Last week, China's State Council held an executive meeting to discuss rebuilding efforts after the snowstorms. Prior to that, government institutions, such as the central bank, had already introduced damage control and emergency relief policies to ensure production recovery and keep losses to a minimum. Presently, we believe that macro-policies, too, should adapt to change. 

Preventing the Chinese economy from overheating and restraining inflation are the government’s main economic goals this year. Set at the Central Economic Work Conference held late last year, they are to be accomplished via a combination of moderate fiscal and tight monetary policies. To meet these challenges, adjustments to the macro-policy framework may be necessary. 

The full impact of the snowstorm has yet to be assessed, but in the short run, consumption prices are expected to rise further and fuel inflationary pressure. Monetary policies should check inflation and provide sufficient currency supply to support the rebuilding and production recovery process in disaster-hit areas.  

For external challenges, the US sub-prime mortgage crisis continues and the US economy remains weakening. The deteriorating external environment will certainly exert negative impact on Chinese exports while tight macro-controls may dampen domestic investment and consumption. If these happened, the Chinese economy could face a hard landing. 

Any macro-control policy is a short-term measure, introduced according to need after assessing future risks and trends. It should also adapt to the latest changes macro-economic environment and external challenges. In reality, we can never precisely diagnose and predict all future risks. Therefore, it is necessary to remain sensitive to changes and assess accompanied risks in order to react timely to policies adjustments.

At present, "tightening" is still the main theme of macro policies. Last week, the Chinese central bank issued 195 billion yuan worth of bonds to soak up liquidity; and for the first few months of this year, the central bank needs to offset one trillion yuan worth of maturing bills. However, as the corporate sector is facing a tougher domestic and global environment, a moderate reversal of policy (instead of inflexible credit controls) could also bring positive results and help businesses to pull through hard times.

As China becomes increasingly integrated into the global economy, policy adjustments in any economy will affect others linked to it. As the US Federal Reserve continues to lower its interest rates, the interest spread between China and US has been reversed. Under these circumstances, the Chinese government should reconsider its monetary policy. If the central bank continued the policy of increasing interest rates gradually, it would widen the interest spread between China and US, thus luring in more hot money and exerting more pressure on the yuan to appreciate. In this regard, a better policy would be adjusting deposit reserves and quicken the pace of yuan appreciation.

If in the long term the external economic environment worsened, China’s fiscal and monetary policies would certainly have to undergo adjustments in response. For instance, if external demand shrunk, domestic investment and consumption would become the main drivers for Chinese economic growth. Under such a scenario, more aggressive fiscal policy would be necessary and "tight" monetary policy would change to "moderate" or even "expansionary" in nature. 

In fact, the above example actually happened a decade ago. At the end of 1997, the Central Economic Work Conference had set the tone to tighten macro controls the following year. However, as the Asia Financial Crisis set in and prices dropped abruptly, China sank into deflation. In response, the government adopted an expansionary formula instead – issuing bonds to expand domestic demands and relaxing credits to prevent economic downturn. Despite the adjustments, it took China six years to walk away from deflation. 

In other words, we should not hold on to a rigid understanding of tight monetary control. While guarding against the risks of an overheated economy and inflation, we should also beware of the ripple effects from the declining US economy. Macro-control policies should be introduced based on the above concerns. Once domestic and external factors change and risks of economic downturn become apparent, policy makers should react immediately and decisively to implement necessary adjustments, with monetary policy becoming more flexible.

Original article: [Chinese]