Monetary policy need not be bound by interest rate differentials


The monetary policy represented by the Federal Reserve has changed from loose to tight, which is bound to affect global capital flows and risk appetite and asset pricing in global financial markets. This brings new challenges to China's economy and China's monetary policy choices, which are still under triple pressure.

The focus of this paper is on how China's monetary policy can meet the challenges and better serve the Chinese economy. The main conclusion is that China does not need to maintain the stability of capital flows by maintaining interest rate differentials, and a market-oriented exchange rate formation mechanism and maintaining a good economic prosperity are the fundamental guarantees for stabilizing China's capital flows. In addition to monetary quantitative measures, China needs more active interest rate policy measures to support aggregate demand growth.

1. Interest spreads are not the dominant factor in China’s cross-border capital flows

Numerous empirical studies on China’s cross-border capital flows share a common direction: interest rate spreads are not the dominant factor in China’s cross-border capital flows. In some time periods, the direction of changes in China-US interest rate spreads is even opposite to the expected change in capital flows. The domestic empirical research literature does not particularly emphasize the impact of the external financial cycle on China’s cross-border capital flows. Even in the empirical regression model that includes external financial cycle factors, the impact of external financial cycle factors on cross-border capital flows is also subordinate. status.

The above empirical research found that the reason behind it lies in the unique institutional environment, participants and behavioral motivation behind China's capital flow. China has adopted a pipeline-style capital account opening, and foreign-invested enterprises (rather than residents and financial investors) have a more prominent impact on short-term capital flows.

Reflected in the balance of payments, short-term capital flows under other investment items (rather than short-term capital flows under portfolio items) dominate my country's short-term capital flows. The short-term capital flows under other investment projects include deposits, ordinary loans, trade financing, overdrafts, financial leases, receivables/payables and other activities of foreign-invested enterprises. Changes in interest spreads have an impact on capital flows for these activities. But these activities are relatively less sensitive to changes in spreads than pure financial investors.

2. The key to stabilizing China's cross-border capital flows is a floating exchange rate and a good level of economic prosperity

Another common point of many empirical studies on China's cross-border capital flows is that exchange rate expectations are the most prominent factor affecting China's short-term capital flows. The reason behind this finding is that China has adopted a gradual reform of the RMB exchange rate formation mechanism, and has maintained the expectation of unilateral appreciation or depreciation of the renminbi for a long time.

During the period from 2005 to 2015, except for the fact that the RMB exchange rate was re-pegged to the US dollar during the global financial crisis from the second half of 2008 to the first half of 2010, the RMB exchange rate against the US dollar maintained a slight gradual appreciation trend for most of the rest of the time. Most of the time, the expectation of unilateral appreciation of the RMB is maintained. During this period, the pressure of net capital inflows was greater.

After the "8.11" exchange rate reform in 2015, the RMB turned to a continuous unilateral depreciation expectation, and the unilateral depreciation expectation did not ease until 2017. During this period, the pressure of net capital outflow was greater.

After 2017, the flexibility of the RMB exchange rate has increased, the expectation of unilateral changes in the exchange rate has weakened, and cross-border capital flows have generally been relatively balanced.

The expectation of unilateral changes in the exchange rate is the main source of pressure on my country's cross-border capital flow, while the unilateral expectation comes from the insufficient marketization of exchange rate formation. The pressure of appreciation or depreciation cannot be released through adequate market-based exchange rate price adjustments, resulting in persistent expectations of unilateral exchange rate changes.

After 2017, the monetary authorities will no longer use foreign exchange reserves to intervene in the market. In 2020, the Secretariat of the National Foreign Exchange Market Self-Regulation Mechanism of the China Foreign Exchange Trade System announced that the "countercyclical factor" in the quotation model of the central parity rate of RMB against the US dollar will gradually fade out. These changes have increased the degree of marketization of the RMB exchange rate, more fully released the pressure of supply and demand in the foreign exchange market through real-time adjustment of exchange rate prices, reduced expectations for unilateral changes in the RMB exchange rate, and played a role in stabilizing cross-border capital flows.

In addition to the impact of exchange rate expectations, another finding in the empirical study is that the degree of China's economic prosperity has a significant impact on cross-border capital flows. When China's economic prosperity is high, the net capital inflow will increase, and vice versa, the net capital outflow will increase. This finding is also relevant to the composition of the actors behind China's capital flows. Businesses, not residents or financial investors, are the main drivers of capital flows in our country. When the level of economic prosperity is high, domestic enterprises have relatively strong demand for funds. Enterprises increase domestic funds by increasing overseas liabilities and reducing overseas assets, which is reflected in an increase in net capital inflows. At the same time, when the economic prosperity is high, foreign investors are more willing to invest in China, which will also lead to an increase in net capital inflows. Conversely, when economic prosperity is low, short-term capital inflows decrease.

3. China's economic prosperity needs to be improved

Different from the inflationary pressure generally faced by developed countries, the most prominent challenge facing China's economy is that the economic operation is lower than the potential growth rate and the economic prosperity is low.

In 2022, China will face pressures from three aspects to reach its potential economic growth rate: First, the repeated epidemics will still hamper economic recovery in 2022, especially the pressure on the service industry and employment. Second, the real estate industry faces the dual challenges of long-term trend adjustment and short-term liquidity difficulties, and it is inevitable that commercial housing sales and real estate development investment will slow down. As a result, not only the upstream and downstream industrial chains of real estate will be affected, but the credit expansion of the whole society will also be significantly affected. Third, the contribution of exports to economic growth declined. With the passing of the peak of the global economic rebound and the impact of the high base period, it is inevitable that the export growth will decline significantly.

Under a variety of scenario simulations, my country's economy will face greater difficulties in achieving potential economic growth in 2022. It is necessary to pay close attention to and avoid the risk of an excessive slowdown of economic growth, because it may accelerate the exposure of some potential risks in the short term, and structural contradictions will become more prominent, making it more difficult to prevent and resolve major risks.

my country needs a strong macroeconomic policy mix to help revitalize the economy. The main lesson of the "4 trillion" stimulus policy is not to adopt stimulus policies in the face of insufficient demand, but to use less standardized monetary and fiscal policy tools and excessive use of local governments, state-owned enterprises and the financial system to cooperate with each other. investment expansion. The sequelae such as the hidden debt risks of local governments, local financial risks, and the rapid rise in leverage ratios largely come from this way of stimulating the economy. By relying more on regulated interest rate policy, fiscal policy and policy-based financial tools, and reducing over-reliance on local government platform companies, my country can achieve economic growth goals while greatly reducing policy sequelae.

4. Monetary policy is "mainly based on me" and "based on price means"

First, the focus of monetary policy is to boost domestic demand, and there is no need to worry about the impact of widening interest rate spreads on capital flows.

Against the backdrop of the Fed raising interest rates and the downward pressure on China's economy, my country may face capital outflow and RMB depreciation pressure this year. If my country chooses to cut interest rates to widen interest rate spreads, it should not only see that the widening interest rate spreads may put pressure on capital flows, but also see that interest rate cuts can increase the level of aggregate demand, improve the level of economic prosperity, and play a supporting role in stabilizing capital flows.

Judging from past experience, the less we do not intervene in the foreign exchange market, the less there will be unilateral expectations and the more conducive to stabilizing capital flows. The main support for stabilizing capital flow is the market-oriented exchange rate formation mechanism, which allows changes in the RMB exchange rate to spontaneously resolve capital flow pressures. Even some depreciation of the yuan would not be a bad thing, which would help boost demand and economic growth momentum this year. my country has strong export competitiveness, which is significantly different from other emerging market economies, which also determines that the RMB exchange rate will not continue to fall. While adhering to the market-oriented exchange rate formation mechanism, it is necessary to consider the counter-cyclical management plan for cross-border capital flows under special circumstances as the main policy tool to prevent speculative capital flows.

The second is to show the market the determination and path to stabilize growth through a clear interest rate adjustment trajectory.

Under the circumstance that economic operation faces triple pressure and economic growth faces many constraints, the argument that there is room for future policy adjustment is no longer suitable for the current economic environment. The next reference for monetary policy is to cut the policy rate by 25 basis points each time, and continue to cut until the growth target is achieved.

There are three advantages to promoting demand growth through the interest rate policy: First, the interest rate policy achieves credit expansion through channels such as reducing the cost of debt, increasing asset valuation, and strengthening the balance sheet. Guide market expectations and promote the combined force of market micro-subjects and policies to stabilize growth; third, the interest rate policy can be adjusted flexibly and in a timely manner, with little policy sequelae.

As of the first half of 2021, the debt of my country's government, enterprises (including platform companies) and the household sector has reached 73 trillion yuan, 171 trillion yuan and 67 trillion yuan respectively. Just looking at the impact of reducing debt cost channels, a 100 basis point drop in interest rates can save the government, enterprises and residents about 3 trillion yuan in debt interest expenses, and play an important role in supporting investment and consumer spending. Judging from the practice of developed countries, both the United States and the euro area have gradually achieved their employment and economic growth goals after sharply reducing interest rates. Although the loose monetary policy during the Abe administration in Japan did not ultimately achieve the 2% inflation target, it also won Japan’s 80%. The longest economic cycle since the end of the decade.

In response to concerns about interest rate policy stimulating asset price hikes, asset price hikes are not necessarily detrimental to the real economy. Asset prices support consumption through wealth effects and investment through valuation effects, all of which support the expansion of aggregate demand. The concern should be the excessive use of leverage and asset price bubbles in the process of rising asset prices. The logical response to this situation is to contain asset price bubbles through macroprudential policy tools, rather than sacrificing interest rate policy tools.

The third is that monetary policy is "primarily price-based".

The real role of monetary policy is to make companies and residents willing to spend money willing to borrow money and start borrowing money. This cannot be achieved only by issuing additional base money (net money in the open market), nor by banks giving money to residents and businesses (credit and social financing data rise).

January's credit data looks boosted, but be careful. Commercial banks currently have a strong willingness to lend to companies with good qualifications. In order to maintain their relationship with commercial banks, companies have borrowed a lot of money in cooperation with commercial banks. If the money borrowed by a well-qualified enterprise is actually not used in the operation, the money is still put on the account rather than used for business activities. This demand is still not up, even if the credit and social financing data seem to have risen a lot.

The focus of monetary policy is to bring down financing costs, or at least interest rates first. Whether interest rates should be lowered cannot be compared with other countries, nor with the past, but depends on whether they match the economic conditions.

In addition, not only the nominal interest rate, but the real interest rate is more important. Since 2012, my country's economic growth rate and return on capital have continued to decline, and the real interest rate has risen instead of falling. On the surface, the nominal interest rate has fallen, but in fact the real interest rate has risen. The trend of the real interest rate is out of line with the trend of the real economy, curbing the investment demand and consumption demand of the private sector.

my country has ample room for monetary policy. After the financial crisis, the monetary policy practices of other countries have shown us that the monetary policy space is much larger than previously imagined. The monetary authorities can invent many new tools to reduce the financing costs of enterprises and residents, stimulate their investment and purchasing power, and then increase the Vibration of the overall economic vitality. China's current nominal interest rate is much higher than zero, the standard policy space is still abundant, and the innovative policy tools mentioned in the second and third steps are at the bottom. Economies such as Japan, Europe and the United States whose economic fundamentals are far weaker than China's have monetary policy space or can create monetary policy space, and China does not need to worry about this issue.