In recent months the Chinese central bank (the People’s Bank of China) has taken a number of measures to boost aggregate demand and arrest the slowing economic growth rate. Such measures have included quantitative easing, cuts in interest rates, a devaluation of the yuan and daily injections of liquidity through open-market operations. It has now announced that from 1 March it will reduce the reserve requirement ratio (RRR) for banks by a half percentage point.
The RRR is the percentage of liabilities that banks are required to hold in the form of cash reserves – money that could otherwise have been used for lending. This latest move will bring the compulsory ratio for the larger banks down from 17.5% to 17%. This may sound like only a small reduction, but it will release some ¥650bn to ¥690bn (around $100bn) of reserves that can be used for lending.
The cut from 17.5% to 17% is the fourth this year. Throughout 2014 and 2015 it was stable at 20%.
The hope is that this lending will not only help to boost economic growth but also stimulate demand for the consumption of services. The measure can thus be seen as part of a broader strategy as the authorities seek to re-balance the economy away from its reliance on basic manufacturing towards a more diversified economy. It is also hoped that the extra demand will help to boost jobs and thus provide more opportunities for people laid off from traditional manufacturing industries.
It is expected that further reductions in the RRR will be announced later in the year – perhaps a further 1.5 to 2 percentage points.
But what will be the effect of the releasing of reserves? Will the boost be confined to $100bn or will there be a money multiplier effect? It is certainly hoped by the authorities that this will stimulate the process of credit creation. But how much credit is created depends not just on banks’ willingness to lend, but also on the demand for credit. And that depends very much on expectations about future rates of economic growth.
One issue that concerns both the Chinese and overseas competitors is the effect of the measure on the exchange rate. By increasing the money supply, the measure will put downward pressure on the exchange rate as it will boost the demand for imports.
The Chinese authorities have been intervening in the foreign exchange market to arrest a fall in the yuan (¥) because of worries about capital outflows from China. The yuan was devalued by 2.9% in August 2015 from approximately ¥1 = ¢16.11 to approximately ¥1 = ¢15.64 (see chart) and after a modest rally in November 2015 it began falling again, with the Chinese authorities being unwilling to support it at the November rate. By January 2016, it had fallen a further 2.8% to approximately ¢15.20 (click here for a PowerPoint file of the chart).
But despite the possible downward pressure on the yuan from the cut in the reserve requirement, it will probably put less downward pressure than a cut in interest rates. This is because an interest rate cut has a bigger effect on capital outflows as it directly reduces the return on deposits in China. The central bank had already cut its benchmark 1-year lending rate from 6% to 4.35% between November 2014 and October 2015 and seems reluctant at the current time to cut it further.
China central bank resumes easing cycle to cushion reform pain Reuters, Pete Sweeney (29/2/16)
China cuts reserve requirements for banks to boost economy PressTV (29/2/16)
China Moves to Bolster Lending by Easing Banks’ Reserve Ratio New York Times, Neil Gough (29/2/16)
Economists React: China’s ‘Surprise’ Bank Reserve Cut Wall Street Journal (29/2/16)
China Cuts Banks’ Reserve Requirement Ratio Bloomberg, Enda Curran (29/2/16)
China Reserve-Ratio Cut Signals Growth Is Priority Over Yuan Bloomberg, Andrew Lynch (29/2/16)
China reserve ratio cut not a signal of impending large-scale stimulus: Xinhua Reuters, Samuel Shen and John Ruwitch (2/3/16)
China injects cash to boost growth and counter capital outflows Financial Times, Gabriel Wildau (29/2/16)
China’s Economic Policy Akin To Pushing On A String Seeking Alpha, Bruce Wilds (2/3/16)
China cuts banks’ reserve ratio for fifth time in a year: Why and what’s next Channel NewsAsia, Tang See Kit, (1/3/16)
Questions
- Explain what is mean by the required reserve ratio (RRR).
- Explain how credit creation takes place.
- What will determine the amount of credit creation that will take place as a result of the $100bn of reserves in Chinese banks released for lending by the cut in the RRR from 17.5% to 17%.
- What prompted the recent cuts in the RRR?
- Why may China’s recent monetary policy measures be like pushing on a string?
- Is the reduction in the RRR a purely demand-side measure, or will it have supply-side consequences?
- Explain how different types of monetary policy affect the exchange rate.
- Should other countries welcome the cut in China’s RRR? Explain.
Deflation is currently a concern in the UK and across Europe. However, relative to Japan, the deflation concern is small. In Japan, deflation has been problematic for more than two decades and this has had significant implications for the Japanese economy.
‘Abenomics’ has been in practice in Japan, as the Prime Minister, Shinzo Abe, has been trying to reflate the economy. Growth has been improving and the deflation concern appeared to be under control. However, GDP data now shows that the economy is once again declining and so with aggregate demand falling, this pushes down average prices across the economy and so the deflation risk re-emerges. This article from BBC News and another from The Guardian look at the economic policy known as ‘Abenomics’ and how the Japanese economy is faring.
Articles
Off target: Is it the end of ‘Abenomics’ in Japan? BBC News, Rupert Wingfield-Hayes (15/2/16)
Japan’s economy shrinks again as Abenomics is blown off course The Guardian, Justin McCurry (15/2/16)
Previous blogs
Japan’s deflation fears grow (update) (27/2/16)
Riding the Japanese roller coaster (15/2/16)
Japan’s interesting monetary stance as deflation fears grow (14/2/16)
Japan’s arrows missing their target (17/11/14)
Japan’s recovery (3/2/14)
Abenomics – one year on (16/12/13)
Japan’s three arrows (6/6/13)
Questions
- What are the key features of Japan’s ‘Abenomics’?
- Why is deflation such a concern? Surely falling prices are good for consumers and hence the economy.
- How has Japan been trying to reflate its economy and why has this failed?
- The yen is getting stronger, but how will this affect the Japanese economy? Use a demand and supply diagram to illustrate what has caused the value of the yen to fall and an aggregate demand and supply diagram to show the impact.
- Negative interest rates have been implemented in Japan. What does this mean for savers and borrowers and the economy?
- How do you think Japan’s stance on immigration and structural change is affecting its macroeconomy?
In the blog Japan’s interesting monetary policy as deflation fears grow we detailed the aggressive monetary measures of Japan’s central bank to prevent a deflationary mindset becoming again established. In January it introduced a negative interest rate on some deposits placed with it by commercial banks. This is in addition to it massive quantitative easing programme to boost the country’s money supply. Despite this, the latest consumer price inflation data show inflation now running at zero per cent.
As the chart shows, since the mid 1990s there have been protracted periods of Japanese price deflation (click here to download a PowerPoint file of the chart). In January 2013 Japan introduced a 2 per cent CPI inflation target. This was accompanied by a massive expansion of its quantitative easing programme, through purchases of government bonds from investors.
Following this substantial monetary loosening, buoyed too by a loosening of fiscal policy, the rate of inflation rose. It reached 3.7 per cent in May 2014.
However, through 2015 the rate of inflation began to fall sharply, partly the result of falling commodity prices, especially oil. The latest inflation data show that the annual rate of CPI inflation in January 2016 fell to zero percent. In other words, consumer prices were on average at the levels seen in January 2015.
The latest inflation numbers appear give further credence to the fear of the Bank of Japan that deflation is set to return. The introduction of a negative deposit rate was the latest move to prevent deflation. As well as encouraging banks to lend, the move is intended to affect expectations of inflation. By adopting such an aggressive monetary stance the central bank is looking to prevent a deflationary mindset becoming re-established. Hence, by increasing the expectations of the inflation rate and by raising wage demands the inflation rate will rise.
The loosening of monetary policy through a negative interest rate follows the acceleration
of the quantitative easing programme announced in October 2015 to conduct Open Market Operations so as to increase the monetary base annually by ¥80 trillion.
The decline of Japan’s inflation rate to zero may yet mean that further monetary loosening might be called for. Eradicating a deflationary mindset is proving incredibly difficult. Where next for Japan’s monetary authorities?
Data
Consumer Price Index Statistics Bureau of Japan
New Articles
Japan’s inflation drops to zero in January MarketWatch, Takashi Nakamichi (25/2/16)
Japan inflation falls back to zero in January: govt AFP (26/2/16)
With pause in inflation, many brace for retreat Nikkei Asian Review (27/2/16)
Japan’s inflation rate has fallen again – to 0% Business Insider Australia, David Scutt (26/2/16)
Previous Articles
Bank of Japan adopts negative interest rate policy CNBC, Nyshka Chandran (29/1/16)
Japan adopts negative interest rate in surprise move BBC News (29/1/16)
Bank of Japan shocks markets by adopting negative interest rates The Guardian, Justin McCurry (29/1/16)
Japan stuns markets by slashing interests rates into negative territory The Telegraph, Mehreen Khan (29/1/16)
Japan introduces negative interest rate to boost economy The Herald, (29/1/16)
Questions
- What is deflation?
- What are the dangers of deflation? Why is the Bank of Japan keen to avoid expectations of deflation becoming re-established?
- To what extent are national policy-makers able to exert pressure over the rate of inflation?
- What does a negative interest rate on deposits mean for depositors?
- What effect is the Bank of Japan hoping that a negative deposit rate will have on the Japanese economy? How would such effects be expected to occur?
- What effect might the Bank of Japan’s actions be expected to have on the structure of interest rates in the economy?
- How might the negative interest rate effect how people wish to hold their wealth?
In an attempt to prevent recession following the financial crisis of 2007–8, many countries adopted both expansionary monetary policy and expansionary fiscal policy – and with some success. It is likely that the recession would have been much deeper without such policies
But with growing public-sector deficits caused by the higher government expenditure and sluggish growth in tax receipts, many governments soon abandoned expansionary fiscal policy and relied on a mix of loose monetary policy (with ultra low interest rates and quantitative easing) but tight fiscal policy in an attempt to claw down the deficits.
But such ‘austerity’ policies made it much harder for loose monetary policy to boost aggregate demand. The problem was made worse by the attempt of both banks and individuals to ‘repair’ their balance sheets. In other words banks became more cautious about lending, seeking to build up reserves; and many individuals sought to reduce their debts by cutting down on spending. Both consumer spending and investment were slow to grow.
And yet government and central banks, despite the arguments of Keynesians, were reluctant to abandon their reliance solely on monetary policy as a means of boosting aggregate demand. But gradually, influential international institutions, such as the IMF (see also) and World Bank, have been arguing for an easing of austerity fiscal policies.
The latest international institution to take a distinctly more Keynesian stance has been the Organisation for Economic Co-operation and Development (OECD). In its November 2015 Economic Outlook it had advocated some use of public-sector investment (see What to do about slowing global growth?. But in its Interim Economic Outlook of February 2016, it goes much further. It argues that urgent action is needed to boost economic growth and that this should include co-ordinated fiscal policy. In introducing the report, Catherine L Mann, the OECD’s Chief Economist stated that:
“Across the board there are lower interest rates, except for the United States. It allows the authorities to undertake a fiscal action at very very low cost. So we did an exercise of what this fiscal action might look like and how it can contribute to global growth, but also maintain fiscal sustainability, because this is an essential ingredient in the longer term as well.
So we did an experiment of a two-year increase in public investment of half a percentage point of GDP per annum undertaken by all OECD countries. This is an important feature: it’s everybody doing it together – it’s a collective action, because it’s global growth that is at risk here – our downgrades [in growth forecasts] were across the board – they were not just centred on a couple of countries.
So what is the effect on GDP of a collective fiscal action of a half a percentage point of GDP [increase] in public investment in [high] quality projects. In the United States, the euro area, Canada and the UK, who are all contributors to this exercise, the increase in GDP is greater than the half percentage point [increase] in public expenditure that was undertaken. Even if other countries don’t undertake any fiscal expansion, they still get substantial increases in their growth rates…
Debt to GDP in fact falls. This is because the GDP effect of quality fiscal stimulus is significant enough to raise GDP (the denominator in the debt to GDP ratio), so that the overall fiscal sustainability [debt to GDP] improves.”
What is being argued is that co-ordinated fiscal policy targeted on high quality infrastructure spending will have a multiplier effect on GDP. What is more, the faster growth in GDP should outstrip the growth in government expenditure, thereby allowing debt/GDP ratios to fall, not rise.
This is a traditional Keynesian approach to tackling sluggish growth, but accompanied by a call for structural reforms to reduce inefficiency and waste and improve the supply-side of the economy.
Articles
Osborne urged to spend more on infrastructure by OECD Independent, Ben Chu (18/2/16)
OECD blasts reform fatigue, downgrades growth and calls for more rate cuts Financial Review (Australia), Jacob Greber (18/2/16)
OECD calls for less austerity and more public investment The Guardian, Larry Elliott (18/2/15)
What’s holding back the world economy? The Guardian, Joseph Stiglitz and Hamid Rashid (8/2/16)
OECD calls for urgent action to combat flagging growth Financial Times, Emily Cadman (18/2/16)
Central bankers on the defensive as weird policy becomes even weirder The Guardian, Larry Elliott (21/2/16)
Keynes helped us through the crisis – but he’s still out of favour The Guardian, Larry Elliott (7/2/16)
G20 communique says monetary policy alone cannot bring balanced growth
Reuters (27/2/15)
OECD publications
Global Economic Outlook and Interim Economic Outlook OECD, Catherine L Mann (18/2/16)
Interim Economic Outlook OECD (18/2/16)
Questions
- Draw an AD/AS diagram to illustrate the effect of a successful programme of public-sector infrastructure projects on GDP and prices.
- Draw a Keynesian 45° line diagram to illustrate the effect of a successful programme of public-sector infrastructure projects on actual and potential GDP.
- Why might an individual country benefit more from a co-ordinated expansionary fiscal policy of all OECD countries rather than being the only country to pursue such a policy?
- What determines the size of the multiplier effect of such policies?
- How might a new classical/neoliberal economist respond to the OECD’s recommendation?
- Why may monetary policy have ‘run out of steam’? Are there further monetary policy measures that could be adopted?
- Compare the relative effectiveness of increased government investment in infrastructure and tax cuts as alterative forms of expansionary fiscal policy.
- Should quantitative easing be directed at financing public-sector infrastructure projects? What are the benefits and problems of such a policy? (See the blog post People’s quantitative easing.)
The perceived wisdom is that nominal interest rates have a lower zero bound. The Swedish central bank (the Ricksbank) has effectively been charging financial institutions to deposit money at the central bank since 2009. On 29 January 2016 the Central Bank of Japan also introduced a negative interest rate on deposits. The -0.1 per cent rate currently applies to a portion of the reserves held by financial institutions at the central bank. The move is another attempt to pump energy into a struggling economy.
As the chart shows, since the mid 1990s there have been protracted periods of Japanese price deflation. In January 2013 Japan introduced a 2 per cent CPI inflation target. This was accompanied by a massive expansion of its quantitative easing programme, principally through purchases of government bonds from investors. Following the monetary loosening, buoyed too by a loosening of fiscal policy, the rate of inflation rose. It reached 3.7 per cent in May 2014.
However, through 2015 the rate of inflation began to fall sharply, partly the result of falling commodity prices, especially oil. Now there appears to be an increasing fear at the Bank of Japan that deflation may be set to return. The introduction of a negative deposit rate is intended to prevent deflation. In particular by affecting expectations of inflation. The hope is to prevent a deflationary mindset becoming re-established.
The further loosening of monetary policy through a negative interest rate follows on the heels of an acceleration of quantitative easing last October. Back then, the Bank of Japan said that it would conduct Open Market Operations so that the monetary base would increase annually be ¥80 trillion. This was reaffirmed in its 29 January announcement. For an economy that has experienced four recessionary contractions since 2008 and with provisional estimates suggesting that it contracted by 0.4 per cent in the final quarter of 2015, it remains to be seen whether further monetary loosening might yet be called for.
Data
Consumer Price Index Statistics Bureau of Japan
Articles
Bank of Japan adopts negative interest rate policy CNBC, Nyshka Chandran (29/1/16)
Japan adopts negative interest rate in surprise move BBC News (29/1/16)
Bank of Japan shocks markets by adopting negative interest rates Guardian, Justin McCurry (29/1/16)
Japan stuns markets by slashing interests rates into negative territory Telegraph, Mehreen Khan (29/1/16)
Japan introduces negative interest rate to boost economy The Herald, (29/1/16)
Questions
- What does a negative interest rate on deposits mean for depositors?
- What effect is the Bank of Japan hoping that a negative deposit rate will have on the Japanese economy? How would such effects be expected to occur?
- What effect might the Bank of Japan’s actions be expected to have on the structure of interest rates in the economy?
- How might the negative interest rate effect how people wish to hold their wealth?
- What are the dangers of deflation? Why is the Bank of Japan keen to avoid expectations of deflation becoming re-established?
- To what extent are national policy-makers able to exert pressure over the rate of inflation?
In recent months the Chinese central bank (the People’s Bank of China) has taken a number of measures to boost aggregate demand and arrest the slowing economic growth rate. Such measures have included quantitative easing, cuts in interest rates, a devaluation of the yuan and daily injections of liquidity through open-market operations. It has now announced that from 1 March it will reduce the reserve requirement ratio (RRR) for banks by a half percentage point.
But what will be the effect of the releasing of reserves? Will the boost be confined to $100bn or will there be a money multiplier effect? It is certainly hoped by the authorities that this will stimulate the process of credit creation. But how much credit is created depends not just on banks’ willingness to lend, but also on the demand for credit. And that depends very much on expectations about future rates of economic growth.
