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Economic Review

10/25/2010

Can the Federal Reserve learn lessons from China monetary authorities on how to preserve stable economic growth?

Last week, Chinese monetary authorities raised interest rates some 25 basis points in reaction to the potential formation of asset bubbles, mostly in the form of real estate price appreciations.  In fact, sources have mentioned that the move was implemented to stem recent increased speculative activity by individuals and companies in the local real estate markets.  As most good economists are aware, monetary policy is used to maintain price stability and a sustainable pace of economic growth.   Well, the authorities in the globe’s second largest economy seem to have learned their economics well…despite their short term managing of the quickly developing nation.

The question to ask at this juncture is….can US authorities learn something from their Chinese counterparts?  Now this question almost seems preposterous given the advanced knowledge, experience and wisdom of the world’s economic leaders monetary authorities, however when considering the past decade of US monetary stewardship, this question is well founded.  US monetary policy stood idle in the face of a massive bubble building in US Equities back in the mid 1990s, only to raise rates at the extreme of the bubble in the late 1990’s.  This was followed by US monetary authorities again staring idly at the creation of a massive real estate bubble from 2002 to 2007, only increasing rates again at the very extreme of the market in 2006.  Both policies led to a creation of a bubble and extreme economic instability when the bubbles were pricked.

By being pre-emptive and sending their local market a sign that heavy speculation leading to the creation of bubbles will be managed, Chinese authorities are seeking to preserve a sustainable growth policy for the medium to long term.

Before we get too positive on China economic activities however, we will note that the dirty float of the Yuan and actions to maintain a relatively weak currency by these authorities resembles that of dirty pool on the global playing field.  We also must note that a vast majority of why the Chinese economy is expanding in robust fashion is because of major industrialized nations like the US pumping investments, creating jobs and providing a source of demand for Chinese products and services.  Regardless of these realities however, it is nice to see someone looking to implement policies to avoid bubbles rather than create them as a source for economic growth.

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