I often wonder if the human brain is wired to look for monocausal explanations. Think about how often you hear the phrase, “The real problem is . . . “
Why assume there is just one real problem? Most macroeconomic problems are somewhat complex. Here’s a typical situation:
1. A negative real shock slows economic growth, lowering the natural rate of interest.
2. Central banks are slow to react, and thus the policy rate moves above the natural rate.
3. This tightens monetary policy, slowing nominal GDP growth.
4. Because nominal wages are sticky, this slows economic growth by even more than the original negative real shock.
A recent Bloomberg article discusses Xi Jinping’s attempt to address China’s recent economic problems. The focus is entirely on non-monetary factors.
It’s true that China faces a number of structural problems. Xi Jinping inherited a highly flawed economic model, made a few improvements, but also created a new set of problems. In particular, China has moved in the direction of authoritarian nationalism, which is not good for economic dynamism:
As Xi’s corruption campaign rolls on after more than a decade of purges there’s a growing reticence to take chances among officials increasingly focused on security and studying Xi Jinping Thought. Bureaucrats “lying flat” is a problem even recognized by the top leader. At a key economic meeting in December, Xi criticized local officials for procrastinating or misinterpreting the party’s orders.
“Sometimes you have to give people the room to make mistakes. But right now that’s not there,” said Liqian Ren, director of Modern Alpha at WisdomTree Inc., a New York-based asset management firm. “That’s a problem for China. You need the local officials to be willing to try things.”
Of course, the Western world has also become more nationalistic. Thus China’s problems are partly due to factors beyond its control. But in my view a country’s performance is at least 90% determined by home grown policies, and at most 10% explained by external factors.
In addition to the structural problems in China, their monetary policy has recently become much more contractionary. In the short run, this has a bigger impact on growth that all of the various supply side problems:
A NGDP growth rate of roughly 4% might seem fine for a country like the US, but it represents a sharp slowdown from the roughly 8% to 10% figure seen during most of the past decade. This likely explains why the Chinese public is currently so pessimistic about the state of their economy. In contrast, long run growth is almost 100% determined by supply-side factors, as money is roughly neutral in the long run.
So what’s the real problem in China? Is it structural or monetary?
Why not both?
PS. I also agree with Adam Posen’s views on China’s structural problems.
