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Capacity Reduction Policy Under the Interest Rate Peg in China

Author

Listed:
  • Bing Tong

    (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan)

Abstract
Capacity reduction has been a recurrent theme in China’s economic policy. This paper proves in a New Keynesian model that the effects of the decapacity policy depend on its persistence and monetary policy regime (interest rate flexibility). Under an interest rate peg, a temporary policy is ineffective and even expansionary, whereas a permanent policy is effective due to a negative wealth effect. When the nominal interest rate is pegged, the real rate moves oppositely with inflation, which adds positive feedback to the economy. Thus the de-capacity policy has greater uncertainty under the interest rate peg. As a policy tool, it may easily deviate from its target and bring about excessive volatility. Last, long-run price stability and a gradually advanced de-capacity policy are helpful to the achievement of policy targets.

Suggested Citation

  • Bing Tong, 2020. "Capacity Reduction Policy Under the Interest Rate Peg in China," CFDS Discussion Paper Series 2020/2, Center for Financial Development and Stability at Henan University, Kaifeng, Henan, China.
    • Handle: RePEc:fds:dpaper:202002
    as

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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Chinese economy; Capacity reduction; De-capacity; New Keynesian Model; Supply shock; Interest rate peg;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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