Why increase the countercyclical adjustment of fiscal and monetary policies

The 2023 Central Economic Work Conference emphasized the need to strengthen counter-cyclical and cross-cycle adjustments of macroeconomic policies. The Central Political Bureau meeting held on September 26, while analyzing and researching the current economic situation and deploying the next steps for economic work, specifically stressed the need to increase the counter-cyclical adjustment intensity of fiscal and monetary policies.

Counter-cyclical adjustment of fiscal and monetary policies is a primary means of macroeconomic regulation. Both theory and practice have shown that correctly understanding and reasonably applying counter-cyclical adjustments play a crucial role in maintaining macroeconomic stability. A stable macroeconomic environment is a necessary condition for promoting sustained economic development, continuous optimization of the economic structure, and steady improvement of people's livelihoods.

Currently, China's economic operation is generally stable and making progress. However, some new situations and issues have emerged in the current economic operation. Therefore, to implement the central government's decision-making and deployment on strengthening counter-cyclical adjustments of macroeconomic policies, it is necessary to effectively implement existing policies, intensify the introduction of additional policies, promote the balance of economic supply and demand, and encourage economic growth rates to approach potential growth rates.

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Counter-cyclical adjustment is a routine policy operation in market economies. Economic cycle fluctuations are a common occurrence in market economies. Under market economy conditions, influenced by factors both within and outside the economic system, indicators such as economic output, income, employment, and prices will exhibit cycles of expansion and contraction, which is referred to as economic cycle fluctuations. For example, the United States has experienced 23 alternating cycles of economic expansion and contraction from the early 20th century to 2020. Since China is still in a stage of medium-high-speed economic growth, economic cycle fluctuations in China are mainly manifested as changes in the speed of various indicators, rather than absolute quantity changes in positive or negative terms. Other major market economies around the world have also generally experienced similar cyclical changes, indicating that the cyclical nature of economic changes under market economy conditions is universal and inevitable.

Although different economic schools of thought have different views on the necessity and actual effects of government counter-cyclical adjustments, from the perspective of policy practices in various countries, conducting counter-cyclical adjustments in response to economic cycle fluctuations is a common practice worldwide. The main policy tools for government counter-cyclical adjustments are monetary and fiscal policies. Maintaining price stability, promoting employment, and economic growth are the main objectives of monetary policies in various countries. For instance, a considerable number of countries, including Japan, the United Kingdom, and India, have central banks that implement inflation targeting, with monetary policies reacting and adjusting according to clear rules when there are deviations from the inflation target. The Federal Reserve and the European Central Bank have not officially announced the implementation of inflation targeting, but their monetary policy frameworks possess the main characteristics of inflation targeting, requiring monetary policy to make necessary policy responses to changes in prices, employment, and economic conditions.

Counter-cyclical fiscal policies vary significantly due to the influence of each country's political structure, but a recent study by the International Monetary Fund shows that the counter-cyclical nature of fiscal policies worldwide has been strengthening over the past 20 years. Moreover, the stronger the counter-cyclical nature of fiscal policies, the more severe the economic downturn encountered.

Correct understanding of counter-cyclical adjustments is essential for maintaining macroeconomic stability and promoting sustained economic development. It is important to recognize that counter-cyclical adjustments are a regular policy operation in market economies and that they play a crucial role in addressing economic cycle fluctuations. By effectively implementing existing policies and introducing additional policies, we can promote the balance of economic supply and demand and encourage economic growth rates to approach potential growth rates.The Role and Effect of Policy

The actual economic operation is influenced by a variety of complex factors, and different policy tools need to be adopted to address different issues. Counter-cyclical regulation falls within the category of macroeconomic policy, mainly addressing short-term and cyclical problems.

The necessity of counter-cyclical regulation is evident. From the perspective of market operation, a stable macroeconomic environment is a necessary condition for rational expectations and decision-making by various market entities, including investors, producers, and consumers, and is the foundation for the sustained and healthy development of the economy. On the contrary, it can lead to deviations in the expectations and behavior of market entities, and under the influence of self-fulfilling expectations, it can lead to a continuous worsening of macroeconomic imbalances, ultimately interrupting the normal growth trajectory of the economy. From the perspective of social welfare, the social cost of relying entirely on market-driven adjustments during periods of significant economic fluctuations is enormous. Large-scale, long-term unemployment can cause serious social problems, and the physical and mental health of the unemployed and their family members can be harmed. Therefore, it is necessary to use macroeconomic policies to accelerate economic recovery and reduce losses in social welfare.

Counter-cyclical regulation is generally effective. Due to the complexity of factors affecting economic operations, there have been instances in history where macroeconomic policies were inefficient or ineffective. However, overall, the implementation of macroeconomic policies has effectively reduced the degree of economic fluctuations, shortened the period of economic contraction, and extended the period of economic expansion.

For example, in the United States, during the period of 1854-1919 with virtually no macroeconomic policies, the average economic contraction period was 21.6 months, and the average economic expansion period was 26.6 months, with the contraction period almost equal to the expansion period. In contrast, during the period of 1945-2020 with more macroeconomic policies in place, the average economic contraction period was reduced to 10.3 months, while the average economic expansion period was extended to 64.2 months, with the average economic expansion period far longer than the contraction period. Moreover, the implementation of macroeconomic policies has significantly mitigated the severity of economic contractions. Despite experiencing the 2008 international financial crisis and the 2020 COVID-19 pandemic in the 21st century, the Great Depression of the 1930s did not reoccur, and the speed of economic recovery was much faster than during the Depression era.

At the same time, macroeconomic policies cannot solve all economic problems, and their negative impacts also require close attention. Macroeconomic policies, also known as stabilization policies, primarily act on the demand side, addressing demand不足 caused by short-term and cyclical factors, or simply put, the issue of actual economic growth deviating from potential growth. However, macroeconomic policies have a minimal impact on the potential growth level of the economy. If the economic slowdown is mainly caused by a reduction in the potential growth level, macroeconomic policies would be powerless. It is generally believed that the main factors affecting the potential growth level of the economy are long-term and structural issues on the supply side, which require resolution through systemic reform and structural reform policies. Of course, well-coordinated macroeconomic policies also facilitate the smooth progress of systemic and structural reforms.

The effective implementation of macroeconomic policies also requires a proper grasp of the intensity and rhythm of counter-cyclical regulation; otherwise, it may produce too many side effects and after-effects. For example, it is widely believed that the high inflation in recent years in countries such as the United States is related to the excessive scale of fiscal stimulus during the COVID-19 pandemic. An overly loose macroeconomic policy may also sow the seeds of financial risks. Market entities may over-leverage during periods of loose macroeconomic policies, and a policy shift could potentially trigger a financial crisis. For instance, overly loose real estate credit policies were the source of the 2008 international financial crisis.

At present, China needs to increase the intensity of counter-cyclical regulation of fiscal and monetary policies. In the first three quarters of this year, China's economy has basically maintained a stable operation, and the development momentum of new quality productive forces is good. However, looking at the economy on a quarterly basis, the economic growth rate has shown a downward trend, with a 5.3% growth in the first quarter, a 4.7% growth in the second quarter, and a 4.6% growth in the third quarter. The factors affecting the economic operation are complex at present, including supply-side structural issues, such as insufficient innovation capabilities, weak ability of supply to create demand, and the real estate industry and other industries entering a period of adjustment after reaching their peak development.The current issue of insufficient demand on the demand side is more prominent. In August of this year, the growth rate of fixed asset investment and the total retail sales of consumer goods both slowed down for 5 and 3 consecutive months, respectively, with a cumulative growth rate of 3.4% from January to August, which is significantly lower than the overall economic growth rate and has become a constraint on economic growth.

Another manifestation of insufficient demand is the low level of price levels. As of August this year, the Consumer Price Index (CPI) has been at a low level of less than 1% for 18 consecutive months. Excluding the abnormal values during the pandemic period, the core CPI is at its lowest since 2013. The Producer Price Index (PPI) for industrial products has been in a downward trend for 22 consecutive months, indicating that both the consumer goods and means of production markets are facing a situation where supply exceeds demand.

Insufficient demand is closely related to weak expectations. In August, the National Bureau of Statistics' consumer confidence expectation index was 86.6, at a historically low point. Consumers are cautious in their spending behavior. The proportion of urban residents surveyed by the People's Bank of China who are willing to spend more has not yet returned to pre-pandemic levels, and the proportion of entrepreneurs who feel that the macroeconomy is too cold has continued to rise this year. At this juncture, counter-cyclical policies should also be an opportunity to play an important role. It is necessary to increase the intensity of counter-cyclical adjustment policies in a timely manner to interrupt the positive feedback mechanism of economic decline.

Innovate the focus and methods of counter-cyclical adjustment according to the new situation

In the history of our country, counter-cyclical adjustment has mainly focused on large-scale infrastructure investment. Since investment is a fast variable, it has achieved good regulatory effects. However, as the level of our country's infrastructure continues to improve, although there is still considerable room for construction, its multiplier effect is no longer as strong as before. In addition, local governments, as the main body of infrastructure construction, are constrained by the transformation of land finance and high debt leverage, and their ability to expand infrastructure is also not as strong as before. This new situation requires counter-cyclical adjustment to innovate in direction and methods to improve the efficiency and effectiveness of counter-cyclical adjustment.

Firstly, pay more attention to guiding social expectations. Expectation management is an important part of macro-control. The impact on expectations should be an important factor in determining the intensity of policies, the methods of introduction, and the timing, etc. Further improve the monetary and fiscal policy framework, strengthen its counter-cyclical and anti-cyclical characteristics, and enhance policy credibility.

Secondly, pay more attention to expanding consumer demand. On the one hand, the overall recovery of consumption since the pandemic is still the slowest among various indicators and needs more effort to promote. On the other hand, from a long-term development perspective, consumption, especially service consumption, is the most potential for growth. Its proportion in the economy is continuously increasing, and it can play a greater role in stabilizing growth.

Thirdly, pay more attention to strengthening the construction of the social security system. Improve the coverage and benefits of various social security measures, which is not only conducive to improving residents' expectations and enhancing consumer confidence but also helps to form a fiscal automatic stabilizer for counter-cyclical adjustment. International experience has shown that social security expenditure is an important and even the main way for fiscal counter-cyclical adjustment.

Finally, pay more attention to properly handling balance sheet issues. Current counter-cyclical adjustment should target the high leverage issues of local governments, residents, and enterprises, and take measures such as reducing debt burden, increasing transfer payments, and providing necessary liquidity to restore the spending willingness and ability of various entities.