Wu Xiaoling on monetization of fiscal deficit: tight arrangement of fiscal expenditure and maintenance of fiscal discipline

category:Finance
 Wu Xiaoling on monetization of fiscal deficit: tight arrangement of fiscal expenditure and maintenance of fiscal discipline


What is the monetization of fiscal deficit

There are two types of currency used by human beings (not to discuss the current digital currency). One is physical currency, such as gold; the other is paper currency, such as legal currency. There are also two kinds of paper currency, one is the currency created through the bank credit system - bank notes and deposit currency (expressed as cheques). The bank notes issued by the central bank are legal currency cash; the other is the currency invested into the society by the government credit. In the history of the war, the issue of currency to raise funds by power happened from time to time, such as the green back notes of the southern government during the civil war of the United States, the local currency of the Chinese warlords secession, etc. Because the issue of government paper money is difficult to coordinate with economic activities, it often ends up with the fact that paper money is not worth money.

Theoretically, the effect of money creation is the same when the central bank buys government bonds from the primary market and from the secondary market, but the economic mechanism is different, which is two different ways of resource allocation.

The central bank buys from the primary market, lacks initiative, and has limited constraints on fiscal discipline,

Therefore, central banks generally do not buy from the primary market, or even the national legislation forbids central banks to buy from the primary market, which is stipulated in the law of the peoples Bank of China. Although the central bank will also coordinate with the finance when purchasing government bonds from the secondary market, the quantity and price of the purchases will be subject to the monetary policy objectives. Moreover, the yield curve of the secondary market of national debt will form the benchmark of risk-free yield of financial market and guide the formation of financial market price.

02

Quantitative easing monetary policy and central banks buying and selling government bonds

uff081uff09 The essence of QE is that the central bank provides liquidity directly to the society

The essence of quantitative easing monetary policy is that when the central banks policy interest rate is close to 0% and commercial banks lack the ability or willingness to lend, the central bank has to directly face the market to provide liquidity.

Buying and selling Treasury bonds through the open market is one of the policy tools of the central bank. When implementing quantitative easing monetary policy, the central bank not only buys and sells treasury bonds, but also directly purchases the creditors rights of non bank institutions. At this time, the central bank replaces commercial banks to provide credit to the society and create money. The monetary policy goal of the central bank has not changed. The Federal Reserve still targets unemployment and 2% inflation, and its operating space is unlimited before reaching the target.

From the figure below, we can see the alternative relationship between the asset expansion of the Federal Reserve and the credit growth of commercial banks.

Figure 1 fed balance sheet size and bank credit, data source: wind, as of March 2020

From the end of 2010 to January 2020, the asset growth of the Federal Reserve has a negative correlation with the bank credit growth.

2) The US dollar money supply has not expanded indefinitely because of the quantitative easing monetary policy. The year-on-year growth rate of M2 reached a peak of 10.4% in January 2009, and then declined all the way to 1.6% in March 2010, and gradually rose to about 10% in 2012. In the following years, M2 growth fluctuated, but from 2012 to 2019, it averaged 6.1%.

In addition, from the asset expansion of the central bank, the expansion of social credit and the growth ratio of M2, we can see that the credit transmission is not smooth in the implementation of quantitative easing monetary policy in the United States and Japan. From 2007 to 2017, the balance sheets of the central banks of the United States and Japan expanded by 346% and 369% respectively, but the credit expansion was 21.40% and - 0.08% respectively, and M2 increased by 86% and 36% respectively.

This shows that the traditional theory of monetary banking is not out of date.

uff082uff09 Since the crisis, the unconventional operation of central banks such as the Federal Reserve and the Bank of Japan is to buy non-governmental debt

The Federal Reserve has been holding government bonds through the open market. When the crisis is serious, it has increased its claims on commercial banks and the private sector, expanded its claims on non banking institutions. From January 2008 to September 2010, the proportion of government bonds has decreased.

Figure 2 assets structure of the Federal Reserve in 2000-2019

Since 2000, the Bank of Japan began to implement quantitative easing monetary policy to increase the creditors rights of commercial banks, and then increased the creditors rights of non bank financial institutions and the private sector. The proportion of the creditors rights of the government fluctuated.

Figure 3 asset structure of Bank of Japan in 2000-2019

03

The theory of quantity of money is not out of date, but the price of assets should be considered

Since the crisis, the main western countries have implemented quantitative easing monetary policy, but CPI has been difficult to achieve its goal and faced with the risk of deflation. Is monetary quantity theory invalid? If we compare M2 growth with CPI, house price and stock market P / E ratio, we will find that CPI has some alternative relationship with house price and stock market P / E ratio.

Too much money is also reflected in asset prices.

Figure 4 has an intuitive representation.

Figure 4 US currency expansion, price and asset price trends, data source: wind, as of March 2020

The reasons why CPI is facing deflation risk in developed countries are as follows: 1) the supply of consumer goods is sufficient in the context of globalization, and the cost is relatively low; 2) the expansion of income distribution gap makes the consumption ability of low-income people limited, while the consumption ability of high-income people is limited, but the demand for consumer goods is limited, and more income will be used for investment.

For many years, the central bank has been discussing whether monetary policy should pay attention to asset prices.

Figure 5 Chinas currency expansion, price and asset price trends, data source: wind, as of March 2020

Figure 5 also shows the relationship between Chinas CPI and asset prices. In 1998, China started the process of housing commercialization. When the money supply grew rapidly, CPI and asset prices, especially house prices, also showed substitution. Although Chinas house price still has some degree of control, although the main reason for the rise of Chinas house price is the real estate system, land price and tax account for a large proportion, but there is no money supply, and its price cannot be realized.

04

At present, the nominal negative interest rate is the policy interest rate of the central bank, and there is no nominal negative interest rate for bank customers.

In the crisis period, the central bank only considers the negative interest rate policy when the commercial banks are not willing to lend. At present, the willingness of loan in the banking system of China is normal, and negative interest rate should not be used as an option.

05

The impact of crisis relief measures on fiscal deficit

In normal times, the government will have debts, some of which are used for economic benefits and have the ability to repay the principal and interest, such as municipal debts and special debts, so they are not included in the fiscal deficit. Generally speaking, the government bond refers to the bond issued to make up the fiscal deficit, and its repayment depends on the growth of future fiscal revenue. At present, governments of all countries are faced with the dilemma of rigid expenditure increase and difficult income increase, and deficit increase is the norm. Hitherto unknown measures to novel coronavirus pneumonia and measures to deal with the economic crisis have made the financial challenges facing the world unprecedented.

Generally speaking, there are four types of relief measures. The first is tax relief, which is to reduce fiscal revenue; the second is to directly provide cash subsidies to the poor and unemployed; the third is to increase the expenditure of emergency management and epidemic prevention medical treatment; the fourth is to directly provide financial loan principal or financial guarantee and discount for enterprise loans. The latter three items increased financial expenditure.

In this situation, the fiscal deficit will inevitably expand, and increasing the issuance of government bonds is the only way out.

In response to the impact of the epidemic and its impact on the economy, the Chinese government has put forward six guarantee policies to ensure the employment of residents, the basic livelihood of the people, the main body of the market, the safety of food and energy, the stability of the supply chain of the industry chain, and the operation of the grass-roots units. It has also issued a series of fiscal policies to reduce taxes, reduce burdens, subsidize, increase investment, increase targeted loan investment, and the central bank provides low interest re loan The financial policy of loan interest reduction and postponement of repayment period. Some of these policies have economic benefits and can issue special bonds or special treasury bonds. However, a large number of expenditures without economic benefits can only expand the deficit and increase the issuance of government bonds.

In order to reduce the deficit as much as possible, we should give full play to the leverage of financial funds, guide the investment of financial funds by means of financial guarantee and financial discount, and use a small amount of financial funds to leverage social funds.

06

The choice of the way of issuing government bonds

In the face of a large number of government bond issuance, the society has carried out the discussion on the issuance mode, that is, the discussion on the monetization of fiscal deficit. As we mentioned earlier, monetization of fiscal deficits is to let central banks hold government bonds. Some people worry that social funds cant digest a lot of increased government bonds, and put forward suggestions to let the central bank buy directly from the primary market.

Our proposal is to let social funds buy government bonds in the primary market. If there is a problem with market liquidity, the central bank will buy and sell government bonds in the secondary market to provide liquidity.

At present, the Chinese market has enough room to accommodate government bonds.

From a macro perspective, China is a country with a high savings rate, ranking at the top of the world. At the end of 2019, government bonds (government bonds + local government general bonds + local government special bonds) amounted to 37.2 trillion yuan, with banks holding 81%, accounting for 13.9% of the banks asset balance. The increment of government bonds is 4.8 trillion yuan, with 83% of banks and 18.8% of bank assets. By the end of April 2020, the fund utilization balance of deposit financial institutions had increased by 12.2% year on year. If the year-end growth rate is also assumed to be 12.2%, the annual capital utilization increment will be 26.6 trillion yuan. Assuming that the proportion of government bonds in the increase of bank assets is the same as that in 2019, which is still 18.8%, the bank has the ability to buy at least 5 trillion yuan. In 2019, the increment of government bonds held by institutions other than banks is 0.8 trillion yuan, which can be assumed to remain unchanged in 2020. The two amount to 5.8 trillion yuan.

In 2019, the peoples Bank of China released 2.7 trillion yuan of liquidity by reducing the legal reserve ratio. Fiscal issuance is a contraction of liquidity, but the liquidity of fiscal expenditure will return to the market. If the market needs, the central bank can provide liquidity in many ways, including buying government bonds. As long as the central bank and the finance work closely together, it is feasible to issue government bonds in the market. Although there is still room for the above analysis of government bond issuance, we should tighten the arrangement of financial expenditure, improve the use efficiency of financial funds, maintain financial discipline and maintain the healthy development of Chinas economy. (the author is the president of Wudaokou School of finance, Tsinghua University) source: Financial Times editor in charge: Wang Xiaowu Gu NF

In 2019, the peoples Bank of China released 2.7 trillion yuan of liquidity by reducing the legal reserve ratio. Fiscal issuance is a contraction of liquidity, but the liquidity of fiscal expenditure will return to the market. If the market needs, the central bank can provide liquidity in many ways, including buying government bonds. As long as the central bank and the finance work closely together, it is feasible to issue government bonds in the market.

We should also tighten the arrangement of financial expenditure, improve the efficiency of the use of financial funds, maintain fiscal discipline and safeguard the healthy development of Chinas economy.

(the author is chairman of Wudaokou School of finance, Tsinghua University)