How China can protect its economy – and the world’s – amid US recession headwinds
- China, with its low inflation, can continue to boost its economy and stimulate demand, which will shore up the global decline
- Beijing just needs to keep its monetary policy prudent and look out for the yuan becoming too strong
The US economy was already overheating in November, when unemployment fell below the “natural rate” – the lowest sustainable level without creating inflation. Inflation had also surged, to nearly 5 per cent for the core consumer price index, which excludes food and energy prices, well above the Federal Reserve’s target rate.
But it was not until March that the Fed began to raise interest rates, which remain well below the “neutral rate” – a theoretical level at which Fed policy is neither accommodative nor restrictive. This delayed reaction has made US inflation worse and the wage-price spiral is becoming a reality.
China’s service sector has been badly affected by the pandemic and many urban residents saw their incomes shrink significantly. However, the ongoing tax rebates will stabilise demand with most households less able to spend.
As signs emerge of faltering foreign demand, the government could consider offering more support, such as a maternity allowance for parents with more than one child and payments to households in areas with excellent pandemic prevention, to help stabilise demand and economic expectations.
Ensuring equal access to basic public services will more effectively strengthen consumer confidence and promote common prosperity, but it may take much longer to achieve.
Although these fiscal measures may cut the savings rate, they may not reduce effective capital formation and economic potential. The domestic private sector currently lacks confidence and is unwilling to invest. But the increase in household income from government payments can boost demand, and thus enhance business confidence and drive investment.
A further rise in China’s already-high housing prices could make foreign assets appear more attractive, potentially causing capital flight and affecting financial stability.
More importantly, the central bank should keep the yuan’s real effective exchange rate stable, and in particular avoid a disproportionate appreciation.
The yuan’s real effective exchange rate rose to its highest rate in March after two years of overseas production interruptions. As other countries reopen their economies and resume industrial production, Chinese exports have become easier to substitute.
In this environment, a stronger yuan would hurt China’s export competitiveness, reduce labour demand, lower local wages and raise the dollar prices of domestic assets, hurting income and wealth distribution.
However, many Japanese companies have moved their factories abroad, Japan lacks energy and labour, and is less competitive in most emerging industries. Thus, a rapid and large depreciation of the yen may not have a great impact in the short term on Asian economies, including China.
But China should still take the lead and strengthen economic coordination with other Asian countries and newly industrialised economies, to avoid any competitive currency devaluation.
Against the backdrop of the Fed’s preoccupation with tightening demand, many countries that depend on low-interest US dollars and merchandise exports will be subject to economic headwinds and turmoil. In contrast to the overheated US economy, China’s economy may be in a recession, marked by low growth, low inflation and high unemployment.
Therefore, Beijing will need to stimulate the economy and expand demand, to provide a hedge against the decline in global demand and stabilise the turbulent global economy.
Fang Zihao is currently studying for a PhD in economics at Koc University in Istanbul