LECTURES 10 & CASE STUDY: RECENT MACROECONOMICS OF CHINA

Transcription

1 LECTURES 10 & CASE STUDY: RECENT MACROECONOMICS OF CHINA 1. Sterilization of reserve inflows, Overheating, GFC & fiscal response, The Swan Diagram, applied 5. Monetary tightening, Exchange rate policy, The end of undervaluation, Current troubles, 2015

2 1. Sterilization of reserve inflows, (continued from end of Lecture 4) Reserve accumulation Initially successful sterilization Declines in NDA Increases in reserve requirements

3 Recall that China ran large BoP surpluses after BP dr/dt >> 0 API Prof. J.Frankel, Harvard

4 The People s Bank of China sold sterilization bills, taking cash RMB out of circulation (dnda/dt < 0) and so counteracted increases in Net Foreign Reserves. Source: Zhang, 2011, Fig.7, p.47.

5 In , the PBoC had little trouble sterilizing the rising reserve inflows: overall MB expansion was relatively steady (at 10%/yr.). Growth of Monetary Base & its components: \ FX reserve contribution Source: HKMA, Half-Yearly Monetary & Financial Stability Report, June 2008 API Prof. J.Frankel, Harvard

6 The sterilization shows up as a steadily rising share of foreign reserves (vs. domestic assets) in the holdings of the People s Bank of China, R/MB. Chang, Liu & Spiegel, 2015, Capital Controls and Optimal Chinese Monetary Policy FRB SF WP , Fig. 1, p.26

7 Another tool: The PBoC raised banks required reserve ratios, thus sterilizing in the broad sense of slowing M1, even as MB grew. Chinese Banks Average Reserve Ratio Source: Zhang, 2011, Fig.6, p.46. API Prof. J.Frankel, Harvard

8 (2) : Sterilization faltered (i) The PBoC began to run quasi-fiscal deficit or negative carry. (ii) Money growth accelerated. (iii) The economy overheated.

9 (i) Cost of carry : By 2008 the cost of domestic funds exceeded the interest rate PBoC was earning on its foreign reserves (US Treasury bills). } Cost of carry Chang, Liu & Spiegel, 2015, Capital Controls and Optimal Chinese Monetary Policy, FRB SF WP

10 Sterilization eventually faltered, continued (ii) Money accelerated sharply in

11 Sterilization eventually faltered, continued (iii) Signs of overheating in : a. Real growth > 10% probably > potential. b. Inflation became a serious problem. c. Also a bubble in the Shanghai stock market.

12 (a) Real growth > 10% in Growth > 10%

13 L6 appendix (b) China s CPI accelerated in Inflation 1999 to 2008 Source: HKMA, Half-Yearly Monetary and Financial Stability Report, June 2008 API Prof. J.Frankel, Harvard

14 L4 appendix (c) Apparent bubble in China s stock market Data from EconStatsTM, Reuters, and major online news outlets such as the BBC & NYT.

15 L4 appendix The PBoC tightened money by raising reserve ratios and also raising lending rates while continuing to underpay depositors: { financial repression Source: HKMA, Half-Yearly Monetary & Financial Stability Report, June 2008

16 3. Global recession & response: The macroeconomy in The global recession hit in 2008, 4 th quarter, originating in the North Atlantic financial crisis. It cut China s exports by 1/4. Growth and inflation fell sharply. The government responded with a big counter-cyclical fiscal stimulus in The economy returned to rapid growth in 2010, even excess demand in 2011.

17 China was hit by the global recession in late July 2015

18 Chinese government investment spending in 2009 counteracted the recession. } A rise in public investment offset the loss of export demand in Reserve Bank of Australia

19 China s inflation broke sharply in 2009, But took off again in Inflation 2001 to 2011 API Prof. J.Frankel, Harvard

20 WTP, Ch or The Swan Diagram To derive the diagram, assume an economy starts from: external balance, say, TB = 0; and internal balance, Y = Y. Consider an expansion in demand: A. Implications for external balance: At a given exchange rate, A => TB < 0. If TB is to be restored, would need E. So the BB curve slopes up. Implications for internal balance: At a given exchange rate, A => Y > Y. I.e., EDG. If Y = Y is to be restored, we would need E. So the YY curve slopes down. E E YY BB TB<0 A EDG A

21 China s position in the Swan Diagram in 2008 showed a large TB surplus plus overheating. It called for appreciation. ED & TB>0 Excgange rate E in RMB/$ China BB: External balance CA=0 ES & TB>0 China 2002 ED & TD ES & TD Spending A YY: Internal balance Y = Y 21

22 China s 2009 position in the Swan Diagram: Hit by global recession. The government responded by increasing spending. ED & TB>0 China 2008 Exchange rate E in RMB/$ China 2009 China BB: External balance CA=0 ES & TB>0 ED & TD ES & TD YY: Internal balance Y = Y Loss of export demand => YY curve shifts out. Spending A 22

23 5. Monetary tightening, Overheating resumed in Again, inflation soon rose. Annual change in CPI, through August 2015

24 Besides general inflation, overheating in 2010 also showed up in rapidly rising land prices. Real Beijing land prices API Prof. J.Frankel, Harvard

25 When house prices rise relative even to rents, it suggests easy money or a bubble. API Prof. J.Frankel, Harvard Scott Reeve blog

26 China in 2010 resumed raising reserve requirements in a renewed attempt to rein in M1 growth. API Prof. J.Frankel, Harvard

27 China tightened monetary policy in 2011, as it had in 2007: raising interest rates & reserve requirements. June 1, 2015, Fiscal Times,

28 Monetary tightening came in response to overheating, dy dt? each time: 2004, 2008, & API Prof. J.Frankel, Harvard Fxtimes.com

29 Besides tightening monetary policy in 2011, China also tightened macro-prudential policies, particularly in housing finance: Loan-to-Value and Debt-Service-to-Income limits Interest rate and credit policies in China Fig.3, Kenneth Kuttner & Ilhyock Shim, Can non-interest rate policies stabilize housing markets? Evidence from a panel of 57 economies, NBER WP 19723, 2013.

30 Chinese inflation, once again, began to ease off after 2011 API Prof. J.Frankel, Harvard

31 6. Exchange Rate Policy, As of , there were several good reasons to allow RMB appreciation, leaving aside US pressure. i. External balance: Reserves were increasing rapidly to levels high enough for precautionary purposes. Sterilization would become more difficult. ii. iii. Internal balance: The economy was overheating. Currency regime: A country as large as China should have a flexible exchange rate. Better to exit the peg in good times than in crisis. iv. PPP: The RMB was undervalued by the price criterion even taking into account China s GDP/cap (Balassa-Samuelson). Frankel, 2006, "On the Yuan: The Choice Between Adjustment Under a Fixed Exchange Rate and Adjustment under a Flexible Rate," Understanding the Chinese Economy, G. Illing, ed. (Oxford U. Press).

32 The Balassa-Samuelson Relationship Log of Real Per capita GDP (PPP) coef = , (robust) se = , t = Source: Arvind Subramanian, PB10-08, Peterson Institute for International Economics, Undervaluation of RMB in the 2005 regression estimated above = 26%. Estimated 2005 undervaluation averaging across four such estimates = 31%. Compare to estimate for 2000 (Frankel 2005): 36%. Or, as recently as 2009 (Chang 2012) : 25%. 32

33 The RMB was allowed to rise against the $ , though it returned to a peg in mid

34 Appreciation versus the US $, nominal and real, CNY/USD, 2005M06=1 1.3 real 1.2 nominal

35 Appreciation vs. index of currencies, nominal and real, CNY Index, 2005M06= Real value of CNY Value of CNY

36 7. The end of undervaluation? Various key measures suggest that China achieved much of the needed trade adjustment between 2009 & 2013: Substantial real appreciation of the RMB has brought it closer to equilibrium. Some nominal appreciation & Some price inflation and, especially, wage increases. Its current account surplus peaked in 2008 > 10% of GDP and then narrowed dramatically, to 2% in 2013.

37 Adjustment of relative prices The famous China price : Ever since China rejoined the world economy 3 decades ago, its trading partners have been snapping up exports of manufacturing goods, because low Chinese wages made them super-competitive on world markets. But relative prices adjusted following the laws of market economics.

38 Adjustment of relative prices, continued The change in relative prices is reflected as real exchange rate appreciation. This comprises, in part, nominal appreciation and, in part, Chinese inflation. Government officials might have been better advised to let more of the real appreciation take the form of nominal appreciation ($ per RMB). But since they didn t, it showed up as inflation instead.

39 A trend of real appreciation since 2005 Dooley, Folkerts-Landau, Garber (2014)

40 Against an average of currencies, rather than just the $, the RMB hit a record high in

41 China s trade & CA surplus peaked in 2007, and then fell as % of GDP. Sean Miner, China s Current Account in 2014 Feb. 8th, 2015, PIIE

42 China runs a deficit in primary products, offset by a surplus in manufactures. Source: Reserve Bank of Australia (June 2013)

43 China s trade balance, continued The bilateral surplus with the United States is as big as ever which has no economic importance, but is politically sensitive. 43

44 The natural adjustment process was delayed. 1 st, because the authorities intervened to keep the exchange virtually fixed against the dollar, in the years and nd, wages had not fully adjusted to (rising) marginal product of labor in coastal factories surplus labor in countryside (A.Lewis, 1954) impediments to migration (hukou system). China continued to undersell the world.

45 But prices eventually adjusted. Labor shortages began to appear => China s urban workers won rapid wage hikes. Meanwhile another cost of business, land prices, rose even more rapidly. The yuan was finally allowed to appreciate against the $ during & , by 25% cumulatively =17% + 8%, though less against other currencies.

46 Chinese wages rose Source: China s wage inflation, marketrealist.com, Aug. 28,

47 In response to rising wages, some labor-intensive manufacturing has moved back out of China. Mexican employment is rising Source: Noel Maurer, April

48 Balassa-Samuelson estimated for 2011 In 2014, the ICP released new absolute price data. Is the Renminbi Still Undervalued? Not According to New PPP Estimates M.Kessler & A.Subramanian, PIIE, May 2014 Benchmark years GDP per capita (in PPP dollars) RMB undervaluation (percent) , , API Prof. J. Frankel

49 6 types of adjustment are gradually reallocating resources in response to the new high level of costs in the factories of China s coastal provinces: 1 st, some manufacturing is migrating inland, where wages & land prices are still relatively low. 2 nd, export operations are shifting to Vietnam or Bangla Desh where wages are lower still. 3 rd, Chinese companies are beginning to automate, substituting capital for labor. 4 th, they are moving into more sophisticated products, following the path blazed earlier by Japan, Korea, & other Asian tigers in the flying geese formation. 5 th, multinational companies that had in the past moved some stages of their production process to China, out of the US or other high-wage countries, are now moving back.

50 6th dimension of adjustment: expansion of the services sector. China has had great past success in manufacturing especially via exports and investment. It is time for the other side of the economy to catch up: services, via domestic demand, especially consumption Retail, education, environmental quality, health care, pensions, social safety net.

51 American politicians find it hard to let go of the syllogism that seemed so unassailable just a decade ago: (1) The Chinese have joined the world economy; (2) their wages are $0.50 an hour; (3) there are a billion of them, and so (4) their exports will rise without limit: Chinese wages will never be bid up in line with the usual textbook laws of economics because the supply labor is infinitely elastic. But it turns out that the laws of economics do eventually apply after all -- even in China.

52 8. Current troubles In , growth slowed substantially, probably below the official 7 %. The PBoC responded by cutting interest rates, Nov Aug which boosted the stock market. Aug. 25, 2015

53 The stock market underwent an apparent bubble in the 1 st half of You would not guess it from the commentary, but: the stock market regulator raised margin requirements three times, in January & April and on June 12.

54 American congressmen did not got the memo, but: Chinese foreign exchange reserves have been falling since June through September 2015 DATA SOURCE: PEOPLE S BANK OF CHINA, via TRADINGECONOMICS.COM

55 See appendices i. Is China s slowdown a new trend? If so, is it a middle-income growth trap? ii. Countercyclical use of macro-prudential policies by China & some other Asian countries. iii. Did China s GDP surpass the US in 2014?