What is moderately loose monetary policy??

This afternoon, the press release for the December monetary policy meeting was finalized.

One statement in the press release has attracted everyone's attention—“moderately loose monetary policy.” The last time this expression appeared was in 2009 and 2010, after which there was a long period of “prudent monetary policy,” often with some adjectives added in front.

So, how should we understand this term? First, we need to focus on a basic concept— neutral interest rate.

If a policy interest rate R* neither imposes restrictive effects on the economy nor provides supportive effects, then this interest rate is the neutral interest rate.

In the article “The Unified Path of Central Bank Policy Rates and Discussion on Monetary Policy Outlook,” we put a lot of effort into explaining “why the one-year deposit rate is currently the policy rate.”

To be honest, we cannot clearly explain “prudent monetary policy” solely based on “natural language”; we need to rely on the two basic concepts of “neutral interest rate” and “policy interest rate.”

As shown in the figure above, prudent monetary policy refers to the actual policy interest rate fluctuating narrowly around the neutral interest rate.

In this case, the policy interest rate neither imposes excessive restrictions on the economy nor provides excessive support.

Since the neutral interest rate is dynamic, during periods of economic downturn, the neutral interest rate generally declines step by step, so under prudent monetary policy, we will see the actual policy interest rate oscillating downward.

This will create an interesting phenomenon where many investors may misinterpret “the policy interest rate oscillating downward” as “loose monetary policy.”

To be honest, this misunderstanding is difficult to clarify, mainly for the following three reasons:

1. The neutral interest rate is a theoretical concept that cannot be observed in reality;

2. The neutral interest rate is dynamic, and many factors influence it;

3. The domestic policy interest rate system is somewhat complex;

With the above foundation, we can revisit our monetary policy without feeling that “prudent monetary policy” is meaningless.

As shown in the figure above, if we imagine the blue line as the actual trend of the neutral interest rate, we can summarize the following:

1. Monetary policy is generally robust most of the time;

2. Monetary policy is restrictive only a small part of the time;

Once we understand "robust monetary policy," we can then understand "moderately accommodative monetary policy" based on that.

As shown in the figure above, moderately accommodative policy refers to a situation where the actual policy interest rate deviates significantly from the neutral interest rate. In this case, monetary policy provides sufficient support to the real economy.

In the article "The Unified Path of Central Bank Policy Rates and Discussion on Monetary Policy Outlook," we provided two judgments:

1. The neutral interest rate is around 1.80%;

2. The one-year time deposit rate will reach around 1.30% in the future, providing 50 basis points of support to the real economy;

This 1.80% is not arbitrarily set. As shown in the figure above, the monetary authorities have clarified the approximate position of the neutral interest rate to the market through a period of "volatile market conditions," around 1.85%.

In fact, the neutral interest rate has another function, which is to determine the bottom of the ten-year government bond yield.

According to the definition of the neutral interest rate, when the policy interest rate is significantly below the neutral interest rate, monetary policy provides sufficient support to the economy. In this case, the long-term bond yield's response to the policy interest rate will significantly weaken, and a "seesaw effect" may even occur.

Therefore, if R*=1.80% is true, it will be difficult for the ten-year government bond yield to smoothly break through 1.80%.

This is another use of the neutral interest rate.

Finally, if we clarify the definitions of "neutral interest rate" and "policy interest rate," then the conclusions above are evident.

Interestingly, neither "robust monetary policy" nor "moderately accommodative monetary policy" is obvious, yet many people mistakenly believe that these two composite concepts are self-evident and easily understood.

This is akin to the "self-evident" in mathematical proof problems.In addition, there is bound to be widespread controversy regarding the question "What is the current neutral interest rate in China?" However, market experts will certainly provide an answer based on the trend of the ten-year government bond yield.

Source: 沧海一土狗, original title: "What is moderately loose monetary policy??"