2024: Getting out of low inflation is the only way to enter economic prosperity

Edited by Chen Li

In 2023, China's economy achieved the economic growth target set at the beginning of the year. In this year, we have seen the rapid changes of new energy vehicles and the resulting upgrading of the huge industrial chain, the growth of ultra-cost-effective fashion new domestic products, the upgrading of various services that are more and more considerate of customers, and the excellent results of Made in China going overseas.

Even so, China's economic growth potential has not been fully unleashed. As pointed out at the recent Central Economic Work Conference, it is necessary to overcome some difficulties and challenges to further promote the economic recovery, mainly due to the lack of effective demand, overcapacity in some industries, weak social expectations, and still many hidden risks.

China's core CPI in 2023 is around 0.7%, which is the fourth consecutive year that the core CPI has been below 1%. Based on past experience, if the core CPI can reach a reasonable range of about 2%, this year's real GDP growth rate can increase by 2 percentage points on the current basis, and nominal GDP growth can increase by 3.5% percentage points. The increase in national income as a whole will increase by 4.2 trillion yuan on the current basis, of which the disposable income of residents will increase by 2.5 trillion yuan, the disposable income of enterprises will increase by 1 trillion yuan, and the disposable income of the government will increase by 0.6 trillion yuan. This is what China's economy should look like when it reaches its potential growth rate.

Among the difficulties and challenges raised by the Central Economic Work Conference, insufficient demand is the number one contradiction. It is the lack of effective demand that leads to the overcapacity of the industry, the slowdown in the growth of residents' disposable income and the slowdown in corporate earnings caused by the lack of effective demand, which aggravates the weak social expectations, and the lack of effective demand that exacerbates financial risks and various hidden dangers. If the lack of effective demand is solved, many other difficulties and challenges will be greatly alleviated or even disappeared.

The lack of demand is mainly reflected in weak domestic consumption and investment spending. In the operation of the economy, the income of each sector depends on the consumption expenditure or investment expenditure of other sectors, and the amount of expenditure will be affected by income, and income and expenditure feed back to each other. Once caught in the negative feedback of income and expenditure, the lack of demand becomes apparent. In recent years, China's economy has continued to face the impact of this negative feedback, which is a more significant drag and varies from year to year.

Looking back at 2023, the growth rate of government-led spending has declined most significantly, including public support from the government's general budget, as well as government fund spending, and government-led investment project spending, which accounts for about one-third of the mainland's total spending. In 2023, the growth rate of government-led spending will be about 2.7%, which is much lower than the growth rate of nominal GDP and much lower than the growth rate of private sector consumption and investment spending, which has become the main source of economic growth. Moreover, the decline in the growth rate of government-led expenditure has been accompanied by a decline in the growth rate of private sector revenue from government expenditure, which has further dragged down the growth rate of private sector expenditure.

The expansion of aggregate demand, whether it is the expansion of consumption or the expansion of investment, must be implemented in the growth of credit. Credit goes up, there is more money in the pockets of residents, businesses and governments, expenditure and income go up, profits and investment go up. At this stage, there are three main bases for expanding credit: First, the government will borrow money by exerting force on fiscal policy; second, by exerting force on monetary policy and lowering policy interest rates; and third, by stabilizing the real estate market, there can be no further sharp decline. Judging from international and historical experience, as long as the countercyclical policy is sufficient, credit can go up, and the lack of demand can be greatly alleviated.

The Central Economic Work Conference pointed out that next year's fiscal policy should be moderately strengthened to increase quality and efficiency. The "afterburner" is specifically to increase the growth rate of government-led expenditure not lower than next year's GDP growth target. It is necessary to achieve this growth target in a realistic way so as not to drag down aggregate demand. Improving quality and efficiency is to enhance the efficiency of fiscal revenue and expenditure, which is a long-term project that needs the support of many reform measures.

To achieve the goal of fiscal reinforcement in 2024, it is necessary to increase government debt, which can be in the form of a combination of government debt included in the budget and the debt of policy financial institutions. The government's increase in debt and expenditure, while at the same time bringing about an increase in the level of revenue and financial assets of the non-governmental sector, will have an immediate effect on expanding domestic demand.

Some worry that the government's increased debt and spending will threaten government credit, crowd out private sector investment, and bring about severe inflation. In many developing countries, it is true that many of the harms of excessive government borrowing and increased spending are being seen. However, the fundamental difference between China and these developing countries is that China's supply capacity is particularly strong, China has an oversupply, not a demand transition, and China has no inflationary pressures. We cannot apply the experience of governments in developing countries in borrowing to China.

In an environment where the main pressure is persistently low rather than high, the private sector is willing to save much more than it is willing to invest. This means that there is a lot of room for the government to borrow, and the government borrowing to expand spending will not only not threaten the government's credit, but can also make use of the resources that the private sector cannot fully utilize, which can improve the cash flow of the private sector, and also have a crowding effect on the private sector.

Monetary policy adjustments are also crucial to getting out of the lack of demand. The mainland's policy interest rate and credit rate have fallen this year, but the decline is less than the decline in inflation, and from the perspective of real interest rates, real interest rates have risen rapidly. This is a constraint on raising the level of aggregate demand.

For monetary policy to help the core CPI rise, real interest rates need to be lowered. Only a reduction in real interest rates will provide a monetary policy environment conducive to private sector investment and consumer spending. Next year, the monetary policy should be more active, the policy interest rate should be adjusted more widely, and the real interest rate should be lowered by a large margin ahead of the market. Lowering the policy rate is the aggregate policy, and it is also the most precise policy, which is to allow hundreds of millions of investors and consumers to choose how to expand their spending through a financial environment that is more conducive to investment and consumption. There is no policy more precise than this.

Stabilizing real estate is also necessary to achieve the 2024 economic growth target. The relevant departments have introduced many policies to help resolve the risks of real estate companies, but at present, they are not enough. There is still a risk of further downside in real estate sales and investment.

Stabilizing the financing cash flow of real estate enterprises is a top priority, which requires the efforts of enterprises themselves and policy support. Policy support requires both supply and demand to exert force at the same time, as soon as possible. For housing demand, it is necessary to further reduce the policy interest rate to drive down the mortgage interest rate, encourage the competition of bank housing loan interest rates to drive down the mortgage interest rate, lift the purchase restriction and loan restriction policies in stages, and adopt subsidy policies for the first home of low- and middle-income groups. For real estate companies, the focus is on helping real estate companies return to the financial market for financing through selective asset acquisition or other forms of government credit endorsement.

Zhang Bin is Deputy Director of the Institute of World Economics and Politics, Chinese Academy of Social Sciences