In recent months, the Chinese government has made a significant pivot towards utilizing monetary policy to stimulate economic growth. This shift has sparked widespread debate, with many economists and financial analysts questioning the efficacy of monetary measures in reviving the country’s slowing economy. One of the central arguments in this ongoing discussion is whether China requires a substantial fiscal stimulus package—some proposing as large as RMB10 trillion—or if the current economic challenges could be adequately addressed through strategic adjustments to monetary policy. The focus on monetary measures underscores the crucial role of interest rates and their alignment with the natural rate of interest, known as “r-star,” in shaping economic outcomes.
Interest Rates and the Natural Rate
At the heart of China’s monetary policy debate is the concept of the natural rate of interest, or r-star. This theoretical rate represents the ideal level at which interest rates neither stimulate excessive inflation nor cause deflation, thus maintaining equilibrium in the economy. The challenge, however, is that r-star is not a fixed value. It fluctuates in response to economic conditions and can be difficult to measure with precision. Nonetheless, former People’s Bank of China (PBOC) Governor Yi Gang offered valuable insight into this concept during an April 2023 presentation. He suggested that in the Chinese context, the natural rate of interest could be closely aligned with the economy’s potential growth rate.
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