Economists puzzled by state of economy

Quantitative easing is an unconventional monetary policy used by a country's central bank to stimulate its economy when standard monetary policy has become ineffective. The world's first and third most powerful economies — the US and Japan — are implementing QE policy but a senior Chinese economist warns that excessive money supply is like "a tiger in a cage". "Once it is released, the consequences will be severe," he said. [Provided to China Daily ]

The People's Bank of China, the central bank, plays a leading role in national economic development. The traditional economic growth pattern that excessively depends on investment increases the fast expansion of bank credit, when other financing channels are underdeveloped. Therefore, base money supply is driven incredibly high by surging credit, said Ji Zhihong, director of the research bureau of the People's Bank of China. [Provided to China Daily]

Policy makers hesitant about next step as money supply increases a lot

A faster-than-expected increase in money supply and soaring bank credit but modest economic growth is an equation that has left Chinese monetary policy makers puzzled and hesitant about their next step.

Any impulse to ease or tighten monetary policy at the moment may lead to irretrievably awful results as economists reveal their helplessness.

Robert E. Hall and David H. Papell wrote in their book Macroeconomics — Economic Growth, Fluctuations and Policy — that "unsound monetary policy is the chief culprit" leading to serious recession and inflation.

By the end of April, the broad money supply, or so-called M2, had exceeded 103.3 trillion yuan ($17 trillion), up by 16.1 percent from a year earlier, compared with a year-on-year growth of 15.7 percent in March, according to the central bank.

But the year's target for money supply increase was anchored at 13 percent, which requires an average lower-than-12 percent M2 growth rate in the final eight months of this year, meaning there will have to be relatively tightened monetary policy.

Up to the end of 2012, M2 in China was close to double the total value of the gross domestic product, higher than a world-recognized warning line of 1.5 for the M2/GDP ratio. In comparison, that ratio was only 0.32 in 1978.

Cheng Siwei, a renowned scholar in economic, financial and managerial fields and the former vice-chairman of the Standing Committee of the National People's Congress, warned that the excessive money supply is like "a tiger in a cage". "Once it is released, the consequences will be severe."

Cheng attributed high property prices and the recent rush to buy gold to the faster-than-expected increase in money supply. He is concerned about high inflation in the long term.

Since the year 2009, policy makers have written the annual M2 growth target into the annual government work report, which is announced by the premier at the opening of the National People's Congress every March.

Ji Zhihong, director of the research bureau of the People's Bank of China, said that for making monetary policy, the nation uses money supply as the key control tool, while also paying attention to other reference indexes including interest and exchange rates.

"The final target is to maintain price stability and steady economic growth," said the bank official.

There has been no sign of inflation spiraling out of control so far this year. In April, consumer prices increased by 2.4 percent from a year earlier. That was slightly higher than March's 2.1 percent but still much lower than the year's target of 3.5 percent.

The flat inflation figures are taken to mean by economists that policy makers may not aggressively tighten money supply in the near future.

Because of the increase in interest rate liberalization, money supply may not be used as the main tool in deciding the whole monetary policy mixture, but there will be more of a focus on interest rates, as the US Federal Reserve and the Japanese Bank undertake currently, Ji said. "The monetary policy making process is in transition."

Money supply is dependent on monetary multipliers and base money. Base money is the total of domestic credit plus foreign exchange reserves.

When the total of social financing jumped to a historical high by 160 percent from a year earlier in January and 58.2 percent in the first quarter, fixed-asset investment growth slightly increased to 21.2 percent in January and February, and then slowed to 20.9 percent in March.

Beyond all expectations, GDP growth during January to March slowed to 7.7 percent year-on-year from 7.9 percent in the last quarter of 2012.