Historically, the People's Bank of China only implemented a "moderately loose" monetary policy in 2009-2010

Looking back at the practice of China's monetary policy over the past 30 years, the tone of monetary policy can be divided into intervals of "tight," "moderately tight," "prudent," "moderately loose," and "loose."

In September, Lian Ping, Chief Economist of Guangfa Securities and Chairman of the China Chief Economist Forum, published an article titled "Recommendation to Adjust the Monetary Policy Tone to 'Moderately Loose'." Lian Ping suggested a more scientific and reasonable definition of the monetary policy tone. Adjusting the monetary policy tone to 'moderately loose' would create a suitable policy environment for implementing more substantial reductions in reserve requirements and interest rates.

Prior to this, the central bank only used 'moderately loose' monetary policy during the period of 2009-2010.

The following is the full research report:

Since 2011, China has maintained a "prudent" monetary policy tone for 14 years. The current domestic and international economic situation has undergone significant changes, especially with domestic demand facing severe insufficiency, deflation, and downward pressure, while monetary policies in the US and Europe are comprehensively shifting towards easing. In this context, should China's monetary policy continue to maintain a "prudent" tone? Or should it be adjusted in a timely manner to send more positive and clear policy signals to the market, allowing monetary policy to better play its role in counter-cyclical adjustment? This article will discuss and present views.

1. Flexible Adjustment of Monetary Policy Should Be the Norm

Looking back at the practice of China's monetary policy over the past 30 years, the tone of monetary policy can be divided into intervals of "tight," "moderately tight," "prudent," "moderately loose," and "loose." The monetary authorities flexibly adjust between "tight" and "loose" around the "prudent" center based on changes in objective circumstances, aiming to stabilize the economy and achieve counter-cyclical adjustment.

In 1993, China experienced economic overheating and severe inflation, prompting the central government to adopt a moderately tight monetary policy. By the end of 1996, the inflation that had persisted for three years significantly receded. In 1997, facing weak domestic demand and the severe external shock brought about by the Asian financial crisis, a deflationary situation emerged. To cope with internal and external pressures, the monetary policy tone shifted from "moderately tight" to "prudent," maintaining the stability of the RMB's value by appropriately increasing the money supply and using credit leverage to promote domestic demand and increase exports. At the end of 2007, to prevent economic growth from shifting from fast to overheating, the Central Economic Work Conference set the monetary policy tone for 2008 as "tight." In September 2008, marked by the bankruptcy of Lehman Brothers, the US subprime mortgage crisis accelerated, impacting China's economy amid an unprecedented financial crisis. Consequently, the central government decided to implement an active fiscal policy and moderately loose monetary policy, which continued until 2010. Starting in 2011, to prevent inflation, asset price bubbles, "hot money" fluctuations, and financial risks, China returned to a "prudent" monetary policy tone Since then, for about 14 years, the tone of China's monetary policy has not undergone significant changes, only showing tendencies of being slightly loose or tight in actual operations. Among them, from 2011 to 2013, the prudent monetary policy was generally tight, emphasizing the prevention of inflation; from 2014 to 2019, the prudent monetary policy returned to "prudent and neutral," emphasizing neither loose nor tight; from 2020 to 2024, the prudent monetary policy is essentially loose, highlighting the flexibility and appropriateness of monetary policy.

Looking back, there are several points worth noting about the tone of China's monetary policy in practice:

First, when the economy faces severe shocks, the tone of monetary policy often undergoes directional or significant adjustments. Historical experience shows that under conditions of economic overheating or inflation threats, the tone of monetary policy usually adjusts quickly towards a tighter direction. For example, the "moderately tight" in 1993 and "tight" in 2008; while under the background of contraction shocks, the tone of monetary policy will timely adjust towards a looser direction, which may be a one-tier or two-tier adjustment. For instance, in 1997, the monetary policy tone shifted from "moderately tight" to "prudent," and in 2009, it jumped from "tight" to "moderately loose," skipping "moderately tight" and "prudent."

Second, the tone of monetary policy sometimes exhibits a "discrepancy between name and reality" in actual operation. Among the five major tones, "tight," "moderately tight," "prudent," and "moderately loose" have appeared at different times, but "loose" has been notably absent. However, this does not mean that the "loose" tone is genuinely absent. During 2009-2010, China's monetary credit grew rapidly, especially from the end of 2009 to the beginning of 2010, where the year-on-year growth rate of M1 reached as high as 38.96%, M2 growth approached 30%, and the growth rate of various RMB loans exceeded 34% for several consecutive months; matching the rapid growth of credit, local financing platforms emerged like mushrooms after rain, with some regions even establishing more than ten financing platforms in a short period. It can be seen that the monetary policy tone at that time was far from nominally "moderately loose," but was genuinely "loose." Similarly, "prudent" sometimes genuinely means "moderately loose" (as in 1997) and sometimes means "moderately tight" (as in 2011-2013), often showing a reverse change compared to the previous policy tone, requiring an understanding of its relative looseness or tightness based on actual circumstances.

Third, in recent years, the tone of monetary policy has lacked flexibility. Before 2011, the tone of monetary policy switched timely among "tight," "moderately tight," "prudent," and "moderately loose" based on changes in objective circumstances and regulatory goals; After 2011, despite significant changes and fluctuations in economic operations, the flexibility of the monetary policy tone has been clearly insufficient, with the "prudent" tone being maintained for 14 years. In fact, over the past 14 years, the Chinese economy has experienced a series of fluctuations, such as the economic downturn and capital outflow from 2015 to 2016; the trade war initiated by the United States against China in 2018-2019; and the impact of the pandemic from 2020 to 2022, among others. However, the overall tone of monetary policy has not changed. This is obviously detrimental to the ability of monetary policy to conduct counter-cyclical adjustments based on the demands of the real economy. Of course, the spillover effects of the Federal Reserve's monetary policy have imposed certain constraints on China's monetary policy, but the Federal Reserve's monetary policy has undergone several major adjustments over the past 14 years.

II. It is necessary and feasible to adjust the current monetary policy tone to "moderately accommodative."

First, from the domestic environment, macroeconomic and financial indicators are relatively weak, necessitating further support from monetary policy. In August 2024, China's manufacturing Purchasing Managers' Index (PMI) was 49.1%, a decrease of 0.3 percentage points from the previous month, indicating a continued decline in manufacturing prosperity, and it has been below the boom-bust line for four consecutive months. Since the beginning of this year, the manufacturing PMI has only briefly stood above the boom-bust line in March and April, while in the remaining six months, it has been below 50%; in 2023, only four months were above the boom-bust line, with eight months below 50%. In other words, for most of the past two years, China's manufacturing sector has been in a state of recession. From the financial data perspective, the year-on-year growth rate of broad money (M2) in August was 6.3%, remaining below 8% for five consecutive months; the year-on-year balance of narrow money (M1) decreased by 7.3%. In July, new RMB loans amounted to only 260 billion yuan, and if we exclude 558.6 billion yuan in bill financing, the actual new loans were negative; although new RMB loans in August rebounded to 900 billion yuan, there is still a significant gap compared to the 1.22 trillion to 1.36 trillion yuan during the same period in 2021-2023. From the sub-item data, the scale of short-term and medium-to-long-term loans for households and enterprises has significantly declined, with insufficient demand likely being a more significant factor for the decrease in credit than seasonal factors. Additionally, indicators such as prices, real estate, and consumption are also in a state of continued sluggishness.

Second, there is a significant gap between the existing "prudent" monetary policy tone and market psychological expectations. Since 2020, even in the face of major external shocks such as the COVID-19 pandemic and insufficient domestic demand, the tone of monetary policy has only slightly shifted from a "prudent neutral" tone to maintaining a prudent monetary policy with "flexible and moderate," "flexible and precise, reasonable and moderate," and "precise and effective" adjustments towards a looser direction, but the overall tone remains "prudent." Since 2023, the central bank has made several adjustments to the LPR rates, such as lowering the one-year LPR rate by 10 basis points in June 2023, August 2023, and July 2024, and the five-year LPR rate in June 2023, In February 2024 and July 2024, the rates were lowered by 10, 25, and 10 basis points. Except for the 5-year LPR rate, which decreased from 4.2% to 3.95% in February 2024, the other rate cuts were relatively small. Compared to the 25-50 basis points cuts often seen in Europe and the United States, or even a single cut of up to 100 basis points, this has more symbolic significance than practical significance, and there is a clear gap between this and market expectations. Therefore, small rate cuts are unlikely to have a significant impact on the market. From the perspective of strengthening expectation management and effectively guiding market expectations, making reasonable and appropriate adjustments to the monetary policy tone as soon as possible will help boost market confidence and change the current situation where market expectations are generally weak.

Again, from the perspective of policy coordination, it is necessary for monetary policy to better align with fiscal policy to enhance the effects of counter-cyclical adjustments and implement a "dual easing" combination. In the process of counter-cyclical adjustment, the government typically uses expansionary fiscal policy to stimulate overall social demand through measures such as borrowing, deficits, tax cuts, and increased government spending. However, expansionary fiscal policy has the side effect of "crowding out," meaning that when government spending increases, the demand for money also rises. Given a fixed money supply, interest rates will increase, leading to a suppression of private sector investment. At this time, it is often necessary to pair it with expansionary monetary policy to suppress rising interest rates by increasing the money supply. In recent years, our country's fiscal policy has clearly positioned itself as "proactive fiscal policy," proposing to "increase strength and efficiency," leaning towards expansion overall. The national fiscal budget deficit for 2023 was initially set at 3%, and in October 2023, the budget was adjusted to include an additional 1 trillion yuan of ultra-long-term government bonds, resulting in a final fiscal deficit rate of 3.8%. In 2024, our budget deficit rate continues to be set at 3%, with the quota for local government special bonds arranged at 3.9 trillion, further increasing compared to last year, while also deciding to issue ultra-long-term special government bonds on a large scale for several consecutive years starting this year. With the fiscal policy tone clearly expanding, monetary policy must actively cooperate, including increasing liquidity supply and further lowering interest rates. At this time, it is very necessary for the monetary policy tone to make corresponding adjustments from "prudent" to substantial "moderate easing."

Finally, changes in the external environment provide a time window for adjusting our monetary policy tone. On August 23, Federal Reserve Chairman Jerome Powell delivered a speech at the global central bank governors' meeting, officially confirming that "the time for policy adjustments has come." The market generally believes that the Federal Reserve's announcement of interest rate cuts in September has become a foregone conclusion. We expect that this round of Federal Reserve interest rate cut cycle may last for 14-16 months, with 6-8 rate cuts, totaling a reduction of 150-200 basis points It is undeniable that in recent years, under the increasing pressure of economic downturn and deflation, the tone of our country's monetary policy has not been adjusted, and an important reason for this is the constraints imposed on our economic and financial situation by the high interest rate policy implemented by the Federal Reserve. Currently, a new round of interest rate cuts by the Federal Reserve is imminent. Against this backdrop, our country's monetary policy tone has gained a rare window of adjustment, providing space for promoting a new round of reserve requirement ratio cuts and interest rate reductions.

The "moderately loose" monetary policy tone lies between "prudent" and "loose," and implementing it under the current circumstances has three positive significances: First, compared to the "prudent" monetary policy tone, it is more proactive and can match a greater intensity of the use of aggregate, price, and structural monetary policy tools, injecting sufficient liquidity into the market and significantly lowering real interest rates. Second, compared to the "loose" monetary policy tone, it is relatively more cautious. Due to the moderate degree of looseness, it can avoid causing "flooding" and severe inflation as side effects. Third, compared to the current so-called "prudent" but actually loose monetary policy tone, its greatest positive significance lies in its ability to send clearer and more explicit policy signals to the market, allowing all parties to better understand the intention of policy loosening and form a consistent positive expectation for subsequent policies, thereby enhancing confidence in economic recovery. Since in recent years, reserve requirement ratio cuts and interest rate reductions, as well as structural tools, have frequently adjusted towards looseness, and the direction of counter-cyclical adjustments will not change in the next phase, why can't we pragmatically adjust the "prudent" tone to "moderately loose" in a timely manner? Considering various factors, the conditions for implementing a truly "moderately loose" monetary policy tone have matured.

III. Relevant Policy Recommendations

Recommendation 1: More scientifically and reasonably define the monetary policy tone. Policymakers should comprehensively sort out and standardize the monetary policy tone system and related definitions, especially the boundaries between "loose" and "moderately loose," "tight" and "moderately tight," and clarify what specific changes will occur in monetary policy objectives and operational tools under different policy tones, how to refine the trigger conditions for entering and exiting each policy tone, and how to coordinate the monetary policy tone with the fiscal policy tone.

Recommendation 2: Further strengthen expectation management and convey clear monetary policy signals to the market. While establishing a standardized monetary policy tone system, it is recommended that monetary authorities adopt a more rigorous and accurate policy tone that better reflects current demand, allowing all market participants to better understand the direction of monetary policy and form a positive feedback loop of resonance. As pointed out by the central bank leaders, "When the transparency of monetary policy increases, the understandability and authority of the policy will also enhance, and the market will spontaneously form stable expectations regarding the future direction of monetary policy, reasonably optimizing its own decisions, making monetary policy regulation more effective." Suggestion 3: Adjust the monetary policy tone to "moderately loose" to create a suitable policy environment for implementing greater reductions in reserve requirements and interest rates. From the perspective of the possibility of lowering reserve requirements, the weighted average deposit reserve ratio of small banks in China has currently dropped to around 5.0%, leaving relatively little room for further reduction in the short term, but this does not mean it cannot be lowered further; the weighted average deposit reserve ratio for medium-sized banks is 6.5%, and for large banks, it is 8.5%. If the monetary authorities implement a new round of reserve requirement cuts, it may be considered to focus on targeted reserve requirement reductions for state-owned large commercial banks and national joint-stock commercial banks. Given that these banks account for 60% of deposits in China's banking sector, a targeted reduction of 0.5 percentage points could release over 600 billion yuan in liquidity to the market. Considering that the current domestic real interest rates remain relatively high, it is also necessary to further lower interest rates. It is recommended to concentrate policy resources to implement a significant interest rate cut of around 50 basis points at the end of this year or the beginning of next year. At the same time, considering that structural monetary policy tools such as carbon emission reduction support tools, inclusive micro-loan support tools, and inclusive pension special relending will all expire by the end of this year, it may also be appropriate to add new quotas to these structural monetary policy tools at the beginning of next year and reduce the interest rates for agricultural support relending, small loan relending, and rediscounting by 0.5 percentage points each, to facilitate the promotion of green finance, inclusive finance, and pension finance.

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