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Seminar on CF40 Q4 Macroeconomic Policy Report

The China Finance 40 Forum (CF40) held a seminar on its Q4 Macroeconomic Policy Report on January 24, 2021.

The report was released on a quarterly basis and led by Zhang Bin, CF40 Non-resident Senior Fellow and Deputy Director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. It consists of two parts, with the first focusing on the overall performance of the Chinese economy in Q4 and the second a thematic paper focusing on the loose monetary policy taken by major economies in recent years.

Before Zhang’s introduction of the report, Gao Shanwen, CF40 Academic Committee member and Chief Economist of Essence Securities, gave an opening speech in which he discussed China’s 2035 economic outlook against the unfolding efforts laid out in the 14th Five-Year Plan on economic and social development.

According to Gao, based on the experience of eastern Asian economies, the slowdown of the Chinese economy since 2010 may continue in the following decade before the rate reaches a plateau of around 4%-5% in 2025-2030 and then converges to around 3%. There will be no so called “L-shaped” recession as the economy tends to converge to a long-term growth level following a high growth period, he said.

Gao also pointed out that exchange rate should be taken into account when forecasting China’s economic growth in long term. And under a neutral scenario in which the value of the Chinese currency continues to rise in years to come, it is possible that China will become a “moderately developed economy” by 2035with its GDP expected to reach around $33 trillion,though per capita GDP might still be lower than that of the US.

Meanwhile, he noted that 2021 could be a significant year for China’s economic and social development after its per capita GDP surpassed $10,000 in 2019 and 2020 and began to transition toward a high-income economy.

The significance of the year 2021 is self-evident considering that China achieved growth of 2.3% in 2020after suffering a historic 6.8% contraction in the first quarter due to the COVID-19 outbreak and its economic recovery, to a large extent, will still depend on the evolution of the virus and the availability of effective vaccine in the new year.

The positive whole-year growth is related to the recovery of the Chinese economy in second, third and fourth quarters which reported year-on-year growth of 3.2%, 4.9% and 6.5%, respectively.

According to the Q4 Macroeconomic Policy Report, the strong economic recovery of China in Q4 was attributed to export and manufacturing investment.And the improvement of export was a combined result of increasing output gap due to the disruption in production and fiscal stimulus that supported demand in foreign countries which were still struggling from the pandemic, Zhang noted.

Overall, Chinese economic recovery remained uneven across different economic sectors in Q4, according to the report. The economy was still recovering from the pandemic and the output gap narrowed; meanwhile, strong export drove manufacturing investment to rebound, but the recovery of services sector was sluggish, domestic demand remained weak and job market was still under pressure.

Under the precondition that the pandemic is put under control, the recovery of services sector will improve, and export may remain robust while some of the cyclical manufacturing industries will continue to recover in the first and second quarters of 2021, though domestic demand may remain weak in a longer term.

According to the report, market participants and policy makers should pay attention to three potential risks in 2021. First, policies aimed at preventing risks of implicit debt of local governments may lead to rapid decrease in infrastructure investment, hence impeding economic recovery. Second, credit risk associated with financing platforms and small- and medium-sized banks may increase, threatening financial stability. Third, inflation across the world will rise and central banks of developed economies will exit from loose monetary policy, triggering turmoil in global financial markets.

In response to these potential risks, the report suggested that fiscal policy remain supportive particularly for infrastructure financing; monetary policy maintain a moderate tone while keeping a close eye on credit risk; structural reform focus on civil areas and the development of metropolises where the supply of housing land and housing policies should be further improved.

Following the analysis on China’s economic performance in Q4, Zhang talked about the thematic paper which discusses some of the controversial views about loose monetary policy taken by major economies and the implication for China’s macroeconomic policy.

Such controversial views, according to Zhang, concern issues including why developed economies introduced loose monetary policies, whether loose monetary policy can effectively increase aggregate demand, and whether loose monetary policy will bring excessive monetary growth and inflation, asset price bubbles, deterioration in income distribution, zombie enterprises and delay in economic restructuring.

After going through the academic discussions on loose monetary policies in developed economies and the effects of loose monetary policy over time, the paper has drawn the following conclusions.

First, the main motive of developed economies implementing loose monetary policy is to deal with an inflation that is lower than the expected inflation target. The fact that inflation is the most prominent objective of monetary policy remains unchanged, and it is necessary to consider the causes and the related benefits and costs before deciding whether or not to react to the continuously rising asset prices.

Second, loose monetary policy helps encourage consumption and investment expenditure, which in turn stimulate the aggregate demand and raise prices. The implementation of loose monetary policy helped the U.S. and Europe achieve the expected inflation objectives and Japan experience the longest period of economic recovery since the 1980s. The danger of dropping the loose monetary policy prematurely and constant policy reversals show the critical role of loose monetary policy in a sluggish environment.

Third, empirical research from the U.S. shows that loose monetary policy in general can improve income and wealth distribution in short term. The influence of monetary policy on income and wealth distribution is more short-term rather than long-term in a cyclical sense. The tackling of unequal income distribution requires more targeted policy instruments.

Fourth, loose monetary policy drives asset prices up, and it is hard to differentiate the fundamental factors and bubbles behind the rise in asset prices. The impact of the rise in asset prices primarily depends on financing structure and leverage.

Fifth, structural policy, not monetary policy, is needed to tackle structural issues. Loose monetary policy does not necessarily aggravate economic structure. But if monetary policy does not adequately respond to economic downturns, and when economic and social stability is seriously challenged, structural reform will be needed.

Sixth, loose monetary policy of the U.S. can cause spill over effects on economies with open capital account; even countries that adopt floating exchange rate may not be insulated from the impact. For such economies, it is necessary to introduce capital control and measures to reduce leverage and credit growth to mitigate potential shocks on domestic market.

As one of the major challenges for China’s macroeconomic policy at present is dealing with insufficient aggregate demand, the paper holds that reducing interest rate and increasing budgetary expenditure while reducing debt expansion led by local governments can help enhance the role of private sector in boosting demand and lowering systemic risks resulting from excessive monetary and debt expansion.

Following the two speeches, participants shared further exchanges on China’s economic recovery and outlook in short and long run, and appropriate policy measures needed to better deal with major challenges facing the Chinese economy.

Wang Haiming, CF40 Secretary-General, moderated the event.