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| Estimation of China’s Potential Output and Its Policy Implications |
| XU Zhong, JIA Yandong
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| Research Bureau, the People's Bank of China |
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Abstract Summary:Over the past decade, China's macroeconomic operation has shown a more obvious trend. The growth of major macroeconomic indicators has slowed down. The average growth rate of real GDP declined from 13% to 6.6% before the crisis; the growth rate of total retail sales of consumer goods and investment in fixed assets dropped rapidly from over 20% in 2008 to about 6% and 9%, respectively; and the growth rate of M2 declined from 16% before the crisis to a historic low of 8%. Although theoretical and policy discussions proposed many different explanations for this phenomenon, there is still a lack of adequate quantitative analysis. In general, when inflation is basically stable, the long-term downward trend in economic growth usually results from the change of potential output growth rate. What is the current trend of potential output in China？ What factors influence the trend change？ Will this trend sustain for a long time？ The answers to these questions are not only the focus of theoretical research, but also key to the decision-making of future macro-policies.
Measuring potential output and output gap is particularly important for central banks, as they not only are the core objectives of monetary policy, but also enter the monetary policy decision-making rules directly, which affect the operation of the whole policy. Unfortunately, both potential output and total factor productivity (TFP) are unobservable state variables and can only be estimated from various methods or models. Therefore, it is of great theoretical and practical significance to effectively estimate China's potential output, to analyze the impact of different factors on potential output, and to carry out medium-and long-term trend prediction.
In this paper, we first give a brief overview of the current mainstream methods for estimating potential output and compare their characteristics and applicability. Second, we estimate the potential output of China from 1993 to 2018 though four methods, including production function method, state space model, macro-econometric model and DSGE model from the perspective of monetary policy decision-making. Next, we analyze and forecast the causes and trends of potential output changes. Finally, the main conclusions and corresponding policy implications are obtained.
The main conclusions are as follows. (1) The average growth rate of China's potential output from 1993 to 2018 is 9.4%, slightly lower than that of real GDP at 9.5%. The average growth rates of TFP trend, capital input and labor input are 3.6%, 11.7% and 0.6%, respectively, while their average contribution rates to potential output growth are 38.3%, 58.3% and 3.4%, respectively. Overall, the trend of potential output growth rate in China shows a clear periodic characteristic. (2) The slowing down trend of potential output growth in recent years is mainly due to the decline of the growth rate of effective capital input which leads to the continuous decline of the pull of capital input on potential output. The slow progress of investment-specific technology, the rising cost of investment adjustment and the rapid decline of capital formation efficiency are the deep-seated reasons for the change of the growth rate of effective capital investment. (3) The low contribution rate of labor growth leads to the underutilization and effective exertion of China's population advantage, and further aggravates the slowdown of potential output growth in recent years. (4) In the next 5-10 years, the average growth rate of China's potential output will continue to decline slowly and stabilize in the range of 4.8% to 5.1%. However, compared with developed economies, China still has considerable room for improvement in potential output growth, especially from the area of labor input.
This paper proposes the following suggestions. (1) In balancing short-term demand and medium-term and long-term reform objectives, we should stabilize investment growth and pay more attention to optimizing the investment structure and improving investment quality, capital formation efficiency and the level of investment-specific technology progress. (2) We should further improve the labor market, reduce the searching and matching cost of employment, improve labor quality and the matching degree of demand, and reduce ineffective supply to increase the contribution rate of labor input. (3) Institutional mechanism construction should be strengthened to further promote structural reform. While deepening the implementation of innovation-driven strategy and increasing R&D investment, we should take various measures to promote the overall improvement of TFP. (4) Faced with the trend change of potential output, we should pay attention to the identification of macroeconomic trend change and cyclical fluctuation in making monetary policies, strengthen policy coordination, grasp the implementation of policies, and improve the accuracy of policy response.
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Received: 15 December 2018
Published: 12 April 2019
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