Posted by: Dirk | November 11, 2008

The Chinese stimulus: where does the money come from?

Printing money vs selling dollar-denominated assets: This is the choice Chinese authorities are facing after announcing their $586 bn stimulus package. The FT reports:

The source of the new funding is also unclear. A leading Chinese academic in Beijing suggested that only a quarter of the investment might actually come from direct public spending, with the rest coming from state-owned enterprises and banks. As part of the fiscal stimulus announcement, the government confirmed that quotas on new bank credit had been lifted and that banks would be encouraged to lend to small companies, rural areas and industries that were consolidating or investing in technology.

Pump-priming is the old-school name for this. Printing money sounds too mean, doesn’t it? However, the Chinese authorities are not always trustworthy when it comes to economic policy announcements.  Chinese authorities in general had problems dealing with inflation, as reported by Businessweek in March 2008. So let’s think through both possibilities considered for financing the fiscal stimulus.

  1. Printing money: The Chinese authorities can expand credit by printing money. This can have inflationary tendencies, depending on how large the output gap is. However, the authorities can react quickly be withholding credit. Time lags in Chinese fiscal policy should be small, since their is no democratic process that consumes time between drafting policy and agreeing on policy. However, there can be pressure on the Chinese yuan to devalue. This means higher import costs for inputs and imported consumption and investment goods, but more competitive products on world markets since the yuan is cheaper to buy for the rest of the world. However, many Chinese export industries (like electronics) import a lot of inputs from their Asian neighbor countries. The more foreign imports are used, the less is the gain in competitiveness on world markets.

  2. Selling dollar-denominated assets: Last year, China has set aside $300 bn for investment purposes, out of dollar reserves which are close to $1.8 trn now. China would be able to sell those assets, or the dollar reserves, and use the money to pay for the fiscal stimulus. This would create tensions in the exchange rate, this time making the yuan dearer and the dollar cheaper. It would be bad for Chinese exports, given their local input share is relatively high. But probably the fiscal stimulus overcompensates for that. Stimulating domestic demand might also be a good idea since the US will be in a period of depressed growth for the next years.


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