China's Monetary-Policy Surprise

But the risk of cyclical disruptions, such as an unexpected decline in global economic growth, remains. This raises an important tactical challenge for China. How can it stay the reform course without being derailed by a significant growth slowdown in the short term?
This is not the first time that China has confronted this challenge–nor will it be the last. The Great Recession of 2008-2009 alsopushed China to the brink of outrightrecession. With global trade collapsing and Chinese export demand having plummeted from 26% annual growth in mid-2008 to a 27% contraction by early 2009, the government moved aggressively to inject CN¥4 trillion ($586 billion) into the economy. Though this enabled growth to recover by the end of 2009, it also contributed to new problems, including excessive debt, a property-market overhang, and mounting local-government financial risk.

The last thing China needs is more fiscal stimulus. Today's cyclical disruption pales in comparison to that of 2008-2009, and, unlike the fiscally reckless developed economies, China recognizes excessive governmentdebt as a legitimatethreat to sustainable growth and development.

Moreover, unlike major developed economies, most of which have used up all of their conventional monetary-policy ammunition by reducing their policy interest rates to zero, China has plenty of monetary stimulus on reserve to address cyclical disruptions. In these circumstances, it makes sense for China to lean more on monetary policy than on fiscal expansion.

Nonetheless, the PBOC's tactical decision is not without potential pitfalls – not least because interest-rate cuts encourage the extension of more credit at a time when China is trying to wean itself from debt-intensive growth. A key challenge will be to avoid escalating credit risk, which could undermine the process of reform and rebalancing.
From the start, China's leaders knew that the interaction between structural transformation and the business cycle would be complex. As former Premier Wen Jiabao noted nearly eight years ago, China's economy had become increasingly “unstable, unbalanced, uncoordinated, and unsustainable.” The longer China delayed addressing its problems, the more intractable the solution became.

Xi and his colleagues are resolute in attempting to solve this problem by stayingthecourse to rebalance the Chinese economy, while remaining acutely aware of cyclical risks. After all, China's vulnerability to such risks is rooted in its old growth model, which was allowed to remain in place for far too long.

With the recent monetary easing, the Chinese authorities seem to be drawing a line in the sand to prevent an excessive drop in growth.Thissuggests that they nowview a cyclical disruption as a real threat to the country's longer-term structural-reform agenda. To the extent that those fears persist, additional monetary easing can be expected.

Copyright: Project Syndicate, 2014.
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