Later, when he attended Friedman's 90th birthday celebration as a member of the Federal Reserve Board, Bernanke also specifically affirmed Friedman's previous criticism of the Federal Reserve.
Of course, some scholars explain that the Federal Reserve did not try to loosen monetary policy during the Great Depression because it was constrained by some factors. First, society at the time was generally worried about the moral hazard problem after the crisis, so even if the Federal Reserve had the ability, it did not have a strong motivation to expand the money supply. Second, the classical gold standard limited the money supply. In fact, many scholars believe that an important reason why the economies of various countries entered the Great Depression was that under the classical gold standard system, the money supply could not keep up with the growth of economic output, thus forming a serious deflation. [4]
Figure 1. Broad money supply in the United States during the Great Depression (in billions of U.S. dollars)
Flexible fiscal and monetary policies have brought benefits to macroeconomic stability. When the economy is in a downturn, the government can increase the deficit ratio, increase public spending, and improve economic activity. On the contrary, if the economy is overheated, the government can reduce aggregate demand by increasing fiscal surpluses. Such countercyclical adjustments can reduce the amplitude of economic fluctuations, enhance economic stability, and thus help improve welfare levels.
The same is true for monetary policy. Especially after the decoupling of gold and the US dollar in 1971, many countries moved towards floating exchange rates. The central bank has mastered the autonomy of issuing credit currency, which provides a lot of room for macroeconomic regulation. When economic activities are active, the money supply can be expanded to meet the needs of economic activities and maintain the stability of price levels. At the same time, counter-cyclical adjustments can be implemented. When economic growth is weak, expansionary monetary policies can be adopted to promote the increase of total demand and stabilize the economy.
Both fiscal and monetary policies have become flexible, providing a very important means of regulation for macroeconomic stability. An important logical basis for countercyclical regulation is that "stability can increase welfare". Of course, appropriate economic fluctuations are also conducive to improving the quality of economic development. When the economy is on the rise, many new projects will be added, and when it is on the decline, some projects of poor quality will have to be withdrawn. However, if the amplitude of economic fluctuations is too large, it may cause a lot of waste, affect people's lives, and even endanger financial stability.
Of course, there is a degree to which this kind of "policy flexibility" can be used. If used improperly, it may also bring new risks. Excessive fiscal overdrafts and excessive money supply have occurred in the past. The Latin American debt crisis in the 1980s and the European sovereign debt crisis after the subprime crisis were major risk events that occurred because the government did not manage its debts well.
In the first decade of this century, Zimbabwe experienced hyperinflation. Faced with the collapse of the national economy, the government did not think about how to respond actively, but continued to issue banknotes. The inflation rate once exceeded 200,000%. A Zimbabwe dollar with a face value of 100 trillion yuan is actually worth about 40 cents, equivalent to 2.5 yuan. This is the problem that the expansion of money supply without market discipline may cause, which can cause a country's monetary system to collapse in just a few years. my country also had the experience of hyperinflation caused by the large-scale issuance of gold yuan coupons in the late Republic of China.
How can we maintain policy flexibility while avoiding major risks? Countries, especially developed countries, have begun to explore the establishment of some important macroeconomic policy rules. In terms of fiscal policy, they mainly set limits on deficit ratios and public debt.
Generally speaking, the fiscal deficit cannot exceedGDPThe ratio of public debt to GDP cannot exceed 60%.The Organization for Economic Cooperation and Development (OECD) is headquartered in Paris.OECD), when absorbing new members, the above two indicators were used as important evaluation indicators. Later, many countries also began to use these two indicators to measure whether the fiscal situation is healthy. In terms of monetary policy, an inflation targeting system is implemented, while granting the central bank a certain degree of independence. The Federal Reserve sets the inflation rate target at around 2%, while my country's is around 3%. It can accept moderate inflation, but does not allow arbitrary over-issuance to ensure currency stability. An important logic of the inflation targeting system is that if the currency is over-issued, high inflation is likely to occur. Therefore, as long as the inflation target is clear, it is possible to avoid serious over-issuance of currency while giving the central bank a certain degree of policy flexibility.
However, since the subprime crisis, some extraordinary practices have emerged in the macroeconomic policy practices of various countries, breaking the previously defined rules to a certain extent, especially during the subprime crisis and the COVID-19 pandemic. The fiscal deficit ratio of many countries has significantly exceeded 3%, and the public debt is also far higher than 60% of GDP. Now, except for Germany, whose public debt to GDP ratio is slightly higher than 80%, the public debt of other G7 countries has exceeded 100%, and Japan is even above 200%.
The same is true for monetary policy. During the crisis and the epidemic, the central banks of the United States, Japan and Europe all implemented quantitative easing monetary policies, that is, after reducing the short-term policy interest rate to zero, they continued to take measures to lower medium- and long-term market interest rates, change the shape of the yield curve, and reduce corporate financing costs. These practices were not included in the original monetary policy framework.
There have always been criticisms of these policy practices, mainly because they believe that the irresponsible relaxation of macroeconomic policies by decision makers may lead to serious consequences. However, some experts believe that in the past decade or so, the macroeconomic policies of European and American countries have truly achieved "flexibility", and they have decisively relaxed when it is time to relax, and have no hesitation when it is time to tighten.At least so far, these extraordinary practices have not led to catastrophic consequences.
So, are these new policy practices temporary crisis responses or long-term rule changes? If these breakthroughs cannot return to normal in the short term, what consequences will there be in the future? It may not be possible to give a clear and authoritative answer to such questions at present, so we can continue to observe closely for a period of time.
Compared with market economies, my country's macroeconomic policies do have many unique features. Taking monetary policies as an example, the central banks of many countries have a high degree of independence, many of which have implemented explicit or implicit inflation targeting, and the main policy tool is the short-term policy interest rate.
my country's central bank is one of the components of the State Council, and its policy objectives are more diverse. Its policy tools include both policy interest rates and quantitative indicators. In 2016, Governor Zhou Xiaochuan gave the Kandesus Central Bank Lecture at the International Monetary Fund, explaining why my country's monetary policy framework is different from that of market economies.To put it simply, because China is a developing country with a transitional economy, there are some unique mechanisms in its economic operations.[5] This may also be the most critical factor in understanding the characteristics of China's macroeconomic policy framework. Compared with market economies, my country's macroeconomic policy framework does have many unique features, from policy objectives to policy tools, from decision-making processes to implementation methods. However, the most prominent features are reflected in the following three aspects:
The first characteristic is that there are some non-price or even non-market policy tools in the macroeconomic policy framework. For example, the monetary policy tools of market economies are mainly short-term policy interest rates, although the adjustment methods of central banks in different countries vary. my country's policy tools are more diverse, including policy interest rates, quantitative tools and even administrative measures. Even the policy interest rate is relatively complex, with both medium-term lending facility rates and short-term lending facilities.Reverse repoInterest rates, controlled both in the short and medium term, may affect the shape of the yield curve in the market.
However, Governor Pan Gongsheng has recently indicated that the policy tool function of the medium-term lending facility rate may be cancelled. In addition, there are some quantitative tools in the monetary policy toolbox.The most unique is the so-called "window guidance", which means that central bank officials use mild language to convey clear policy requirements.
One of the important reasons for the emergence of diverse and complex policy tools is that China is an economy in transition, market-oriented reforms have not yet been completed, and the interest rate transmission mechanism is not smooth enough.For example, some state-owned enterprises are not very responsive to interest rate changes, so it is better to use quantitative tools such as money supply or even credit scale, which is more effective. Although window guidance has market-oriented elements, it is ultimately an administrative measure, and it is easier to achieve immediate results during the implementation process. In the past, the medium-term lending facility rate was used as a policy tool to directly affect the loan interest rate benchmark target LPR, which was also because the interest rate transmission from short-term to medium-term was not smooth enough.
Since the reform and opening up, my country's monetary policy framework has been evolving along two main lines:One is from direct control to indirect regulation, and the other is from quantity tools to price tools.Perhaps the monetary policy framework in the future will be closer to the practices of Europe, the United States and Japan, but this transition is not yet complete. Some studies on monetary policy rules have also found that the current system is a mixture of quantity rules and price rules. So far, this regulatory system is generally effective, but there is indeed a lot of room for improvement in sensitivity and accuracy.
The second characteristic is that the positions of the finance and central banks are very clear, which sometimes affects policy coordination. In the past, European and American countries attached great importance to the independence of the central bank, so the government could only manage fiscal policy but not monetary policy. In the past decade or so, this pattern has changed a bit, but in general,Fiscal policy and monetary policy decisions are separate.
my country's finance and central bank are both part of the government, so policy coordination should be easy. But this is not always the case in practice. In macroeconomic policy discussions, it is common to hear central bank officials calling for a more proactive fiscal policy, while finance officials advocate for a more aggressive monetary policy. There is nothing wrong with cross-discussing policy choices, and it may even be a sign of a healthy discussion atmosphere. But it cannot be ruled out that officials sometimes consider their departmental positions. Traditional policy thinking is that there should be room for policy space, especially if one considers "managing the purse for the country", and will take a conservative stance on seemingly radical policy measures. Both the central bank and the Ministry of Finance attach great importance to "preserving policy space" in case of future needs.
The problem is that sometimes there is a difference between the macro position and the sector position. The value of sector policy space lies in meeting the needs of adjusting the economic cycle in the future, which is not wrong in itself.However, if the goal of "preserving policy space" is affected at the expense of achieving "macroeconomic stability", it may be a bit of putting the cart before the horse.
Therefore, a proper balance should be struck between "prudent policies" and "prudent economy". The purpose of maintaining "prudent policies" is to have policy space to support "prudent economy" in the future, and not to use up all the ammunition at once. However, it is worth noting that if the policy is conservative, once it affects "prudent economy", there will be no "prudent policies".
For example, the government has always attached great importance to the threshold of the fiscal deficit rate of 3%. Except in 2022, the government has set the deficit rate at 3% or below. But this has caused two potential problems. First, the whole world knows that my country's broad fiscal deficit rate in recent years is far more than 3%. The only difference is that a large part of the expenditure is not included in the narrow fiscal expenditure. The government issued special special treasury bonds of 1 trillion yuan each in 2023 and 2024, and neither of these two sums of money is directly included in the fiscal deficit. But the problem is that the threshold for the allocation and use of special treasury bonds is relatively high, which directly affects the actual effect of fiscal expansion. Second, the reluctance to expand too much in the short term seems to be conducive to the health of fiscal policy, but if the economy is not active, it may increase the probability of a deterioration in the fiscal situation in the future.
The third characteristic is the amplifying effect of local governments on macroeconomic regulation. In the past, one of the characteristics of my country's macroeconomic regulation was that local governments played a big role. The central government made policies and local governments worked hard. Take the "4 trillion" stimulus policy announced in 2008 as an example.The central government spent 1.13 trillion yuan, but the actual amount reached 30 trillion yuan. This amplification mechanism mainly came from local governments.
There are two mechanisms that determine the behavior of local governments. One is the so-called "GDP bidding competition". Many academic studies have found that when other conditions are roughly the same, the faster the GDP growth rate of a region, the more likely the leaders of the region will be promoted. Later, some scholars called it the "GDP beauty pageant". Second, local governments have obtained many resources through land finance, urban investment companies, financing platforms, etc. After the tax-sharing reform in 1994, local fiscal capacity was squeezed, resulting in a mismatch between administrative power and financial power. But soon local governments creatively found many new sources of funds, including land transfer and platform financing.
These two mechanisms often make local governments the amplifiers of macroeconomic policies, especially when they are relaxed. During the Asian financial crisis and the global subprime crisis, local governments played a pivotal role in amplifying the role of macroeconomic control mechanisms and stabilizing the macroeconomy. It should be emphasized that this amplification effect is not completely symmetrical. For example, when the central government decides to implement an expansionary macroeconomic policy, the amplification effect of local governments is more significant.
However, when the central government decides to implement a tight macroeconomic policy, the amplifying effect of local governments is not very significant.Of course, this amplification effect will also have sequelae. After the "four trillion" stimulus policy, many problems emerged, such as overcapacity, high leverage, zombie enterprises, real estate bubbles, financial inefficiency, inflationary pressure, etc. Some problems are still being digested, which may be the reason why many officials are skeptical about excessive stimulus policies, and decision-makers have even begun to pay attention to cross-cycle adjustments.
From 1949 to 1978, the fiscal system was based on “unified revenue and unified expenditure”. After 1978, various types of “fiscal contracts” were formed, “profit-to-tax” changed the source of fiscal revenue, and “decentralization and profit sharing” increased the financial resources that local governments could control independently. In 1994, the “tax-sharing system” reform was implemented. However, fiscal revenue also includes government fund revenue, social security fund revenue, and various fees and fines, forming a land fiscal model. After 2008, local financing platforms have developed rapidly. Local governments try various ways to borrow money, but in the end, it may not be the local government that bears the responsibility. [6]
If a city or state government in the United States cannot repay its debts, it has to file for bankruptcy and bear the consequences. my country's system is different from that of the United States. It is impossible to let a city or provincial government go bankrupt, so the ultimate responsibility can only be borne by the central government.
Since 2018, my country's local finance has implemented a reform policy of "opening the front door and closing the back door" to limit the total amount of local debt. Over the years, on the one hand, local government financing has been restricted, and on the other hand, the real estate market is not stable, and land finance is unsustainable. Especially after the COVID-19 pandemic, the finances of most regions are stretched. The traditional macro-control framework has ushered in a historic turning point.
At the end of the COVID-19 pandemic at the end of 2022, my country's economic development has entered a post-pandemic period. Exports, investment and consumption have all shown a certain degree of recovery, but overall the strength of economic growth is still not very strong. One very important factor is the contraction of the balance sheet. During the three-year COVID-19 pandemic, households consumed a large amount of previously accumulated savings, and companies increased a lot of debt. Unlike the practices of European and American governments, the Chinese government did not adopt the practice of issuing cash subsidies to households and companies during the pandemic.This means that when the epidemic ends, the balance sheets of households and enterprises in China will have been squeezed to a great extent.After the epidemic, the real estate market has experienced another major shock, which has further shrunk the balance sheets of households. Against this backdrop, it is easy to understand why my country's total economic demand is weak.
It stands to reason that when aggregate demand is weak, macroeconomic policies should play an expansionary role. In fact, at the beginning of 2023 and 2024, the government decided that the tone of macroeconomic policy for that year would be active fiscal policy and prudent monetary policy. Later, central bank officials further defined "prudent monetary policy" as "accommodative" monetary policy. But the reality is that in those two years, the intensity of macroeconomic policy stimulus has been lower than the expectations of market players. Broad fiscal expenditures in 2023 increased by only 1.3%, while net expenditures after deducting income from expenditures fell by 1.3%. Although the monetary policy interest rate has experienced several small cuts, the real interest rate has risen because the inflation rate has fallen more sharply. Overall, macroeconomic policies have not fundamentally reversed the weak economic trend.
China's macroeconomic policy stimulus is relatively weak, which seems a bit strange. In the past few decades, the Chinese government's macroeconomic policies have been known for being vigorous and effective. There may be a series of reasons behind the relatively mild policies in recent years.Some officials have clearly described the changes in the macroeconomic landscape, which has changed from the past "easy to heat up but difficult to cool down" to the current "easy to cool down but difficult to heat up". This is because economic development has entered a new stage, and total demand, including consumption, exports and even investment, is no longer as strong as before. This actually poses new challenges to macroeconomic policies.
However, the macro policy is weak, and there are some more specific interpretations. First, the previous stimulus policies have achieved good results, but they also have many side effects, such as high leverage, low efficiency, asset bubbles, etc., which makes some people have reservations about adopting a very strong stimulus policy. This is a normal phenomenon. "Once bitten by a snake, you will be afraid of the rope for ten years", probably means this.
Second, with GDP growth at around 5%, perhaps in the eyes of some officials, the economic situation may not be as bad as many people worry about? The Fed adopted extraordinary quantitative easing policies, the first time during the global crisis and the second time during the COVID-19 pandemic, both times taking drastic measures in the face of crises. my country's current GDP growth rate remains at around 5%, and the necessity of adopting drastic stimulus policies is indeed debatable.
Third, macroeconomic policies are good at supporting supply but not good at supporting consumption.At present, my country's economy is already facing a severe challenge of overcapacity, and further stimulus policies are likely to aggravate the contradiction of overcapacity.
Fourth, because the Chinese government has strong administrative mobilization capabilities, especially since macroeconomic policies are easier to loosen than to tighten, decision-making departments therefore adopt a relatively cautious attitude.These reasons all sound reasonable, but they are based on specific contexts and conditions. If those contexts and conditions change, then the decision-making approach may need to be adjusted.
A very important change in recent years is that local governments have begun to be absent from macroeconomic regulation. In the past, the central government made policies and local governments took actions. The central and local governments worked together to regulate the economy, and the effect was very good. An important reason for the strong administrative mobilization ability is that local governments are actively taking action. But now, due to the lack of financial capacity and market discipline, local governments can no longer amplify the role of macroeconomic policies.
In 2023 and 2024, the central government has indicated that it will support economic growth, but the actual policy effects have been very limited.One of the important reasons is that local governments not only did not help with expansion, but actually did a lot of austerity measures, such as "30 years of tax audits" and exaggerating "living a tight life."Interestingly, local fiscal difficulties are well known, but their impact on macroeconomic regulation is rarely mentioned. This means that traditional macroeconomic policy thinking needs to be adjusted.
There are two mechanisms by which macroeconomic policies change aggregate demand. One mechanism is fiscal or monetary policy adjustments, which directly increase or decrease aggregate demand. For example, the construction of railways, roads, and airports increases the demand for cement and steel, and the economy becomes more active, which increases aggregate demand.
Another important mechanism is to change the expectations of market participants. For example, after the announcement of the 4 trillion stimulus policy, state-owned enterprises, private enterprises, local governments, and financial institutions all felt that the opportunity had come and they must seize it. Therefore, the strength of macroeconomic policies must be large enough to make market participants believe that the economy will change direction.If everyone works in the same direction, it will achieve twice the result with half the effort. If the policy is not strong enough, it will be difficult to change the expectations and behavior of market participants, and the policy effect will be half the result with twice the effort.
Robert Shiller, Nobel Prize winner in economics and professor at Yale University, specializes in the study of financial markets. His most important discovery is that the investor market is irrational and emotions play a big role. In 2013, Shiller published the book "Narrative Economics". If a credible and persuasive narrative can be formed, the behavior of market participants can be guided in the direction of the narrative. Narrative economics is actually a kind of psychology or even art. To make everyone believe sincerely, coercion is not enough. Of course, influential "narratives" are sometimes not necessarily reasonable and rational, so it is easy to cause bubbles and risks.
At the beginning of 2009, the price of copper in the international market suddenly soared. At first, no one understood the reason behind it, because there was no serious imbalance between supply and demand in the copper market. Later, after investigation, it was found that copper prices began to rise after China announced the "4 trillion" stimulus policy. This was mainly because there was an important project in the stimulus policy, which was to update the country's power grid system. The power grid system uses a lot of copper, so the international copper price began to rise after the "4 trillion" stimulus policy was announced.
In the first quarter of 2024, my country's GDP growth reached 5.3%, reaching the annual growth target of about 5%. So why is the perception of market players so different? One possible reason is the decline in prices. The GDP deflator in the first quarter was -1.1%, which means that nominal GDP growth was only 4.2%. The latter is directly related to the operating income and profits of enterprises, which shows that changes in price levels have a very important impact on the perception of market players.
From the fourth quarter of 2023 to January 2024, my country's CPI has been in a state of negative growth, and the growth rate since January has only been slightly above 0%. Most experts and officials predict that the annual CPI growth rate in 2024 will be less than 1%.
There are two reasons for the increase: one is the increase in pork prices.High pork prices will stimulate farmers' enthusiasm and increase supply, which will cause meat prices to fall. When meat prices fall to a very low level, farmers' enthusiasm will be dampened, resulting in a shortage of supply, which will cause meat prices to rise again. This cycle repeats itself, forming the so-called "pig cycle". The "pig cycle" usually lasts 18 months. Now, due to faster breeding, the cycle has shortened, but it still exists.Second, the price of oil energy has risen.If there were only these two factors, overall the pressure of overcapacity would be very high, prices would still be very weak, and core inflation excluding food and energy would still be at a very low level.
Professor Tsutomu Watanabe of the University of Tokyo, who is known as the foremost researcher on prices in Japan, believes that prices are very important, but the most critical thing is price expectations.If prices do not rise, people will postpone consumption, and manufacturers will not increase wages or hire more people because they cannot raise producer prices. Corporate profits will not improve, and investors will certainly not increase investment. This is equivalent to forming an expected vicious cycle between consumers, producers, and investors.Watanabe Tsutomu believes that Japan's lost 30 years is largely the result of such a vicious cycle. The classical gold standard caused deflation because the money supply could not keep up with the economic growth rate, which was essentially the result of the above-mentioned vicious cycle of expectations.
Watanabe Tsutomu found that since 2022, Japan has begun to get out of this vicious cycle. One important piece of evidence is that Japanese consumers have begun to accept price increases. According to his survey of consumers, in the past, if consumers saw price increases when they went to the supermarket, they generally would not continue to buy, but would go to other supermarkets to find products that had not increased in price. But since 2022, more and more consumers have begun to accept price increases.
Of course, there are many factors that contribute to Japan's price increases, such as the narrowing of the domestic output gap and the rise in commodity prices caused by the Russia-Ukraine conflict. Over the past three decades, Japan's CPI has been hovering around 0%, suddenly rising to 4% in 2022, and then falling back to slightly above 2%, which is comparable to the level of most developed countries. Borrowing Watanabe's narrative system, Japan has begun to enter a virtuous cycle of consumer-producer-investor expectations.
It is worth noting that my country will not fall into the "low inflation trap"?PPIIt has experienced 20 months of negative growth and CPI has remained very sluggish.More importantly, there are still a series of contractionary mechanisms in the economy, including weakening demand caused by downward pressure on real estate prices and increasing excess capacity in areas such as steel, alumina, and new energy. Taking mature market economies as a reference, if Japan's inflation rate is moving from the "exception" of the past years to "convergence", the inflation rate remains at roughly the same level as that of European and American countries (Figure 2). Is it possible for my country's inflation rate to follow in Japan's footsteps and become a new "exception"? Exceptions in price levels may also cause a downturn in economic activities, and therefore deserve great attention.
Figure 2: Consumer price inflation rates in China, Japan and the United States (%)
Japanese economic expert Gu Chaoming once proposed the concept of balance sheet recession when analyzing the consequences of the bursting of Japan's asset bubble in the 1990s. His main finding was that companies at that time no longer pursued profit maximization, but debt minimization. This change in behavior may lead to a comprehensive economic recession, and even make monetary policy and structural reform policies powerless. At this time, the most important policy tool is fiscal policy. In recent years, we often hear debates about whether my country's economy will experience a balance sheet recession. I don't intend to intervene in that discussion here, but it is worth learning that once the balance sheet begins to shrink across the board, it will be difficult to maintain the stability of economic activities. At present, the three balance sheets of households, enterprises and local governments in China are facing unprecedented pressure.
On the one hand, the decline in real estate prices has caused household assets to shrink, and the asset quality of financial institutions has come under pressure. On the other hand, the requirements for deleveraging or stabilizing leverage have also made it impossible for local governments to effectively support the expansion of economic activities.If the balance sheet is not stable, it will be difficult to stabilize economic activities. In Gu Chaoming's view, fiscal policy needs to play a greater role at this time. When there are fewer and fewer high-quality borrowers in the market, the government should play the role of the ultimate borrower.
In the past few decades, my country's macroeconomic policies have been vigorous and resolute, and its decision-making speed and implementation results have often amazed international market participants. However, in recent years, although the government still attaches great importance to macroeconomic regulation and has taken many measures, market players generally feel that the policy strength is not as strong as before. This may not be a problem in itself, but the market expectations have not been improved, which needs to be taken seriously. In the final analysis, economic behavior is determined by market expectations.
Two views are often heard in policy discussions.The first view emphasizes that structural reform is far more important than macroeconomic stimulus.This view is certainly correct. After all, only by improving economic efficiency and increasing total factor productivity can the economy achieve sustainable growth.
I have also agreed with this view for a long time in the past. In 2008, I wrote a short commentary article titled "The sky will not fall if GDP growth is less than 8%". The main argument is that the quality of growth is more important than the quantity of growth, and we should not treat "maintaining 8%" as a religious concept. However, this view does not deny the importance of macroeconomic policies. If structural reform is a long-term measure, macroeconomic policies are short-term responses. In fact, both are indispensable. If the economy collapses in the short term, there will be no sustainable growth. Some experts believe that the current lack of confidence among entrepreneurs is a structural problem that can only be solved through structural reforms. Macroeconomic stimulus can only delay the problem at most, and it cannot fundamentally solve the problem. The problem is that structural reform requires conditions, and it takes time to be effective. The important thing is to stabilize the economic situation first, and this is the responsibility of macroeconomic policies.
The second view is that the radical monetary and fiscal policy easing in Europe and the United States is irresponsible behavior that harms both others and oneself.Before 2008, the Federal Reserve maintained a very loose monetary policy for a long time because core inflation had been very stable. In the short term, growth was very strong and employment was full, but it eventually triggered the subprime crisis that affected the world. During the subprime crisis and the COVID-19 pandemic, European and American countries took decisive and drastic fiscal and monetary policy measures to effectively stabilize economic and financial conditions. After the crisis, fiscal and monetary policies were quickly normalized without causing serious consequences. At least from the perspective of "counter-cyclical" regulation, the macroeconomic policies during this period were effective.
Draghi, the former president of the European Central Bank, once said that Europe mainly relies on monetary policy, while Japan has mainly played the role of fiscal policy for a long time. Only the United States has a two-pronged approach of fiscal and monetary policy. Therefore, in comparison, the US economy has the best performance. As for whether the European and American economies will face serious "cross-cycle" problems in the future, further observation is needed.
Therefore, macroeconomic policies should return to cyclical positioning, that is, managing economic cycles. As discussed earlier, some new situations in my country's economy in recent times have reduced the effectiveness of macroeconomic policies.
First, the perspective of cross-cycle regulation may weaken the effect of counter-cyclical regulation.The proposal of cross-cycle regulation is reasonable and is based on the response to problems that have occurred in the past, so it is also highly theoretically innovative. However, the coordination between cross-cycle regulation and counter-cyclical regulation is a new challenge, and counter-cyclical regulation cannot be abandoned due to concerns about cross-cycle problems.
Second, tight financial conditions have caused local governments to be absent from macroeconomic regulation in recent years.This may be the main reason why the recent macroeconomic stimulus policy has not been as effective as expected. Objectively speaking, it is not necessarily a bad thing for local governments to reduce their involvement in macroeconomic regulation. In the future, local governments can return to their narrow government functions. But at the same time, the central government must assume greater macroeconomic policy responsibilities.
Third, over-emphasis on policy stability has affected the pursuit of the goal of economic stability.The robustness of policy tools is superficial, while the robustness of the macroeconomy is fundamental. Take fiscal policy as an example. When the economy is weak, the fiscal deficit ratio is increased to more than 3%. On the surface, it reduces the health of fiscal policy. However, if the fiscal stimulus policy eventually stabilizes the macroeconomy, the fiscal policy space will definitely become larger. If the economy cannot be stabilized, there will be no fiscal policy space.
Fourth, industry policy adjustments have affected macroeconomic stability.The special rectification policies in the past few years have targeted the most active economic sectors, such as real estate, finance, education and training, and platform economy. Now that the special rectification has ended, the market has not yet felt the relaxation of the regulatory policy environment. The special rectification is an industry policy, but it has objectively produced a tightening macro effect.
my country can consider making some policy adjustments in the following areas to improve the effectiveness of macro-control.
First, we should attach importance to guiding market expectations.Directly increasing or decreasing total demand is only part of the function of macroeconomic policies. What is more important is to change market expectations. If the expectations of entrepreneurs, investors, and consumers change, macroeconomic control measures can achieve twice the result with half the effort. To change expectations, we first need to increase the intensity of macroeconomic policies and give market sentiment a big enough impact. At the same time, we should also pay attention to the role of "narrative economics". If we exaggerate "living a tight life", reducing wages, and paying taxes all day long, market players will not be able to become more optimistic about the future.
Second, the central government and the central bank bear the main responsibility for macroeconomic regulation.In the past, local governments had the willingness, ability and resources, and the effects of the central government’s macroeconomic policies were easily amplified. But now, due to various reasons, local governments are unlikely to continue to play such a role. This means that if the central government wants to stimulate economic activities, it must have sufficiently large-scale fiscal expenditures, the budget must be sufficient, and it must be implemented.
Third, attention should be paid to “counter-cyclical regulation” over “cross-cyclical regulation”.If countercyclical regulation is weakened due to concerns about cross-cycle side effects in the future, then macroeconomic policies will be equivalent to self-destruction. The correct approach should be to take supporting measures to alleviate such contradictions. For example, the stimulus policies in the past are prone to cause side effects such as bubbles, leverage, and efficiency. One reason is excessive stimulation. Now this risk has been reduced. Another reason is that macroeconomic policies are "easy to release but difficult to collect". In the final analysis, it is because the market-oriented reform is not thorough. It is difficult for the fiscal and central banks to collect when they should. This requires further structural reforms and strengthening market discipline.
Fourth, strengthen coordination among fiscal, monetary and industrial policies.In the past, there were relatively big problems in this regard. Now that the Party Central Committee has strengthened unified leadership over economic work, it should be more likely that different policies will coordinate with each other and work in a unified direction.
Finally, some short-term policy recommendations are provided for your reference.
First, the pursuit of moderate inflation should be given the same importance as the pursuit of medium-speed growth. The annual “two sessions” will announce the targets for economic growth and inflation, but the government is serious about the former but not so much about the latter. The economy is now “easy to cool but difficult to heat up”, and if it really falls into the “low inflation trap”, the consequences will be serious.Therefore, it is recommended to clearly define the CPI growth of 2%-3% as a rigid policy target.
Second, we need to step up macroeconomic policies, especially to implement the already planned fiscal spending as soon as possible. Broad fiscal spending in 2023 is far behind the plan at the beginning of the year, and it seems that this year is still the case.The policy concept of "focusing on investment and neglecting consumption" should be changed, and fiscal measures to support consumption growth should be adopted with confidence, including allowing migrant workers to settle in cities and directly giving money to ordinary people.
Third, we should give full play to the role of sovereign credit, repair weak points and reduce balance sheet risks. The current economic weakness is due to three interrelated factors: lack of orders, lack of confidence and shrinking balance sheets. The balance sheets of households, enterprises, local governments and financial institutions are facing great pressure. If the deteriorating trend cannot be stopped in time, serious consequences are likely to occur.We can consider better leveraging the role of sovereign credit, with the central government assuming certain responsibilities to stabilize the market and maintain confidence.
Notes:
[1] Xi Jinping, “Hold High the Great Banner of Socialism with Chinese Characteristics and Work Together for the Comprehensive Construction of a Modern Socialist Country—Report to the 20th National Congress of the Communist Party of China,” October 25, 2022, official website of the Central People’s Government of the People’s Republic of China.
[2] Keynes, The General Theory of Employment, Interest and Money, Social Sciences Academic Press, 2009 (original edition published in 1936).
[3] Friedman and Schwartz, A Monetary History of the United States, 1867-1960, Peking University Press, 2009 (original edition published in 1963).
[4] Bernanke, The Great Depression: Economic Recession and Recovery, CITIC Press, 2022.
[5] Zhou Xiaochuan, “Michel Camdessus Central Banking Lecture - Managing Multi-Objective Monetary Policy: From the Perspective of Transitioning Chinese Economy”, International Monetary Fund, June 24, 2024.
[6] Lou Jiwei, Rethinking China’s Intergovernmental Fiscal Relations, China Financial and Economic Publishing House, 2013.
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