Abstract:

Conventional theory holds that interest rate cuts can boost demand, mainly by lowering investment cost and thus stimulating business investment. But many scholars are concerned that, amid current supply shocks and weakening expectations, policy rate cut is no longer sufficient for driving business investment growth, and the role of interest rate policy may have weakened.

Modern views believe that policy rate reduction reshapes the economy via multiple channels. It can stimulate consumption and investment by reducing household debts, especially mortgage loans, increasing the value of collaterals, boosting asset valuation and lowering the risk premium, etc.

Despite pandemic shocks and weakening expectations, policy rate cuts can still significantly improve the cash flows of households, businesses and the government, thereby increasing total expenditure. It is estimated that every 100-basis-point reduction of the policy rate can increase the net cash flows of households, businesses and the government by RMB 1.19 trillion, and boost nominal economic growth by at least 1.2 percentage points. History and international experience show that the widening spread between China and the United States is nothing to fear. Policy rate cuts as appropriate have vitalized the Chinese economy, fundamentally supported the Renminbi and curbed capital flow volatility.

Key words: Monetary policy, quantitative easing, wealth effect, debt service expenditure, income distribution