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, Appendices (i) Chinese growth slowdown (ii) Macro-prudential policy (iii) Did China s GDP pass the US in 2014?

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

3 The Balance of Payments rate of change of foreign exchange reserves (largely $), rose rapidly in China after 2003 due to all 3 components: Trade Balance, Foreign Direct Investment & portfolio inflows Reserves BoP Source: HKMA, Half-Yearly Monetary and Financial Stability Report, June

4 China accumulated FX reserves rapidly after BP dr/dt >> 0 API Prof. J.Frankel, Harvard

5 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.

6 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 China had trouble sterilizing inflows in Source: HKMA, Half-Yearly Monetary & Financial Stability Report, June 2008 API Prof. J.Frankel, Harvard

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

8 Another tool: The PBoC raised banks required reserve ratios, thus sterilizing in the broad sense of slowing M1, even if M Base grew rapidly. Source: Zhang, 2011, Fig.6, p.46. API Prof. J.Frankel, Harvard

9 (2) : Sterilization faltered (i) PBoC began to have to pay higher domestic interest rates and to receive lower interest rate on US T bills => quasi-fiscal deficit or negative carry. (ii) Money growth accelerated. (iii)the economy overheated.

10 (i) Cost of carry : By 2008 the cost of domestic funds exceeded the interest rate the 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 Chang, Liu & Spiegel, Fig. 2, p.27

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

12 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 d. and in housing prices.

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

14 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

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

16 (d) Apparent 2008 bubble in China s housing market. Second-hand House Price Index, Shanghai (2003=1000) House price change, Shanghai (% change over a year earlier) Data source: ehomeday

17 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

18 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.

19 China was hit by the 2009 global recession July 2015

20 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

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

22 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

23 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 23

24 China s position in the Swan Diagram in 2009: Hit by global recession. The government responded by increasing spending. ED & TB>0 Exchange rate E in RMB/$ China 2009 China 2008 BB: External balance CA=0 China ES & TB>0 ED & TD ES & TD YY: Internal balance Y = Y Spending A 24

25 5. Monetary tightening, Overheating resumed in Besides general inflation, it showed up in rapidly rising land prices. Real Beijing land prices API Prof. J.Frankel, Harvard

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

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

28 In addition to raising reserve requirements in , the PBoC also raised interest rates. June 1, 2015, Fiscal Times,

29 China s tightened money in to help head off rising inflation, as it had in 2004 & dy dt? API Prof. J.Frankel, Harvard Fxtimes.com

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

31 Annual change in CPI, through August 2015 Chinese inflation fell in 2012, as it had in

32 Besides tightening monetary policy in 2011, China also tightened macroprudential 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.

33 Housing prices came down in 2012, but had yet another cycle in China's Real Estate Market Entering a Correction Phase: Housing bubble close to bursting 6/4/14. Note: Price Indices of Newly Constructed Residential Buildings until December Price Indices of Newly Constructed Commercial Residential Buildings from January large and medium-sized cities is the simple average. Data Source: Compiled by the author based on the CEIC Database (Original data from the National Bureau of Statistics of China)

34 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).

35 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 regression estimated = 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%. 35

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

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

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

39 7. The end of undervaluation: Various key measures suggest that China achieved much of the needed trade adjustment between 2009 and 2013: Substantial real appreciation of the RMB 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, to <2% in 2013.

40 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.

41 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.

42 A trend of real appreciation Dooley, Folkerts-Landau, Garber (2014)

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

44 China s trade surplus peaked in 2007, and then fell. Source: Reserve Bank of Australia (June 2013) China runs a deficit in primary products, offset by a surplus in manufactures.

45 China s trade balance The bilateral surplus with the United States is as big as ever which has no economic importance, but is politically sensitive. 45

46 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.

47 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.

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

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

50 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

51 5 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 has been 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.

52 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.

53 Expansion of the services sector. This 6th dimension of adjustment still lags behind, despite the consensus in favor of it (3rd plenum, 2014). China has had great success in manufacturing especially via exports. Now it needs to help the other side of the economy catch up: services, via domestic demand Retail, education, environmental quality, health care, pensions, social safety net. With the economy in slowdown in , some of this could be done via government spending as China did in But that was heavy investment. Better to allow households to consume more.

54 8. Current troubles In , growth slowed substantially, to below 7 %. The PBoC responded by cutting interest rates, Nov Aug which fed a big stock market bubble. Aug. 25, 2015

55 China s stock market bubble peaked June 12, 2015, the date of the 3 rd increase in margin requirements by regulators.

56 American politicians did not get the memo, but: China s foreign exchange reserves starting falling after June through August 2016 DATA SOURCE: PEOPLE S BANK OF CHINA, via TRADINGECONOMICS.COM

57 The Chinese authorities have now moved a bit toward more market-oriented determination of the exchange rate PBOC widened daily band (3/2014) and apparently now sets day s midpoint ( CNY fix ) in line with preceding market rate, particularly 2015 devaluation. CNY/$ CNH/$ Corresponds with period when 10 years of upward pressure on RMB ended and turned to downward pressure (2014). Devaluation 4% Aug , 2015 Robin Brooks, Goldman Sachs, China Symposium: How Much Room for Gloom? Oct. 20, 2016

58 See appendices i. Is China s current 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. More on sterilization. iv. Did China s GDP surpass the US in 2014?

59 35 years of strong Chinese growth Slowdown -- from 10% average of , to below 7% in 2015 (officially) -- began well before the fall in the stock market & RMB. Source: Reuters

60 Appendix (i): Transition to slower growth path Growth in is slowing down to about 7% (officially) Convergence (K/L ratio, urban migration, technical catch-up, ) Middle-income trap? e.g., Eichengreen, Park & Shin (2012) Regression to the mean: Pritchett & Summers (2014) Transition with hard-landing or soft-landing? Debt Leverage becomes unsustainable when growth slows. Bad loans in the shadow banking system. Some needed reforms & the Third Plenum of 2013 Rural land rights and hukou system Market orientation Environment The need to shift composition of GDP From Investment and Net Exports, to Consumption From Manufacturing to Services

61 Is there a middle-income growth trap? Avoiding middle-income growth traps, Pierre-Richard Agénor, Otaviano Canuto, Michael Jelenic,VoxEU, 21 December 2012 Eichengreen, B, D Park and K Sh (2011), When Fast Economies Slow Down: International Evidence and Implications for China, NBER WP Formal evidence on growth slowdowns and middle-income traps has suggested that at per capita incomes of about US$16,700 in 2005 constant international prices, the growth rate of per capita GDP typically slows from 5.6 to 2.1%. Using regression and standard growth accounting techniques, recent analysis (Eichengreen, Park, and Shin 2011) suggests that growth slowdowns are essentially productivity growth slowdowns

62 Pritchett & Summers (2014): Regression to the mean fits the data better than middle-income trap Asiaphoria Meets Regression to the Mean, NBER WP No , Lant Pritchett and Lawrence Summers

63 Appendix (ii): Macro-prudential policies in Asia Specific examples of macro-prudential policies Banks: reserve requirements E.g., higher on fx liabilities than domestic. Stock market: Margin requirements Housing market: Maximum Loan/value ratio Maximum Debt service/income ratio Prohibition on foreign-currency mortgages A surprising possible conclusion Emerging Market countries are successfully applying these tools in a counter-cyclical manner more than are the US and other advanced countries.

64 Federico, Végh & Vuletin (2014) find that developing countries use reserve requirements counter-cyclically far more than advanced countries do. Pablo Federico, Carlos Végh, and Guillermo Vuletin, "Reserve Requirement Policy over the Business Cycle," NBER Working Paper No , October 2014, and "Effects and Role of Macroprudential Policy: Evidence from Reserve Requirements Based on a Narrative Approach," presented at 2014 Central Bank of the Republic of Turkey-NBER Conference on Monetary Policy and Financial Stability in Emerging Economies

65 Asia-Pacific & other EM countries take macro-prudential actions more often than advanced countries do -- Kuttner & Shim (2015) Kenneth Kuttner & Ilhyock Shim, Can non-interest rate policies stabilize housing markets? Evidence from a panel of 57 economies, NBER WP 19723, 2013.

66 Kuttner & Shim (2015): Ceilings on ratios of Debt Service to Income significantly affect housing credit. Interest rate and credit policies in Korea Interest rate and credit policies in China Kenneth Kuttner & Ilhyock Shim, Can non-interest rate policies stabilize housing markets? Evidence from a panel of 57 economies, NBER WP Revised, 2015.

67 Appendix (iii): More on sterilization API Prof. J.Frankel, Harvard

68 From Lecture 4 In 2003, forex inflows accelerated rapidly. (Both TB & KA >> 0.) Initially, the PBoC had no trouble sterilizing the inflows. => The MB growth rate was kept down to the growth rate of the real economy ( 10%/year), API Prof. J.Frankel, so there Harvard was little inflationary pressure.

69 From Lecture 4 Appendix FX reserves of the PBoC climbed higher than any central bank in history API Prof. J.Frankel, Harvard

70 ITF Prof.J.Frankel Sterilization of foreign reserves: People s Bank of China sold sterilization bills, thereby taking RMB out of circulation. From Lecture 4 Appendix Data: CEIC Source: Zhang, 2011, Fig.4, p.45.

71 In , sterilization worked to limit monetary growth. ΔReserves While increases in reserves (NFA) were large, changes in net domestic assets (NDA) were negative, limiting rises in the monetary base.

72 Appendix (iv): Has China s GDP surpassed the US? Headlines, December 2014: China surpasses U.S. to become largest world economy FoxNews.com 12/6 based on the latest 6-year update from the World Bank s International Comparison Program. 72

73 The facts On the one hand, China s economic miracle is genuine: Growth 10% p.a. for 3 decades is historic. It took the UK 58 years to double income, starting from 1780 US: 47 years, from 1839 Japan: 35 years, from 1885 Korea: 11 years, from 1966 But it took China only around 8 years, from 1987! On the other hand, China is still poor as of 2014: It ranks only midway among 190 countries (85 th, just above Peru). The claim to rival US in size comes from multiplying a middle income-per-capita times 1.3 billion people. 73

74 China was the world s largest economy two centuries ago, and appears headed for #1 again. PPP basis The global contribution by major economies from 1 AD to 2008 AD according to estimates by Angus Maddison(2007), Contours of the World Economy I-2030AD, (Oxford University Press).

75 Measuring GDP The dragon takes wing New data suggest the Chinese economy is bigger than previously thought May 3rd 2014 Korea 75

76 China s GDP reportedly passed the US in But that is a mis-application of the PPP numbers from the World Bank s ICP project. 76

77 Use PPP rates to compare income per capita e.g., to judge if: governments have successfully raised living standards; a country is rich enough to cut pollution; the currency is undervalued, given its income. Use actual exchange rates to compare GDP e.g., to judge: How big is the market, from the view of multinational companies? How big should a country s quota be in the IMF? How many ships can its navy buy? How big is the global role for its currency? 77

78 Measuring GDP Using actual exchange rates gives a different answer: The US is still 83% bigger than China with IMF WEO forecast 78 Thanks to Qing Yu

79 China GDP reached US in 2014 only if measured in PPP terms.