Commentary: Why Low Interest Rates Won’t Work the Same in China

China’s economic recovery is currently stable but faces challenges such as insufficient effective demand, low inflation, and high real economy financing costs, leading to strong calls for interest rate cuts. However, the effectiveness of low-rate policies in China is questionable due to its distinctive financial system. While the U.S. and other developed economies have implemented unconventional monetary policies like zero interest rates and quantitative easing with notable results in the U.S., these policies do not necessarily translate to success in China due to vastly different financial structures. In America, the predominance of direct financing through capital markets creates a significant wealth effect, boosting investment and consumption, thereby aiding recovery. In contrast, China relies heavily on indirect financing through banks, with over 70% of its financial system structured this way, which dampens the impact of such policies[para. 1][para. 2].

Empirical evidence from the U.S. and Japan shows that, in a low-rate environment, central bank liquidity injections do not lead to significant bank credit expansion. For example, from 2008 to 2023, U.S. base money grew at 12.9% annually, but bank loan balances grew only 4.1%; similar patterns emerged in Japan, revealing the limited stimulus effect through bank-centric systems[para. 3]. The impediments arise from both weak demand for loans amid economic uncertainty and conservative bank lending behaviors, reminiscent of the 1990s Asian financial crisis when central bank stimulus failed to spur growth[para. 4].

The direct pathway through capital markets is notably more effective in the U.S. Between 2009 and 2022, securities accounted for 55.8% of the increase in U.S. financial assets, in contrast to 25.3% in Japan and 29.3% in Germany. The growth in U.S. household wealth and corporate financing from securities has been much stronger, reinforcing the potency of direct-financing-led monetary policy transmission in the U.S. compared to Europe or Japan[para. 5][para. 6].

Critically, a zero-interest-rate policy does not translate to zero lending rates in practice. Even under such policies in the U.S. and Europe, commercial bank lending rates have remained clearly positive, with consumer loan rates typically above 3-4%, indicating that market participants misinterpret the policy implications when demanding ultra-low rates in China[para. 7].

In China, rate cuts tend to be seen as signals of weak economic prospects. Empirical data from 2019-2024 underscore that, unlike the U.S., lower government bond yields in China are correlated with reduced direct corporate financing, reflecting a block in policy transmission via capital markets; as rates fell in 2024, direct corporate financing dropped significantly, in contrast to expansion in the U.S.[para. 8][para. 9][para. 10].

China’s central bank has acted with restraint, constrained not by the exchange rate, but by concerns over banks’ net interest margins (NIMs) and the risk of further narrowing, which could negatively affect bank lending. Persistently low long-term rates compress bank profitability, create herd behavior in bond markets, and send pessimistic signals about China’s long-term economic prospects, prompting caution from policymakers[para. 11][para. 12][para. 13][para. 14][para. 15].

Recommended actions include: optimizing structural monetary policy tools to target critical sectors; reinforcing the supervision and discipline of interest rate policy to alleviate excessive competition and protect bank margins; enhancing fiscal and monetary policy coordination to directly stimulate effective demand; and modernizing the central bank system and monetary policy framework to improve policy transmission and align with international standards. In conclusion, China cannot simply replicate the experiences of other countries; it must address its own unique structural challenges to enhance the effectiveness of low-rate policies and support high-quality economic development[para. 16][para. 17][para. 18][para. 19][para. 20][para. 21][para. 22].