Making money cheaper to borrow is a way to stimulate the economy, and that is just what China is doing. For the second time in three months China is reducing the nation’s benchmark interest rates to address the slowing of the economy. The one-year bank lending rate dropped .25 percentage points to 5.35 percent. Deposit rates also were reduced by a quarter percentage point. China is the world’s second-largest economy behind the U.S., with average annual GDP recently hovering around 7.5%. Momentum has slowed significantly in late 2014 however, putting pressure on the People’s Bank of China to ease its monetary policy to help support growth.
The decline in economic activity can be largely attributed to the ongoing property downturn, Wang Tao, an economist at UBS, wrote last week in a report to clients. Further, a sharper decline in commodity and oil prices has led to rapid disinflation, even deeper deflation for the industrial sector. Many believe monetary policy in China should be eased more aggressively.
However, the government has been hesitant to launch economic stimulus packages and monetary easing out of fear that the policies might lead to significant increases in debt for corporations and local governments, which happened in 2009. Nonetheless, a sagging real estate market and signs of deflation have become serious concerns in the country. The government has tried to make it easier for small businesses to obtain loans and allowed the Chinese currency to weaken against the dollars, benefiting exporters.
Source: http://www.nytimes.com/2015/03/01/business/china-cuts-interest-rates-to-stimulate-slowing-economy.html
Does deflation carry any unique implications when it arises in a high-growth country? Would its effects be magnified or tempered by the otherwise strong momentum of the economy?
I think the real focus should be real wages, not deflation. Among other things, commodities (food and energy) account for a bigger share of the economy than in the US, so we should expect falls in those prices to mute headline inflation numbers, but not necessarily shift longer-run trends.
The interest rate cut also saw Asian stock markets experience a slight surge (about 4.2% to end the month) on its benchmark index, with strides in the commercial sector and lags in consumer staples. The cuts seem to stimulate manufacturing growth, but fail to induce Chinese consumer spending.
Another important point to get out of the Central Bank cutting interests rates is the effort to increase the culture of consumerism. As major Internet players like Amazon have seen growth in China, consumer spending should especially be driven upward by decreasing interest rates. It won’t be an all-of-the-sudden shift for China, however. While its manufacturing sector is experiencing a slowdown in growth, it might not be over for the export-dependent side of China’s economy.
Amazon is nothing alongside Alibaba. Their sales alone — one firm! — generated more package deliveries inside China last year than UPS and FedEx delivered for ALL customers in the US. Furthermore, Alibaba has made money since its inception; Amazon has not.
As China develops and grows further, it will reach a point where growth will slow down and stabilize. This is caused by the “catch-up factor” in emerging economies. Could this slow down be a natural occurrence in a country that has seen significant growth over the previous decades?
Good: we’ll examine factors behind China’s slowdown later this term. Slower labor force growth (offset only in part by continued migration), greater capital per worker, and catch-up towards best practice in industry after industry all point to a muting of the Chinese miracle, though they will still outgrow the US even if they fall short of their 7% target for 2015.
Note that our guest speaker for Monday, Mr. Miller, writes about the (in)effectiveness of monetary policy. Understand his arguments — they are partly a counter to facile comparisons of the impact of monetary policy in China with that in the “developed” OECD countries. What can lower rates do in an economy (i) composed of large, cash-rich SOEs who have long had favored access but see slowing growth, in a banking system that (ii) still lacks the infrastructure to lend to most small businesses while (iii) Local Government Financial Vehicles [more in the Miller book, and in Ma and Adams] now face constraints.