The Balance that China’s Economic Policy Needs to Achieve under Global Inflation

A recent article in the Financial Times cited the views of economists from institutions like Moody’s and S&P, believing that global inflation has peaked. Some indicators, including factory prices, freight rates, commodity prices, and inflation expectations, have begun to retreat from recent record levels. U.S. inflation fell more than expected in October, and most economists expect price growth in the United Kingdom, the eurozone, and Australia to peak this quarter. Economists polled by Reuters expect eurozone inflation to reach 10.4% in November when it comes out on Wednesday, down from 10.6% last month. This trend does make central banks that have had to raise interest rates feel less pressured. However, they also pointed out that while global inflation may fall from its peak, it will still be above the long-term target of central banks.

The peak of global inflation, especially the decline in the high level of inflation in the United States, means that the pace of rate hikes by the Federal Reserve will slow, which should be good news for the Chinese economy. However, in terms of the cyclical differences between China’s economy and other major economies, this does not necessarily spell an improvement in external shocks. According to researchers at ANBOUND, the inflation situation in China will face a more complicated situation. Especially as economic demand continues to slow, there is a risk of deflation in the country. Future monetary policy balancing inflation and deflation may require more precise expectations and a grasp of economic changes.

As far as the trend of inflation in China is concerned, the People’s Bank of China (PBoC) mentioned in its third-quarter monetary policy report that it attaches great importance to the potential possibility of rising inflation in the future, maintains “increasing the implementation of prudent monetary policy”, and does not engage in massive quantity easing. The PBoC’s concerns about global inflation are not unfounded. Recently, Ji Min, the PBoC Director-General of the Office of Senior Advisors, also published an article saying that global inflation remains overall high. He pointed out that despite the tightening of global monetary policy and the gradual decline in inflation, it remains highly uncertain whether inflation can return to the low levels of the past without the economy falling into a deep recession. Compared with the low inflation level of a long period in the past, the inflation center may also rise.

Ji further pointed out that if the relationship between inflation and growth changes inversely in the future, monetary policy will either increase its tolerance for inflation, such as the U.S. raising the inflation target from 2% to 3% or even higher, to obtain policy space to stimulate growth, or it needs to tolerate more raised interest rate centers to curb inflation. The actual approach may be a balance between the two, but no matter what equilibrium, interest rates relative to the growth center will rise, and zero or even negative interest rates will no longer appear. All these will bring forth a series of important effects.

According to ANBOUND’s researchers, the complexity of the external inflation situation mainly lies in the fact that the gradual decline of high inflation and the rapid decline in external demand occur at the same time. In this regard, although the current trend of global inflation peaking is becoming increasingly obvious, it will remain well above the target level of the central banks of various countries for a long time, which means that the global central bank interest rate hike cycle will not end in the short term. Major central banks, such as the Fed, are still looking for a policy path for a “soft landing” of the economy. However, the global economy will face the risk of economic stagnation or even recession for a certain period of time. For China, this means that external demand is falling sharply while external inflation remains high. In fact, the resulting changes are already beginning to affect China’s exports. In this case, even if the exchange rate of the Chinese yuan continues to fall, it will not provide a boost to exports. This has exposed the domestic economy to both external inflation and recession.

Central banks of major economies such as the Fed continue to raise interest rates and maintain the rates at a high level, which has put greater pressure on Chinese monetary policy, hindering its easing policy to promote economic growth, and affecting the independence of the country’s monetary policy. Judging from the recent RRR reduction operation of PBoC, it shows that there is still the intention to maintain the expectation of monetary policy easing and liquidity above the “reasonable” level. However, as ANBOUND researchers have pointed out, in the case of the ongoing COVID-19 outbreaks, the effect of such marginal adjustment on economic recovery will also be “reduced. It will still be difficult for the PBoC to move towards massive quantitative easing in the future to avoid the potential impact of a sharp depreciation of the RMB exchange rate caused by differences in Chinese and foreign policies.

In terms of changes in China’s inflation, the simultaneous decline of CPI and PPI not only means a continuous slowdown in domestic demand but also raises concerns about further deflation of domestic price levels. In October, the domestic CPI rose 2.1% year-on-year, down 0.7 percentage points from September, while the core CPI, which excludes food and energy prices, rose 0.6% year-on-year. The country’s PPI in October turned down 1.3% year-on-year from 0.9% in the previous month. In particular, the negative growth of PPI in October means that the decline in terminal demand is leading to a contraction on the supply side. The simultaneous decline in CPI and PPI means that the risk of endogenous deflation is increasing. Even if external inflation remains high, it is not fully imported into the country, which has the effect of prudent monetary policy and the factor of sluggish domestic demand.

In this context, the profit situation of China’s industrial enterprises in October showed a more worrying picture. According to data released by the National Bureau of Statistics (NBS), from January to October, the total profit of industrial enterprises above the designated size in the country was RMB 6.97682 billion, down 3.0% year-on-year. This is the fourth consecutive month of decline in this cumulative indicator, and the decline has widened from the previous value. At the same time, operating income from January to October increased by 7.6% year-on-year, and the growth rate also slowed down from 8.2% in January to September. NBS data shows that the growth rate of revenue slowed down and the decline in total profit widened, which was affected by factors such as the frequent spread of the pandemic in China and the year-on-year decline in factory prices of industrial producers. The decline in profits of industrial enterprises means that the problem of unemployment and the decline of household income will gradually appear. These are the main pressures that makeup “deflation”. This shows that under the repeated shocks of the novel coronavirus outbreaks, China’s demand and supply are seeking a low-level balance downward. Long-term suppression of demand will lead to a contraction on the supply side, thereby making the economy inelastic, which is no good news for the country to be freed from the COVID-19 constraints and move towards recovery in the future.

It is worth noting that the decline in profits of industrial enterprises due to falling inflation should have promoted downstream consumption, but downstream consumption was constrained by the pandemic, resulting in a considerable amount of liquidity stasis in the banking system. This is also the main reason why the current growth rate of money continues to be higher than the growth rate of the social financing scale, and there is a “liquidity trap”. In the short term, the decline in the currency multiplier due to restrictions on economic activity due to COVID-19 is the main factor in the poor circulation of money. The PBoC is worried about the potential risk of future inflation based on the continued high monetary growth, which may appear as demand recovers quickly when epidemic prevention and control policies are relaxed. This short-to-long-term change is one of the complex diversities of the inflation landscape.

This change in internal and external factors is a severe challenge for China’s monetary policy. In this regard, Ji is of the opinion that the factors affecting inflation are becoming more complex. Under such circumstances, various aspects like political and economic, demand and supply, short-term and medium- and long-term factors are intertwined, and monetary and non-monetary, real economy and financial market factors coexist with each other. For macro policy, how to seek a balance between the three major objectives of inflation, growth and financial stability is undoubtedly a more difficult challenge for the country.

In this context, ANBOUND’s researchers believe that prudent monetary policy requires a more precise transition between short-term and long-term. On the one hand, it is necessary to maintain demand-side stability through countercyclical policies, and at the same time, maintaining supply-side elasticity will be one of the main considerations of domestic macro policies, including monetary policy. Therefore, between inflation and deflation, it is more important in the short term to prevent deflation caused by the pandemic from dragging the economy into a vicious circle. The inflation risk mentioned by the central bank may require a future operation, which will test the central bank’s ability to grasp the domestic and foreign economic and inflation situation.

Changes in the inflation situation both within China and on the international scene are becoming increasingly complex. On the one hand, while global inflation may peak and fall, but it will remain high; On the other hand, the limited demand under the impact of the COVID-19 outbreaks in China is affecting the supply side and bringing deflationary pressure. Between the underlying inflation threat and short-term deflationary trends, Chinese monetary policy, while maintaining a balance, should focus on avoiding deflation.

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ANBOUND

ANBOUND is a multinational independent think tank, specializing in public policy research, incl. economy, urban and industry, geopolitical issues. Est. 1993.