14 February 2022
Welcome to the Economic Surplus, the newsletter brought to you by the Marshall Society! We are the University of Cambridge's flagship economics society. Every week, we bring you our bespoke commentary on economic trends, updates on our exclusive members' events as well as a summary of the headlines you can't ignore! You've probably received this email because you were previously subscribed to the Marshall Society's old email list, but if you have been forwarded this by a friend, feel free to subscribe here!
7PM, 16th February 2022: The challenges of the transition to a low-carbon economy-Professor Rick van der Ploeg
It is our utmost pleasure to host Professor Rick van der Ploeg for a conversation about the challenges and obstacles in the transition to a low-carbon economy. Currently, Professor van der Ploeg is the Research Director of Oxford Centre for Analysis of Resource Rich Economies. Previously, was a Member of Parliament and State Secretary in the Netherlands, as well as the Vice Chair of the UNESCO World Heritage Committee. His research interests focus on public finance and climate economics. He has broad consultancy experience with EU, IMF, World Bank and other international institutions. The event will broadcasted live via YouTube. It will be a 45-minute interview followed by a 15-minute Q&A session. Link to the broadcast: https://youtu.be/la6rMSKvfnU
This week’s Marshall’s Thoughts are written by Jeff Yang.
On January 17th, the People's Bank of China announced a reduction in the medium-term loan facility rate by ten basis points, the rate at which the PBOC lends to commercial banks, followed by the subsequent lowering of the loan prime rates set by commercial banks. This significant monetary stimulus also contained high bond repurchase volumes to ensure bank liquidity, signifying an increased tendency for the PBOC to intervene and maintain market confidence under challenging macroeconomic environments. As a result, many further expect that a lowering of reserve requirements may be imminent.
This move comes with no surprises, under the context that the Chinese economy had recently experienced a winter of discontent. The woes of Evergrande and other developers, where tightening liquidity has raised risks of bond defaults, further exacerbated by the weak housing demand, continued to hang as the Damocles' Sword in the halls of Chang'an Street. With the passing of debt extension proposals for some developers, a shift in the policy approach from crackdown to stabilization could be seen. The lowering of the 5-year LPR does reflect this revived attitude that "Stability trumps all," as the funding squeeze is expected to relax, with the lower mortgage benchmark rate maintaining current housing demand.
With several Omicron outbreaks occurring over the past months, the Chinese economy has been hit hard. The continued dedication to a zero-Covid strategy meant that mass testing and occasional city-wide lockdowns have become familiar to many, often disrupting supply chains. Strict lockdown in Xi'an has already caused delays in chip production, reported by Samsung and Micron. In this respect, the loss of disposable income compounded with the low market confidence culminated in the weak domestic consumption and investment data in December last year. Indeed, the National Bureau of Statistics reported the YOY growth in retail sales at 1.7%, the slowest growth since August 2020. In response, the reduction in LPR with MLF rates meant ease of financing for firms, propping up underperforming private investment demand while undertaking the forward guidance that monetary policies will be continuously expansionary to solidify market confidence. To this end, many also expect further reduction in policy rates and the LPR rate, especially if current measures fail to stimulate investment in private firms.
With record-high inflation in the US, the Federal Reserve has been contemplating the necessity of a considerable rise in interest rates. However, such contractionary policies could potentially create significant pressure on the still-recovering Chinese economy. Xi Jinping was correct when he remarked: "If major economies slam on the brakes or take a U-turn in their monetary policies, there would be serious negative spillovers." Indeed, a significant contributor to the 8% Chinese GDP growth last year was the high export demand, allowing her to obtain a record trade surplus of 676.4 billion dollars. A majority of this was attributable to the much controversial China-US trade. The reduction in rates and the expanding volume of open market operations could thus also be seen as a preparation for the potential hike in US interest rates in March or April.
Whether China may weather the impending tempest with aggressive monetary policies, remain to be seen. Yet, the Chinese policy response does need to continuously target the fundamental weakness the nation has exposed over the past years, namely the continually underperforming domestic aggregate demand hindering China from being transformed according to the notion of dual circulation. Notably, resource allocation must be optimized, such that medium and small private firms, which are responsible for 80% of Chinese employment, see higher returns than large SOEs. In 2021, with the PPI achieving higher growth than CPI, SOEs, which mainly participate in resource production, managed to see increased profits, while SMEs became the sore losers under the weak consumer demand. With the SOEs also enjoying the ease of financing and leveraging their often-monopolistic positions, private firms' returns to investment are squandered. In 2019, their fixed investment expenditure shrunk by 2.7%, hindering employment creation. Thus, the limited expansion of firms could effectively explain the slight growth in domestic consumption and investment over the past years.
Considering this structural concern, monetary policies on their own may thus not be the perfect solution to China's weak investment demand. Instead, support must come from the government. Recently, new academic debates have ignited over fiscal policy's role in near-term macroeconomic management. With Chinese inequality continuing to stay at a high level, redistributive policies to increase the middle-class share of income could potentially be the way to stimulate consumption and thereby expand demand for private businesses. In the end, be it a black cat or a white cat, it's a good cat as long as it can catch mice. However, one thing remains clear. China could not afford to rely her economic performances solely on the government or SOEs anymore, especially if she desires to become the dynamic economy envisioned by the regime.
In Case You Missed It:
This article is a provocative Chinese analysis of the reason for the weak domestic demand seen in the last decade. It points out the negative impacts government intervention and SOEs played in the market and how policymakers could shape policies to support economic targets set by the regime.
A brilliant opinion piece surrounding the hot topic of the expected rise in Fed interest rates, considering the recent high inflation. The article stresses the necessity for the central bank to act and ensure financial stability as borrowing costs increase and recommends deepening reforms in order to contain the various vulnerabilities in the US financial system.
This article discusses the quantitative tightening measures the Bank of England could potentially undertake, given the current high inflation, and their economic consequences. Additionally, the article discusses the risks quantitative tightening could impose on the central bank itself.
That's it from us for now!
The Marshall Society