China’s third interest rate cut and how to think about it
On Sunday the Chinese central bank cut interest rates for the third time since November. I have read a number of pieces on this move, but overall am a little disquieted at how quickly people are comparing China to the Keynesian vision of the United States or for that matter Japan. I would stress a few points:
1. Many of China’s municipal governments are broke or close to broke, and in the meantime too heavily dependent on land sales and land leases for revenue. Lower rates are intended to help them refinance themselves. That is not opposed to a Keynesian or AD framework, but it is distinct from it.
2. The Chinese government is at the same time relaxing controls over deposit interest rates, so some interest rates in the economy will be going up. In other words, part of the problem is figuring out the optimal speed for removing financial repression, and in the process allowing to “shadow banking bubble” to deflate at an appropriate speed, all the while trying to keep deposits in the formal banking system.
2b. A lot of borrowers are paying effective nominal rates of six to seven percent — don’t you wish we had a better understanding of the true rate of price inflation in China? One policy goal is to get more loans to these businesses, but there the very real jawboning of the Chinese government may prove more effective than the interest rate cuts. But should those businesses get more loans?
3. In an Austro-Chinese, excess capacity model of the business cycle, there is a gain and a loss from cutting interest rates when an economy is well into the over-expansion phase. The gain is that you may mitigate the costs of the “secondary deflation,” as the Austrians call it. The cost is that you may overextend the excess capacity even further. That is a call the central bank must make, noting that the excess capacity model applies only with some probability.
4. “China’s imports also plunged 16.2 percent in April from a year earlier, a fall that economists attributed partly to low commodity prices and partly to weak demand within China’s economy.” I doubt if they are growing at a true seven percent, or even a “slightly below seven percent” figure.
5. For well over thirty years, the Chinese economy has lived in a world where both the AD and AS curves swing rather wildly (in a good way) outwards and to the right. Some of this is driven by migration to the cities, some of it is driven by trickle-down growth and the adoption of foreign technologies. Some of it may be driven by China’s own TFP, and for sure some of it is driven by policy reform. In any case, as long as that process continues, China is semi-immune to the standard Keynesian dilemmas — who needs to lower nominal wages when worker productivity and customer demand are rising so quickly? But does that ongoing outward real expansion it render them immune to Austro-Chinese business cycle theory as well? Sadly, Hayek never seems to have considered that problem, but it’s very much on my mind out here in Shaanxi.