Yu Yongding urges China's policymakers to prevent prolonged stagnation by implementing expansionary monetary and fiscal policies

 In January, shortly before the Chinese government set its annual growth target at 5%, I estimated that if net exports stopped declining, achieving 5% growth would require boosting investment growth to 5.3%, given a slowdown in consumption this year. To offset the expected sharp decline in real-estate investment, my calculations suggested that infrastructure investment would need to “increase significantly” – a goal that seemed within reach at the time.

But the latest data show that China’s annual consumption growth, measured by total retail sales of consumer goods, was just 3.4% in August. Spending on fixed assets, a proxy of investment growth, was similarly weak at 3.2%. Although net exports increased by roughly 8%, they account for just 2.5% of GDP, rendering their contribution negligible.

To be sure, the Chinese economy has historically experienced higher GDP growth in the final quarter of the year, and the real growth rates of the aggregates may be higher because of negative producer price index growth. But it is clear that without significant government intervention, China will struggle to reach its 5% growth target for 2024.

China’s GDP growth rate has steadily declined over the past decade, falling from 10.6% in 2010 to 6.1% in 2019 and 5.2% in 2023. China’s PPI has been in negative territory for much of this period, while the consumer price index has increased by less than 2% on average since 2012, recently falling below 1%.

It is fair to say that China’s “economic miracle” of maintaining an average annual growth rate of 10% is over. Still, I believe that with wise macroeconomic policy, market-oriented reforms, and a genuine commitment to opening up its economy, the economy should be able to maintain a solid growth rate of 5-6% for the foreseeable future.

Chinese economists have debated for years whether policymakers should adopt more expansionary fiscal and monetary policies to stimulate GDP growth, or focus instead on structural reforms aimed at eliminating overcapacity. But given this year’s lackluster economic performance, their views are increasingly aligned. In fact, one could even say that all Chinese economists now advocate expansionary measures.

On September 24, the People’s Bank of China lowered banks’ mandatory reserve ratio by 50 basis points and cut its benchmark policy rate by 0.2 percentage points. To stabilize the property market, the PBOC also cut interest rates on existing mortgages by 0.5% and reduced the minimum down payment on second homes from 25% to 15%. Governor Pan Gongsheng revealed plans to boost the stock market by providing institutional investors with liquidity support.

Financial markets reacted positively to these surprising measures, with the Shanghai and Shenzhen stock exchanges rising by 4.2% and 4.4%, respectively, on the day of the PBOC announcement. But when the economy is caught in a liquidity trap, the central bank’s role is limited, requiring the government to step in. Consequently, public attention has now shifted to the Ministry of Finance.

As GDP growth slows, economists are increasingly urging the government to introduce a large-scale stimulus package. In 2023, China’s budget-deficit-to-GDP ratio was 3%, and its total debt-to-GDP ratio stood at 24%, suggesting that the government certainly has the capacity to pursue an expansionary fiscal policy.

Of course, not everyone agrees with this assessment. Fitch Ratings, for example, estimates that China’s government budget deficit will reach 7.1% of GDP in 2024, while the debt-to-GDP ratio will increase to 61.3%. Notably, China’s fiscal risks may be greater than these figures suggest, given the government’s implicit support for heavily indebted local-government financing vehicles.

Despite these concerns, China’s fiscal resources remain substantial compared to other major economies. Moreover, the country’s high savings rate helps it maintain an international investment surplus of nearly $3 trillion. And while GDP growth has slowed, it is still robust enough to cover interest payments on government debt.

Even with these strengths, the PBOC’s actions alone will not be enough to revitalize China’s economy. The ball is now in the finance ministry’s court. However, there are only three months left in 2024. To act hastily may be counterproductive. Instead, the government should announce a comprehensive large-scale stimulates package as soon as possible to use the “announcement effect” to boost morale and raise public confidence.

Policymakers should heed the lessons of 2009, when China introduced a CN¥4 trillion ($560 billion) stimulus package to mitigate the effects of the global financial crisis. By adopting similarly bold fiscal and monetary policies, while minimizing possible side effects brought by the package, China could reinvigorate its economy and fuel growth in 2024 and beyond.

Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. Copyright: Project Syndicate, 2024, and published here with permission.