China’s real problem is nominal

There have been numerous news reports indicating that the Chinese economy is in the doldrums. Strong exports have helped China maintain solid overall growth, but that growth engine may not be sustainable, especially given the likelihood of increasingly protectionist headwinds. Domestic sectors such as housing and retail were quite weak. Here is the Financial times:

China’s economy grew at an annual rate of 4.7 percent in the second quarter, official data showed on Monday. This meant that the forecasts were missing and growth was slower than in the previous three months. . . . The data was released as the Chinese Communist Party’s Central Committee launched its third plenum on Monday, a four-day meeting in which the country’s leaders are expected to set the direction of economic policy. The last such event took place in 2018.

Eswar Prasad, professor of economics at Cornell University, said the latest data release would “add strength to growing calls for stimulus measures, such as fiscal support for households, as well as broader reforms to promote a more favorable business environment for private companies.”

“The dependence on exports for power growth will inevitably result in increasing trade tensions with China’s major trading partners,” he said.

As Western economists continue to recommend more fiscal stimulus, it is becoming increasingly clear that China’s real problem is an overly restrictive approach. monetary policy:

In nominal terms, GDP grew 3.97% in the first quarter and 4.01% in the first half of the year, according to data accessed through Wind Information.

Before I discuss the implications of this data, I would like to clear up a few misconceptions:

1. The fact that China’s nominal growth is slower than real growth is not in itself a problem. This could be seen as “good deflation” if it is driven by productivity growth.

2. I recommended 4% NGDP growth for the US, so I don’t see that figure as a major problem.

What exactly is the problem in China? In my opinion, the biggest problem in China today is not the fact that the NGDP is growing at 4%; rather, China’s monetary policy has slowed NGDP growth too quickly. For more than forty years, China had much higher NGDP growth rates. An abrupt slowdown to around 4% has caused economic sluggishness. If 4% NGDP growth had been the ultimate goal, it would have been better to slow the nominal growth rate more gradually.

If the Chinese government decides that it wants to maintain somewhat faster NGDP growth for a few more years – say closer to 5% – then they should ignore Western calls for fiscal stimulus and focus on using monetary policy to stimulate growth of the NGDP. China already has significant debt problems, the last thing they should do is copy mistakes made in Western countries where public debt is now on an unsustainable path.

I worry that China is making the same mistakes as Japan in the 1990s and 2000s. The Japanese government has been unwilling to provide sufficient monetary stimulus, probably out of concern that this would lead to excessive currency devaluation. Instead, they relied on massive fiscal stimulus measures, which proved to be completely ineffective. Japan experienced no NGDP growth and instead incurred massive public debt. Ironically, there are now signs that Japan may finally escape that long period of zero NGDP growth, perhaps in part because the government is finally willing to allow the necessary currency devaluation.

Abenomics was announced at the end of 2012: