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He Xiaobei: Unchaining Monetary Policy

Aug 15-2023   



Little is disputed that policy support needs to pack more punch to jolt the Chinese economy out of sluggish growth and flagging inflation. But how? As far as the monetary policy is concerned, some experts advise full-blown interest rate cuts, while others point to the difficulty in banks’ loaning efforts as a sign of fairly loose monetary policy and aruge that the economy has fallen into a liquidity trap. He Xiaobei, Deputy Director of NSD Macro and Green Finance Lab, said in a recent commentary on Financial Time’s Chinese website that China’s monetary policy has an idiosyncratic transmission mechanism and one single index can barely gauge policy stance. She also pointed out that the room for policy maneuvering is bounded by policy goals.

 

Her commentary first tries to answer the question whether China has a loose or tight monetary policy, and then examines the leeway for monetary policy. In light of aforementioned the transmission mechanism, she found that neither short-term policy rates nor mid to long-term treasury yields can fully measure the degree of looseness or tightness of China’s monetary policy. Given that monetary policy has the goal of adjusting the financing costs of the real economy, she believed policy stance can be directly observed through the financing performance of the real economy. In terms of loaning amount, ‘credit pulse’ of the private sector at the turn of 2023 was weaker than the previous three rounds recorded since 2010. The recent upsurge in M2, she said, mostly reflected fiscal outlays and deposit movement in financial institutions. The real economy has been experiencing relatively mild credit growth.

 

In terms of loaning cost, though the weighted average real interest rate of loans dropped to around 2.3% in the first quarter of 2023 (lower than the pre-pandemic level of 3-4%), it was only 0.8% below real GDP growth rate (the discrepancy was around 3% between 2012 and 2020).

 

Taken together, the two dimensions showed that the new round of credit loosening, from late 2022 to now, has seen a downward trajectory of real interest rates. In addition, though the monetary policy is not as tight as what short-term interest rates might indicate, the financing conditions are not particularly loose compared with historical data.

 

He Xiaobei believed that counter-cyclical control measures still have some room, but in practice they are subjected to a range of constraints, including the limited effect of quantitative credit policy on the shrinking loaning demand of the private sector, the banks’ questionable capability to accommodate further decrease in nominal rates, and the central bank’s difficulty in raising inflation expectations. She suggested proactively loosening some constraints to free up the maneuvering space. Japan might offer some inspirations, she said. It remains to be seen if Japan can walk out of deflation in a sustainably way, but it has deployed some effective measures, such as a variety of unusual monetary policies to depress long-term interest rates and the coordination between monetary and fiscal policy. Different policy tools are needed for different goals; interest rate regulation alone can hardly measure up to the task, she said.

He Xiaobei: Unchaining Monetary Policy

Aug 15-2023   



Little is disputed that policy support needs to pack more punch to jolt the Chinese economy out of sluggish growth and flagging inflation. But how? As far as the monetary policy is concerned, some experts advise full-blown interest rate cuts, while others point to the difficulty in banks’ loaning efforts as a sign of fairly loose monetary policy and aruge that the economy has fallen into a liquidity trap. He Xiaobei, Deputy Director of NSD Macro and Green Finance Lab, said in a recent commentary on Financial Time’s Chinese website that China’s monetary policy has an idiosyncratic transmission mechanism and one single index can barely gauge policy stance. She also pointed out that the room for policy maneuvering is bounded by policy goals.

 

Her commentary first tries to answer the question whether China has a loose or tight monetary policy, and then examines the leeway for monetary policy. In light of aforementioned the transmission mechanism, she found that neither short-term policy rates nor mid to long-term treasury yields can fully measure the degree of looseness or tightness of China’s monetary policy. Given that monetary policy has the goal of adjusting the financing costs of the real economy, she believed policy stance can be directly observed through the financing performance of the real economy. In terms of loaning amount, ‘credit pulse’ of the private sector at the turn of 2023 was weaker than the previous three rounds recorded since 2010. The recent upsurge in M2, she said, mostly reflected fiscal outlays and deposit movement in financial institutions. The real economy has been experiencing relatively mild credit growth.

 

In terms of loaning cost, though the weighted average real interest rate of loans dropped to around 2.3% in the first quarter of 2023 (lower than the pre-pandemic level of 3-4%), it was only 0.8% below real GDP growth rate (the discrepancy was around 3% between 2012 and 2020).

 

Taken together, the two dimensions showed that the new round of credit loosening, from late 2022 to now, has seen a downward trajectory of real interest rates. In addition, though the monetary policy is not as tight as what short-term interest rates might indicate, the financing conditions are not particularly loose compared with historical data.

 

He Xiaobei believed that counter-cyclical control measures still have some room, but in practice they are subjected to a range of constraints, including the limited effect of quantitative credit policy on the shrinking loaning demand of the private sector, the banks’ questionable capability to accommodate further decrease in nominal rates, and the central bank’s difficulty in raising inflation expectations. She suggested proactively loosening some constraints to free up the maneuvering space. Japan might offer some inspirations, she said. It remains to be seen if Japan can walk out of deflation in a sustainably way, but it has deployed some effective measures, such as a variety of unusual monetary policies to depress long-term interest rates and the coordination between monetary and fiscal policy. Different policy tools are needed for different goals; interest rate regulation alone can hardly measure up to the task, she said.