Monetary Policy in the Context of New Normal
Author：樊纲 Source：创新发展研究院 Date：2015-09-02
Editor's notes: Currently Chinese economy has not recovered from the two economic overheating in the past 10 years, remaining in a sluggish state. Dr. Fan Gang suggests that a soft landing of the economy is needed to resolve issues such as overcapacity and excess supply, by improving efficiency in both market and enterprise level. Dr. Fan Gang illustrates the problems in the Chinese economy on two typical areas, namely the stock market and the exchange rate system. He points out that individual investors should not speculate on the Chinese stock market, because they lack both the professional knowledge and the diversification capability compared with institutional investors. Exchange rate should be allowed to float against “a basket of currencies” more strictly in order to release market pressure and maintain capital stability. Dr. Fan Gang concludes that a “normal high growth” should be the goal of the government for the coming two years, and that to achieve the goal, current contradictory policy needs to “return to neutral” as soon as possible.
On the afternoon of September 2, famous economist Dr. Fan Gang was invited to give a speech at the Public Lecture Series of SZIDI on Monetary Policy in the Context of the New Normal. Dr. Fan Gang is the Vice Chairman of China Society of Economic Reform (CSER), Monetary Policy Committee member of the People’s Bank of China (PBOC) and Director of China Development Institute(CDI). Gang interprets the current economic situation including the sluggish economy and fluctuations in the stock market.
I.The sluggish Chinese economy requires a “soft landing”
In the current period, China has an annual GDP growth rate of 7%, basically considered as “having returned to a normal growth range”. From the fact that PPI has experienced a negative growth rate for the past 40 consecutive months, however, mild deflation still exists in the economy, and overall the economy remains in an “overly sluggish” state. Domestically there are two main reasons to blame for the situation. First and foremost, we are still dealing with various problems originated from two economic overheating in the past 10 years, such as excess capacity, debt problem, housing oversupply, etc. Second, current government policies are not flawless. Over-tightened monetary policy has led to the current over-tightened economy. Contractionary monetary policy has been conducted for too long, lagging to “return to neutral”.
The aftereffects of overheated growth, such as stock insome overheated industries and excess capacity of production, will take some time to be cleared up. Hence, we may adopt theapproach of soft landing to address these problems. The problems can be solvedthrougha certain time period, by utilizing the method ofexposing the problemsgradually and making respective adjustments in a large scale. The positive factor forachieving soft landing is that the past economic bubbles have beencontrolled to some extent, and in the meantime the government has someregulatory power. From the macroeconomic policy that played a positive role between 2004 and 2007 to the restrictions on housing purchase since2010, these measures slowed the expansion of the bubble effectively, especially in the real estate sector.
Currently, the adjustment to soft landing is underway. Why the adjustment is a must?During the economic downturn, the enterprise with higher efficiency and better productivity tend to survivethrough the “survival of the fittest” game in a variety of industries, laying a solid foundation for the next round of development. Besides, some industries have recovered from excess capacityproblem in the past few years, with automobile, mechanicalindustry, general consumer goods and other infrastructure construction gradually returning to normalcy.But soft landing is characterized by a relatively long period of downturn, or say,the adjustment will take arelatively long time. The question is: how long would it be? According to the analysis of China’s previous GDP growth and inflation rate, it’s hard to tell so far. Nevertheless, soft landing, as it is, will not boost the economy in a year or two.Hopefully the economic growth will stabilize without dropping further next year and begin to pick up slightly in the year after next, though it is quite likely to remain at the trough.
The special negative factor at the momentlies in government policies. For example, many contractionarypoliciesadopted to deal with the economic overheatingin 2010, such as the reserve requirement ratio, interest rate and housing purchase restrictions, have not yet “exited”. Meanwhile, the government is not proactive enough in taking measures to address and mitigatethe current economic and financial risks. It is the government’s “inaction” that leads to problems in the institutional reform.
Ⅱ.Individual investors are not advised to speculate on the stock market; Maintaining a floating exchange rateis crucial
There are two special indicators, one is the stock market and the other is exchange rate. These two indicatorscan explain the short-term, long-term and periodic problems of the Chinese economy we now face.
China’s securities market currently remains an immature market at its initial stage of development. With regard to the recent fluctuations in the stock market, I have three pieces of advice: First, the argument that China’s stock market is a “policy-oriented market” has proved wrong.Chinese government has made a series of policies such as lowering the reserve requirement ratio, reducinginterest rates and relaxing mortgage requirement, for the sake of the stability of Chinese economy, especially in manufacturingand real estate industry.These policiesare madeto replacethe contractionarypolicy, rather than affect the stock market. The market runs by its own law, andhence the government is unable to determine how it runs. Second, the government must not conduct expansionary policy when the economy is already at boom. Macroeconomic policy must be conductedin a counter-cyclical manner. In fact, What the government shoulddo is to sendwarnings as soon as the bull market takes shape, and remind investors that certainmeasures will be taken to temper economic overheating. Investors may not be happy about it and the government may be criticized for doingso at the time, but in the long run, it will be beneficialto the economy, and in the end investors will thank the policy for saving them from a greater loss. Third, individual investorsshould not speculate on the stocks. For one thing, speculation on stocks is risky. For another, it requires professional knowledge. While institutions, apart from possessing professional knowledge, can pool the funds together, diversify the risks away and gain a less volatile return through investment portfolios, which isimpossible for individual investors to attain.
Besides, we should view the stock market in a long-term perspective.In order for the capital market to develop, the Chinese government needs a stock market that fluctuates in a healthy way. Bull market is inevitable, but the government should not make it even more bullish. China’s capital market is not confined to stock market. Rather, it also includes direct financing, angle investment, private equity,mergers and acquisitions, as well as bond andother securities. All thesefinancial sectors are developing. We need torecognizethe flawsexistedinthe early stage of market development, and also view it in a long-term perspective.
Another indicator is theexchange rate. China’sexchange rate regime is called “referring to a basket of currencies”. A currency basketisa portfolio of selected currencies. The exchange rate index of the basketis calculated based on trade-weighted averages. At present, the currencies of mostcountrieshave depreciatedagainst the US dollar, resulting in a situationin which ournominal exchange rate against the US dollar remains unchanged, butRMB has actually appreciated a great deal against “ a basket of currencies”. Therefore, the recent depreciation of RMBis, in essence,a correction of the over-appreciation and over-pricing in the laststage. The variables must “vary” so as to maintain a constant balance. Soonce again, we muststick to the principle of referring to a “currency basket” and measuring“real effective exchange rate”. Exchange rates, interest rates and other economic variables must change along with the changing circumstances. Allow the exchange rate to float and adjust as needed, and release the market pressure when it exists. These are important preconditionsto ensure thatthecapital is balanced and stable. In order toachieve a stable flowof capital related to international exchange rates, it is necessary to make constant adjustments according tovarying situations, or make the exchangerate float with the market.
Ⅲ Neutral monetary policy is important for achieving a “normal high-speed growth”
I do not have a high expectation of China’s economic growth in 2015. The economic growth rate in the next year or two should be around 7% or even a bit lower than that. The monetary and fiscal policies should “returnto neutral” rather than continue the currentcontractionary state. Under theappropriateplanning of the central authority,the governments should maintain a moderate size of investment, increase theinfrastructure investment, and improvethe infrastructure usingtheproduction capacity. Moreover, governments should make up for the gap ofenterpriseand real estate investment, to make sure that the economy will notenter into recession and the growth will not deviatetoo far from the normal growth.
How to achieve “normal growth” then? Itrequiresanalyzing the role of cyclical factorscorrectly and viewing the long-term and short-term factorsappropriately.The “Normal growth rate” is called the “potential growth rate”in economicparlance. When the actual growth rate is higher than the potential growth rate, contractionary policy need to be adopted; when the growth rate is lower than the potential growth rate, expansionary policyneed to be adopted. Currently Chineseeconomy is in a downturn, with the growth rate lower than the “normal growth rate”accompanied by overcapacity and deflation. So from the perspective of the government, it should proactively promote “normal high-speed growth”, avoid the economic overheating, andmitigate economic fluctuations. This is not easy though, and fluctuations, as we are nowgoing through, is inevitable in a market based economy. What we can do is to learn from mistakes, to learn how to better adjust the policyso that our economic growth issteady, which is alsothe goal of someof our monetary and fiscal policies.
Opinions expressed here belong to the author and do not necessarily represent the position of SZIDI.
On the afternoon of September 2, famous economist Dr. Fan Gang was invited to give a speech at the Public Lecture Series of SZIDI on Monetary Policy in the Context of the New Normal. Dr. Fan Gang is the Vice Chairman of China Society of Economic Reform (CSER), Monetary Policy Committee member of the People’s Bank of China (PBOC) and Director of China Development Institute(CDI). Gang interprets the current economic situation including the sluggish economy and fluctuations in the stock market.
I.The sluggish Chinese economy requires a “soft landing”
In the current period, China has an annual GDP growth rate of 7%, basically considered as “having returned to a normal growth range”. From the fact that PPI has experienced a negative growth rate for the past 40 consecutive months, however, mild deflation still exists in the economy, and overall the economy remains in an “overly sluggish” state. Domestically there are two main reasons to blame for the situation. First and foremost, we are still dealing with various problems originated from two economic overheating in the past 10 years, such as excess capacity, debt problem, housing oversupply, etc. Second, current government policies are not flawless. Over-tightened monetary policy has led to the current over-tightened economy. Contractionary monetary policy has been conducted for too long, lagging to “return to neutral”.
The aftereffects of overheated growth, such as stock insome overheated industries and excess capacity of production, will take some time to be cleared up. Hence, we may adopt theapproach of soft landing to address these problems. The problems can be solvedthrougha certain time period, by utilizing the method ofexposing the problemsgradually and making respective adjustments in a large scale. The positive factor forachieving soft landing is that the past economic bubbles have beencontrolled to some extent, and in the meantime the government has someregulatory power. From the macroeconomic policy that played a positive role between 2004 and 2007 to the restrictions on housing purchase since2010, these measures slowed the expansion of the bubble effectively, especially in the real estate sector.
Currently, the adjustment to soft landing is underway. Why the adjustment is a must?During the economic downturn, the enterprise with higher efficiency and better productivity tend to survivethrough the “survival of the fittest” game in a variety of industries, laying a solid foundation for the next round of development. Besides, some industries have recovered from excess capacityproblem in the past few years, with automobile, mechanicalindustry, general consumer goods and other infrastructure construction gradually returning to normalcy.But soft landing is characterized by a relatively long period of downturn, or say,the adjustment will take arelatively long time. The question is: how long would it be? According to the analysis of China’s previous GDP growth and inflation rate, it’s hard to tell so far. Nevertheless, soft landing, as it is, will not boost the economy in a year or two.Hopefully the economic growth will stabilize without dropping further next year and begin to pick up slightly in the year after next, though it is quite likely to remain at the trough.
The special negative factor at the momentlies in government policies. For example, many contractionarypoliciesadopted to deal with the economic overheatingin 2010, such as the reserve requirement ratio, interest rate and housing purchase restrictions, have not yet “exited”. Meanwhile, the government is not proactive enough in taking measures to address and mitigatethe current economic and financial risks. It is the government’s “inaction” that leads to problems in the institutional reform.
Ⅱ.Individual investors are not advised to speculate on the stock market; Maintaining a floating exchange rateis crucial
There are two special indicators, one is the stock market and the other is exchange rate. These two indicatorscan explain the short-term, long-term and periodic problems of the Chinese economy we now face.
China’s securities market currently remains an immature market at its initial stage of development. With regard to the recent fluctuations in the stock market, I have three pieces of advice: First, the argument that China’s stock market is a “policy-oriented market” has proved wrong.Chinese government has made a series of policies such as lowering the reserve requirement ratio, reducinginterest rates and relaxing mortgage requirement, for the sake of the stability of Chinese economy, especially in manufacturingand real estate industry.These policiesare madeto replacethe contractionarypolicy, rather than affect the stock market. The market runs by its own law, andhence the government is unable to determine how it runs. Second, the government must not conduct expansionary policy when the economy is already at boom. Macroeconomic policy must be conductedin a counter-cyclical manner. In fact, What the government shoulddo is to sendwarnings as soon as the bull market takes shape, and remind investors that certainmeasures will be taken to temper economic overheating. Investors may not be happy about it and the government may be criticized for doingso at the time, but in the long run, it will be beneficialto the economy, and in the end investors will thank the policy for saving them from a greater loss. Third, individual investorsshould not speculate on the stocks. For one thing, speculation on stocks is risky. For another, it requires professional knowledge. While institutions, apart from possessing professional knowledge, can pool the funds together, diversify the risks away and gain a less volatile return through investment portfolios, which isimpossible for individual investors to attain.
Besides, we should view the stock market in a long-term perspective.In order for the capital market to develop, the Chinese government needs a stock market that fluctuates in a healthy way. Bull market is inevitable, but the government should not make it even more bullish. China’s capital market is not confined to stock market. Rather, it also includes direct financing, angle investment, private equity,mergers and acquisitions, as well as bond andother securities. All thesefinancial sectors are developing. We need torecognizethe flawsexistedinthe early stage of market development, and also view it in a long-term perspective.
Another indicator is theexchange rate. China’sexchange rate regime is called “referring to a basket of currencies”. A currency basketisa portfolio of selected currencies. The exchange rate index of the basketis calculated based on trade-weighted averages. At present, the currencies of mostcountrieshave depreciatedagainst the US dollar, resulting in a situationin which ournominal exchange rate against the US dollar remains unchanged, butRMB has actually appreciated a great deal against “ a basket of currencies”. Therefore, the recent depreciation of RMBis, in essence,a correction of the over-appreciation and over-pricing in the laststage. The variables must “vary” so as to maintain a constant balance. Soonce again, we muststick to the principle of referring to a “currency basket” and measuring“real effective exchange rate”. Exchange rates, interest rates and other economic variables must change along with the changing circumstances. Allow the exchange rate to float and adjust as needed, and release the market pressure when it exists. These are important preconditionsto ensure thatthecapital is balanced and stable. In order toachieve a stable flowof capital related to international exchange rates, it is necessary to make constant adjustments according tovarying situations, or make the exchangerate float with the market.
Ⅲ Neutral monetary policy is important for achieving a “normal high-speed growth”
I do not have a high expectation of China’s economic growth in 2015. The economic growth rate in the next year or two should be around 7% or even a bit lower than that. The monetary and fiscal policies should “returnto neutral” rather than continue the currentcontractionary state. Under theappropriateplanning of the central authority,the governments should maintain a moderate size of investment, increase theinfrastructure investment, and improvethe infrastructure usingtheproduction capacity. Moreover, governments should make up for the gap ofenterpriseand real estate investment, to make sure that the economy will notenter into recession and the growth will not deviatetoo far from the normal growth.
How to achieve “normal growth” then? Itrequiresanalyzing the role of cyclical factorscorrectly and viewing the long-term and short-term factorsappropriately.The “Normal growth rate” is called the “potential growth rate”in economicparlance. When the actual growth rate is higher than the potential growth rate, contractionary policy need to be adopted; when the growth rate is lower than the potential growth rate, expansionary policyneed to be adopted. Currently Chineseeconomy is in a downturn, with the growth rate lower than the “normal growth rate”accompanied by overcapacity and deflation. So from the perspective of the government, it should proactively promote “normal high-speed growth”, avoid the economic overheating, andmitigate economic fluctuations. This is not easy though, and fluctuations, as we are nowgoing through, is inevitable in a market based economy. What we can do is to learn from mistakes, to learn how to better adjust the policyso that our economic growth issteady, which is alsothe goal of someof our monetary and fiscal policies.
Opinions expressed here belong to the author and do not necessarily represent the position of SZIDI.
