The market is looking forward to further clarification of fiscal policy to exert a more direct counter-cyclical regulatory effect, form a synergy of policies, further improve market expectations, and promote the continuous recovery and improvement of the economy.
Recently, policies for stable growth have been introduced one after another. The Third Plenary Session of the 20th Central Committee held in July, while outlining the blueprint for China's medium and long-term economic system reform, also emphasized the importance of achieving the annual economic and social development goals. The Politburo meeting in July required "macro policies to continue to exert force and be more powerful," and deployed "promoting stable growth, adjusting structure, and preventing risks with reform as the driving force"; the Politburo meeting held in September required "to increase the counter-cyclical adjustment strength of fiscal and monetary policies." In terms of monetary and financial policies, several policies have also been introduced recently, including lowering reserve requirements and interest rates, supporting the real estate industry, and stabilizing the capital market. Against the background of new situations and problems in economic operations, the introduction of policies for stable growth undoubtedly strengthens market confidence and helps to solve the problem of insufficient effective demand during the economic transformation process.
Balancing stable growth and structural adjustment
There is a view in the market that the current stage is a new stage of transformation of economic development momentum, and structural adjustment is the policy focus. In fact, structural adjustment and stable growth are equally important. They are not mutually exclusive or opposing relationships, but are prerequisites for each other and promote each other. The adjustment and optimization of the economic structure increase the resilience and potential of long-term growth, while short-term policies for stable growth help to prevent the economy from sliding too fast, and strive for time and space for economic transformation.
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Structural adjustment policies mainly target the medium and long term, and the main task is to solve the problem of long-term potential growth rate. According to the classic Cobb-Douglas production function, it is to change the original development model driven by capital input and labor input into a new development model driven by innovation. This is a necessary transformation made by policies against the background of the economic law of diminishing marginal output of capital and new changes in China's population situation.
Stable growth policies mainly target the medium and short term, mainly in periods when economic growth is below the potential growth level. Through the support of total policy, they increase the effective demand of the economy, make supply and demand more matched, and fully utilize resources. China's economic growth has shifted gears, and production capacity has developed significantly. The main contradiction has gradually shifted from supply shortage to demand shortage, making the economy prone to cooling down and difficult to heat up. In the case of insufficient total demand, it is easy to fall into a negative situation of oversupply, insufficient demand, and a downward cycle of residents' income and expenditure. Therefore, it is more necessary to do a good job in total demand policy, achieve the matching of supply and demand, and prevent the feedback cycle of economic downturn.
Characteristics of monetary policy and fiscal policy
Stable growth policies mainly include two aspects: monetary policy and fiscal policy. The requirements for monetary policy in the Politburo meeting in September include "reducing the reserve requirement ratio and implementing a strong interest rate cut." The central bank and other departments have also made detailed explanations at the press conference. However, the increment of fiscal policy is still relatively vague, and the Politburo meeting requires "to ensure necessary fiscal expenditure and do a good job in the grassroots 'three guarantees' work. It is necessary to issue and use long-term special treasury bonds and local government special bonds well, and better play the role of government investment in driving."
Monetary policy plays a role in reducing the financing costs of the real economy and providing financial support for the real economy. However, it also faces inherent limitations. The formation of a synergy for stable growth requires fiscal, monetary, industrial, employment, and other policies to "lift together." Monetary policy is implemented first, and the market is more looking forward to specific measures of fiscal policy.
From the perspective of Keynesian economics, people's demand for money comes from three aspects: transaction motive, precautionary motive, and speculative demand. When residents' confidence is insufficient, the demand for money for precautionary motives increases infinitely. Residents are more inclined to hold safe assets, and the effect of monetary easing decreases. Koichi Hamada's theory of asset-liability balance sheet recession annotates Keynesian theory from the perspective of stock. Due to the deterioration of the balance sheets of economic entities, the goal of enterprises changes from maximizing profits to minimizing liabilities, and they tend to prioritize repairing the balance sheet. The conclusion of this theory is also that monetary policy has limitations.These two theories are also reflected in China's economic reality. Since 2022, China has seen a high growth rate in broad money supply, with ample currency supply. However, a large amount of created money has been transformed into term deposits or financial products. The scale of "excess" term deposits is around 10 trillion yuan, and the incremental money has not been converted into effective demand. From the perspective of residents, due to their already high leverage levels, coupled with the continuous downward trend in the real estate market, the wealth effect has decreased, and residents lack the motivation to further increase leverage. From the perspective of local governments, the hidden debt issues brought about by the high-speed development phase have not been fully resolved, and a medium and long-term fiscal mechanism reform is needed. In the short term, there is not much room for leverage. This is also the main reason why the market expects fiscal policy, especially central fiscal policy, to play a role.
The performance of the U.S. equity market in the early stage of the pandemic also reflected the role of fiscal policy in improving market expectations. In February 2020, due to the global spread of the pandemic, the U.S. stock market fell sharply. To cope with the impact of the pandemic and financial market turmoil, the Federal Reserve "emergency interest rate cut" by 50BP on March 3, and another "emergency interest rate cut" on March 15, directly reducing by 100BP to zero interest rates. However, during these two interest rate cuts, the U.S. stock market continued to decline. It was not until March 23, when the Federal Reserve announced unlimited purchases of Treasury bonds, and on the 27th, announced a $2 trillion fiscal stimulus bill, that the U.S. stock market rebounded rapidly and then entered a long-term bull market. This case fully reflects the important role of fiscal policy in reversing market expectations.
After the press conference of the central bank and other three departments and the September Political Bureau meeting, the expectations of the domestic equity market have improved significantly. Further clarification of fiscal policy will help to further improve expectations and stabilize economic fundamentals.
Compared with monetary policy, fiscal policy has advantages in stabilizing total demand. During periods of high balance sheet pressure, it is difficult for residents and businesses to expand counter-cyclically, while the expansion of fiscal expenditure can directly create total demand, and the efficiency of counter-cyclical policies is high. This is because for residents and businesses, under the condition of a loose monetary environment, their own leverage behavior ultimately leads to the expansion of liabilities, and the current space is not large. Fiscal policy, by increasing expenditure or transfer payments, increases the income of residents, which corresponds to the direct increase in net assets. The income increase brought by fiscal policy can also further drive the investment and consumption of residents and businesses, bringing the second round of policy effects. On the other hand, although monetary policy also has some structural tools, it is generally a total policy. Fiscal policy is more structural and can provide targeted support to weak industries, weak links, and low-income groups in the economy, playing a role in structural adjustment while stabilizing growth.
There is room for fiscal expansion.
From the perspective of the central government's balance sheet, there is still room for fiscal expansion in China at present. According to international conventions, a deficit rate of 3% and a government debt ratio of 60% are generally regarded as the red line for fiscal expansion. According to the statistics of the Chinese Academy of Social Sciences, the debt ratio of China's government sector is 57.8%, which seems to be not much different from the 60% debt ratio constraint. However, in fact, the 3% and 60% target requirements originated from the famous Maastricht Treaty in 1991, which was a requirement during the establishment of the European Community, and it has been a relatively long time, and it does not have actual economic significance. After the financial crisis and the European debt crisis, the requirements of the Maastricht Treaty have been nominal, and according to the statistics of the IMF, the overall debt ratio of the eurozone in 2024 will reach 88.7%, far exceeding the 60% requirement. The debt ratio of the United States has also reached 99%. Therefore, the space for fiscal expansion should not be dogmatically based on the deficit rate and debt ratio figures, but should be more referenced to the constraints of government bond yields and inflation levels.
At present, the expansion of China's fiscal policy has two favorable conditions: First, the yield on government bonds is at a relatively low level, and the financing cost of issuing national and local bonds is low. The contraction of real estate and urban financing, the emergence of asset scarcity, and the issuance of government bonds can meet the market's demand for safe assets; second, inflation is at a low level, and the risk of inflation overshoot brought by fiscal expansion is controllable.
Of course, fiscal expansion still needs to solve some technical issues. In the new period of economic transformation and development, the traditional model of central fiscal expansion, local fiscal and urban financing support, and driving infrastructure investment growth is difficult to continue. First, localities need to solve the problem of existing debt, and in the long term, it is necessary to clarify the financial rights and responsibilities between the central and local governments; second, effective investment projects are more scarce, the scale effect of infrastructure investment is decreasing, and the lack of projects also restricts the issuance speed of local special bonds this year. Fiscal expansion needs to be more inclined towards emerging high-tech fields and more inclined towards people's livelihood security, forming a new and effective fiscal policy system. The announcement at this year's two sessions to regularly issue ultra-long-term special national bonds, and the determination in the second half of the year to issue 300 billion yuan of special national bonds to support the "two new" and "two heavy" fields, all reflect the direction of fiscal transformation.
Overall, the September Political Bureau meeting has deployed a series of policies to stabilize growth, emphasizing the "sense of responsibility and urgency in doing economic work", and calling for "action first, unity is strength", responding to market concerns, and boosting confidence across society. Looking at the subsequent policy implementation, monetary policy, due to its faster decision-making process and more flexible mechanism, has been implemented one after another. The market expects further clarification of fiscal policy to play a more direct counter-cyclical regulatory effect, form a joint policy effect, further improve market expectations, and promote the continuous recovery and improvement of the economy.