Abstract: The constraints imposed by various control measures are crux of economic operation during the pandemic. Some claim that monetary policy will fail in such circumstances. On the contrary, monetary policy may play a larger role and have a stronger impact on the economy than usual. If we compare the economic environment during a pandemic to forest fires, monetary authorities could play three roles: fire prevention, firefighting, and disaster relief. The monetary authorities have an edge in the implementing the first two tasks, but can only help to a limited extent with the third task.
I. FIRE PREVENTION
Many economic entities, including businesses and consumers, may encounter cash flow difficulties during the pandemic. The situation could be compared to a forest littered with sparks and flames concealed beneath the ground, and it is vital to bring widespread rain to prevent the spread of sparks. In terms of economic policy, it means adopting measures that could have effect on the overall economic operation, especially interest rate reduction. Reduced interest rates could lower the cost of debt and boost asset prices, both of which improve cash flows for most economic entities, thus stopping the fire.
Interest rate is the most important leverage for the macroeconomy, a common policy tool for central banks around the world, and the most valued instrument for monetary authorities. The Chinese government, businesses and households have a total debt of over 300 trillion yuan, which means a rate cut by 1 percentage point would slash total interest expense by 3 trillion yuan; it could also boost asset prices including those for stocks and real estates by trillions, significantly bolstering up the cash flows and balance sheets of both households and businesses.
Covid control has put the economy under constraints, and interest rate cut alone is far from enough to pull it out of the woods. However, without rate cuts, more businesses and households will suffer a cash crunch, and their defaults on debt would only feed to the fire.
II. FIREFIGHTING
As the pandemic continues to paralyze business activities, risks are mounting, and the financial market could hardly stay immune, with the government bond market, interbank market, commercial bill market, and asset backed securities (ABS) market all bearing blows from the stalled economy. These markets are closely connected, and when any one of them catches fire, it would spread rapidly to the others, and then to the real economy as well. The monetary authority will have to put out the fire as soon as possible to protect the financial market, and that is a job only the central bank can do.
To put out the fire, the central bank must release the water bucket where the fire is. At the height of Covid, the Federal Reserve introduced a set of firefighting measures, providing lending facilities across primary and secondary markets for government bonds, ABS, commercial bills and corporate bonds, which helped to pare down the risk premium rapidly and enabled the normal functioning of the markets. The Fed’s firefighting endeavors across markets shared the same ultimate goal of maintaining reasonable growth of credit and aggregate demand.
China’s situation is a bit different. At first glance, all financial markets seem to be running smoothly without much need for firefighting. However, in fact, it’s the same problem under a different cover, and its severity cannot be underestimated. Real estate-related credit in China has declined drastically. The real estate sector holds up both home mortgage loans and local land sales as well as infrastructure loans. No matter how robust the financial markets may seem, excessive downturn of the real estate market could trigger a credit collapse with total demand in the doldrums. The April data on social financing is already indicating huge pressure from a lack of credit demand, which is severely hindering domestic demand expansion.
Despite the policies launched by the central bank and other regulatory departments, the sharp decline in the real estate sector has not been fundamentally reversed so far. A package of measures is needed to save the real estate market. Monetary policy should focus on reducing mortgage rates and promoting market-oriented competition, which can effectively increase housing sales and improve the cash flow of housing developers. There is still ample policy space in this regard. However, there are concerns that lower interest rates will spur further housing price increases.
Though this possibility cannot be ruled out, it should be acknowledged that housing price increases are highly differentiated, and the upward pressure on housing prices is mainly concentrated in big cities, rather than the whole country. The development of China's real estate market has undergone phased changes. In the past, the market used to be booming, and it’s difficult to cool it down. Now it is the opposite situation. Controlling housing prices in the big cities should not be a reason to sacrifice the development of the real estate market of the whole country and the macro economy. The regulation of housing prices should be based on city-specific policies, and should not kidnap monetary policy.
III. DISASTER RELIEF
Disaster relief should be targeted at industries or enterprises, and it’s essential to identity the target that needs relief most. For disaster relief, the money borrowed may not be fully repaid. Monetary authorities have no particular advantage in identifying industries and businesses in need and offering money directly. Fiscal policy can do a better job in disaster relief while monetary policy can play a supporting role.
Monetary authorities have been encouraging commercial banks to lend to small and micro enterprises, but fewer and fewer enterprises can repay the loans. The key point to solve this problem is the price of the loan, which is the interest rate.
Today, most SMEs are struggling to survive. On the one hand, normal operation is disrupted, and for those that are still in operation, they can’t have their goods and services sold at a good price. SMEs are in the middle and lower ends of supply chains, and the goods and services they provide are included in the core CPI basket. When the price of this basket remains low, businesses find it rather hard to have revenue growth. On the other side is the very limited decline of interest rates. In this case, SMEs do not dare to borrow. To solve this dilemma, the monetary authority should bring interest rates down even further.
The article was first published on Caijin’s WeChat blog on May 16, 2022. It was translated by CF40 and has not been reviewed by the author. The views expressed herein are the author’ own and do not represent those of CF40 or other organizations.
