China’s Real Problem is Nominal

There have been numerous news reports suggesting that China’s economy is in the doldrums. Strong exports have allowed China to maintain a solid overall growth rate, but that growth engine may not be sustainable, especially given the likelihood of increasingly protectionist headwinds. Domestic sectors such as housing and retail sales have been fairly weak. Here is the Financial Times:

China’s economy grew 4.7 per cent year on year in the second quarter, official data showed on Monday, missing forecasts and marking a slower rate of expansion compared with the previous three months. . . . The data release came as the Chinese Communist party’s Central Committee on Monday launched its third plenum, a four-day meeting in which the country’s leadership is expected to set the direction of economic policy. The last such event was held in 2018.

Eswar Prasad, professor of economics at Cornell University, said the latest data release would “add force to the rising clamour for stimulus measures, such as fiscal support for households, as well as broader reforms to foster a more favourable business environment for private enterprises”.

“The reliance on exports to power growth will inevitably result in rising trade tensions with China’s major trading partners,” he said.

While Western economists continue to recommend more fiscal stimulus, it is increasingly clear that China’s actual problem is an overly restrictive monetary policy:

In nominal terms, GDP grew by 3.97% in the first quarter, and 4.01% in the first half of the year, according to data accessed via Wind Information.

Before considering the implications of this data, I’d like to clear up a few misconceptions:

1. The fact that China’s nominal growth is slower than its real growth is not in and of itself a problem.  This might be viewed as “good deflation”, if driven by productivity growth.

2. I have recommended 4% NGDP growth for the US, and so I don’t see that figure as being a major problem.

So what exactly is the problem in China?  In my view, the biggest problem in China today is not the fact that NGDP is growing at 4%; rather it is that China’s monetary policy has slowed the rate of NGDP growth too rapidly.  For more than four decades, China experienced much higher rates of NGDP growth.  An abrupt deceleration to roughly 4% has caused economic sluggishness.  If 4% NGDP growth is the ultimate objective, it would have been better to slow the nominal growth rate more gradually.

If the Chinese government decides that they wish to maintain somewhat faster NGDP growth for a few more years—say closer to 5%—then they should ignore Western calls for fiscal stimulus and focus on using monetary policy to boost NGDP growth.  China already has substantial debt problems, the last thing they need to do is copy mistakes made in Western countries, where the public debt is now on an unsustainable path.  

I worry that China may be making the same mistakes as Japan made during the 1990s and 2000s.  The Japanese government was unwilling to do sufficient monetary stimulus, probably out of concerns that it would lead to excessive currency depreciation.  Instead, they relied on massive fiscal stimulus, which turned out to be completely ineffective.  Japan got no NGDP growth and instead ran up an enormous public debt.  Ironically, there are now signs that Japan is finally escaping that long period of zero NGDP growth, perhaps partly because the government is finally willing to allow the necessary currency depreciation.

Abenomics was announced in late 2012: