China's central bank has announced that it will raise interest rates for the first time in three years, signaling a major shift for one of the world's largest and most centrally controlled economies. The move has global financial repercussions, many of which are already being felt in U.S. and European markets. Here's the likely motivation behind China's new policy, what it means for the global economy, and the lessons we can take away.
- Global Financial Ramifications The New York Times' David Barboza reports, "The move had an immediate effect on markets worldwide, sending stocks lower on exchanges in Europe and the United States as investors weighed the effect on China’s continued economic growth and its ability to serve as an engine for a global recovery. The major Wall Street stock indexes were down sharply. Oil prices, also sensitive to the world economic outlook, fell by more than 2 percent."
- China 'Flirting with Danger' The Globe and Mail's David Berman worries, "Oh dear, investors are freaking out over China’s surprise decision to raise its key interest rate by a quarter of a percentage point. Near the start of trading, the Dow Jones industrial average was down more than 150 points, and all 30 stocks within the index were down. Clearly, there are concerns that China is flirting with danger here. In an attempt to confront its relatively high inflation rate, it threatens to derail its economic growth – currently the world’s biggest engine, and a key driver for commodities in particular."
- China Struggling to Manage Economy The New York Times' David Barboza explains, "The move is the latest indication that China is struggling to fight stubborn inflation, soaring housing prices and an overly buoyant economy that is pumping out exports and resulting in the accumulation of huge amounts of foreign exchange reserves. Analysts said they were surprised by the decision, because a bank oficial had suggested just days ago that no rate increase was needed. Still, late Tuesday the bank announced the first rate increase here since 2007. Analysts said it was one of the strongest signals yet that Beijing is having difficulty managing the country’s growth."
- This Is The Responsible, Right Move Michael Pettis, an expert on Chinese economic matters, is optimistic. "This is definitely good news. It increases household income by raising the return on savings, which is a necessary part of the rebalancing process. It (very slightly) reduces the incredible incentive to borrow money and splurge on manufacturing capacity, investment and real estate development. And it signals that the PBoC is concerned about overinvestment. ... Real rates in China have declined rapidly this year and, as I have argued many times before, this is a real problem for the economy. Declining real rates exacerbates China’s already serious over-reliance on excess investment. But I don’t think there is much they can do about it without causing a serious slowdown in growth, and before the leadership transition in 2012 I don’t think there is much appetite for a slowdown, no matter how badly needed."
- China's Irresponsible Policymaking The New York Times' Paul Krugman lays it out, "So, the United States is pursuing an expansionary domestic monetary policy, which increases overall world demand; however, a side consequence of this policy is a weaker dollar. China is pursuing a weak-yuan policy; to counter the inflationary domestic effects of that policy, it’s pursuing a contractionary domestic monetary policy, reducing overall world demand. We’re doing the right thing; they’re making the world as a whole worse off."