China's negative inflation emboldens its aggressive fiscal doves

Conditions ripe for 10 trillion yuan stimulus, says Yu Yongding.

China’s CPI inflation has been less than 2% on average for over a decade, while PPI inflation has been negative for at least two years.

A top Chinese economist says this gives Xi Jinping ample room for a huge 10 trillion yuan stimulus plan that will help to weather a potential Sino-US trade war.

Yu Yongding (余永定 ), a member of the prestigious Chinese Academy of Social Sciences (CASS), has emerged as one of the strongest advocates of forceful macroeconomic stimulus amongst prominent economists in China.

Yu believes it’s high time for China to step up expansive fiscal and monetary policy, in order to deal with slowing economic growth and rising unemployment pressures in the wake of the Covid pandemic.

In a 20 February opinion piece, Yu argues that China has long been averse to fiscal stimulus, due to anxiety over rising levels of government leverage.

“In China a balanced budget has always been an important policy goal, even if this hasn’t been stated explicitly.”

According to Yu, China’s macroeconomic policy settings have been “neutral to tight” since 2011.

During this period, the distinct features of China’s macroeconomic policy have been:

• No short-term stimulus measures.

• No expansion in the deficit.

• No excess issuance of money.

Beijing’s chief macroeconomic goals since then have been to “dissolve excess capacity” and “achieve supply-side structural reforms.”

Conditions now ripe for mass fiscal stimulus

Yu says Beijing finally began to change its tune on macroeconomic policy at the end of 2022 and the start of 2023.

In March 2023, the Government Work Report noted that “the outstanding problem faced by the Chinese economy is inadequate aggregate demand.”

Yu says “this judgement signalled a major adjustment to the direction of macroeconomic policy.”

Yu believes macroeconomic conditions in China are now ripe for mass stimulus plans of around 10 trillion yuan flagged by Beijing at the end of 2024.

He firstly points out that levels of inflation in China have remained extremely low in recent years, while the rest of the world struggled with rampant post-Covid price surges.

CPI inflation has been under 2% on average for more than a decade, while PPI inflation has been in negative territory since October 2022.

Yu further notes that while advanced economies generally seek to keep inflation at around 2%, developed economies like China customarily set levels slightly higher, at potentially between 3 - 5%.

“China should effectively grasp the balance of inflation rates and economic growth, as well as adopt corresponding fiscal and monetary policy,” he writes.

Low levels of inflation would normally mean that the state can’t reduce its debt burdens, just by sitting back and watching price gains erode their real value.

In China’s case at present, however, low inflation has been accompanied by extremely low yields on bonds, meaning that it will cost comparatively little for the Chinese government to issue debt for stimulus spending.

Yu notes that 10-year treasury bonds recently saw yields drop below the 2% threshold, making it very cheap for Beijing to run up long-term debt.

China’s government debt levels and GDP growth

Yu also argues that the Chinese government debt levels are comparatively low, despite concerns over the huge hidden debt of regional authorities.

As of the end of 2023, China’s official total government debt was 85 trillion yuan, including hidden government debt.

This figure means all Chinese government debt - including hidden debt - is 67.5% of GDP.

“China’s fiscal condition is excellent compared to other countries,” Yu contends.

“The central government has considerable room to raise debt and increase the deficit.”

The 10 trillion yuan in fiscal stimulus outlined by Beijing in November last year dwarfs its mammoth 4 trillion yuan GFC rescue package in nominal terms.

The huge growth of China’s economy since then, however, means Beijing is far better positioned to bear the burden of increased government spending.

China’s GDP was 126 trillion yuan in 2023, so a 10 trillion yuan spending package is 8% of this amount.

By comparison, the four trillion yuan rescue package unveiled by Beijing in 2008 was equal to 12% of Chinese GDP at the time.