Lowering real interest rates key to boost China's investment and consumption

Editor's note: Zhang Bin is a non-resident senior fellow at China Finance 40 Forum and deputy director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. The article reflects the author's opinions and not necessarily the views of CGTN. It has been translated from Chinese and edited for brevity and clarity.

The Central Economic Work Conference, held in Beijing from December 11 to 12, pointed out that China's economy has been recovering and improving this year, with solid progress in high-quality development. However, it also mentioned the need to overcome certain difficulties and challenges to achieve further economic recovery and improvement. 

Six major challenges were specifically listed, including "a lack of effective demand, overcapacity in some industries, weak social expectations, hidden risks, bottlenecks in the domestic economic flow, and increased complexity, severity, and uncertainty in the external environment".

As for next year's economic work, the conference proposed "seeking progress while maintaining stability, promoting stability through progress, and establishing new institutions before dissolving the old". In terms of macro policies, the conference stressed the need to enhance the consistency of macro policy orientation. The conference also called for moderately strengthening proactive fiscal policies and improving quality and efficiency. Prudent monetary policies should be flexible, moderate, precise, and effective.

Overall, insufficient demand remains the most prominent challenge in China's current economic operations, which is manifested by the low inflation level. Other challenges mentioned, including "overcapacity in some industries", "weak social expectations", and "hidden risks", are also highly associated with insufficient demand. 

The core to overcoming insufficient demand and expanding investment and consumption relies on two factors: first, lowering interest rates; second, the government raising debt and accelerating the growth rate of fiscal expenditure. We cannot achieve the goal of strengthening fiscal efforts next year by fixing expenditure with reference to revenues. We must raise government expenditure through increased government debts.

It is noteworthy that the conference adjusted the requirements for monetary policies from "maintaining the basic match between the growth rates of broad money supply and social financing scale with nominal economic growth" to "matching the scale of social financing and money supply with the expected targets for economic growth and price levels". 

This change is very important and indicates the management of expectations. At present, the new emphasis on the expected target for prices is to avoid deflation expectations through monetary policy operations.

The adjustment of monetary policy is critical for overcoming insufficient demand. Although China's interest rates and credit rates have decreased this year, the rate of decline is lower than that of inflation. And real interest rates have hiked. This has constrained the increase in the total demand level.

Only by lowering real interest rates can we foster a monetary policy environment conducive to private sector investment and consumption.

Currently, in an environment of inadequate demand and underutilized resources, boosting consumption is beneficial for investment, and raising investment is also beneficial for consumption. At present, the two are complementary rather than substitutionary.

Whether expanding consumption or investment, the key lies in implementing credit growth. With increased credit, residents, enterprises, and the government have more money in their pockets, and then there will be higher expenditures and incomes, as well as increased profits and investments. 

At this stage, expanding credit relies mainly on two pillars: reducing interest rates and raising government debt. From international and historical experience, as long as these policies are powerful enough, credit will increase, and consumption and investment will rise.