Featured faculty: Jiang Wenxi and Gao Zhenyu
Written by Putro Harnowo

During an economic downturn, central banks normally launch a stimulus package to boost economic activity by lowering interest rates. Commercial banks as lenders adjust their interest rates based on the benchmark set by the central bank. Reducing interest rates eventually translates into smaller monthly mortgage payments, allowing households to spend more and boost consumption.

When the US central bank cut its interest rate in September 2024 for the first time since 2020, consumer sentiment soared as they found relief from high loan payments. The same measures were also taken in Chinese Mainland. The People’s Bank of China has adjusted its benchmark interest rate, the loan prime rate (LPR), multiple times from 4.25 per cent in September 2019 to 3.1 per cent in March 2025, to stimulate economic growth.

Oddly, lowering LPR doesn’t seem to help domestic spending much. A new study finds that an interest rate cut doesn’t directly and smoothly translate into more money at the household level. It turns out that many Chinese Mainland households responded to the reduced LPR with mortgage prepayment, or paying off their mortgage early, and cutting their consumption.

“We observe a negative correlation between interest rates and mortgage prepayments in Chinese Mainland,” says Jiang Wenxi, Professor of Finance at the Chinese University of Hong Kong (CUHK) Business School. “In cities where more households prepay their mortgages, essential and non-essential consumption declines in the following months.”

In his latest study, Mortgage prepayments in China and monetary policy transmission, Professor Jiang and his colleague from the same department, Associate Professor Gao Zhenyu, examine what motivates households to prepay their mortgages. Caixin has reported that total mortgage prepayments in 2022 reached 4.7 trillion Chinese yuan (US$700 billion), accounting for 12 per cent of all outstanding mortgage loans, and continued into the first half of 2024.

Professors Jiang and Gao’s study discovers households that prepay their mortgages on average use up more than 70 per cent of their savings and reduce their spending by 2.3 per cent. “This explains why, despite monetary easing efforts since 2019, consumption growth and economic stimulus in Chinese Mainland have been weaker than expected,” says Professor Jiang.

“Households with greater wealth, higher levels of education, and better credit scores are more responsive to the gap between their mortgage rates and LPR, making them more likely to prepay their mortgages.”

Professor Jiang Wenxi

Unique characteristics of Chinese Mainland’s mortgage market

Home loan arrangements vary across markets, but the most common types are adjustable-rate, where the mortgage interest rates fluctuate over time in line with the central bank’s benchmark interest rate, or a fixed-rate mortgage, where the mortgage interest rate stays the same since the loan was taken.

When the central bank lowers interest rates, borrowers with adjustable-rate see lower monthly mortgage payments and more money for spending, making the economic stimulus swiftly affect households. For borrowers with fixed-rate mortgages, they can opt to refinance, which involves replacing the existing mortgage with a new one with better terms.

However, refinancing is prohibited in Chinese Mainland and mortgage rates are mostly adjustable at a very slow pace. Mortgage rate is based on LPR and “local margin” set by the city, which remains fixed throughout the loan term. Local margin varies depending on local rules, but tends to follow the direction of the central bank after a while. Therefore, lower LPR only results in small changes in mortgage rates much later. Researchers called this “mortgage rate rigidity.”

Before 2019, the benchmark interest rate stayed the same for a long time, making the gap between mortgage interest rates and returns on savings relatively small. When LPR was lowered, the rigidity of mortgage rates made the gap with earnings from savings grow more significant, and borrowers started to realise that carrying a mortgage is getting more and more costly.

How interest rate cuts weaken domestic consumption

In the study, Professor Jiang and Professor Gao, as well as Wang Kemin and Ren Haohan from Fudan University, analyse extensive mortgage data obtained from a major state-owned commercial bank in Chinese Mainland. They track borrowers’ payment and consumption behaviour between October 2019 and May 2024 from a randomly selected sample of 100,000 outstanding mortgages.

The researchers find that as the LPR declined, more and more borrowers prepay their mortgages. The prepayment ratio rose to 8.1 per cent by the end of 2021, stalled in 2022 due to the pandemic, and then peaked at 11.5 per cent by early 2023, as shown below. “Borrowers often decided it was best to cut back on both spending and saving so they could pay off their mortgage faster,” says Professor Jiang.

Further analysis shows that consumption of discretionary or non-essential items is particularly affected. “Households with greater wealth, higher levels of education, and better credit scores are more responsive to the gap between their mortgage rates and LPR, making them more likely to prepay their mortgages,” Professor Jiang adds. “The larger the gap between the mortgage interest rate and the LPR, the more likely they are to prepay.”

Designing more effective policy

In August 2023, the People’s Bank of China announced housing credit policies by lowering mortgage interest rates for first-time home buyers and local margin in some cities. The policies expanded the criteria of first-time home buyers, enabling certain borrowers to reset their local margin to a lower rate.

Given the fixed-rate feature of local margin is one of the causes of mortgage rate rigidity, lowering this extra fee helped mortgage rates move closer to the LPR. Around 25 per cent of households in the sample were qualified for this adjustment.

The researchers find that these qualified households were significantly less likely to prepay their mortgage and showed increases in their household consumption. “Policies that directly address mortgage rate rigidity can help monetary policy have a stronger and quicker effect on borrowing and spending decisions, improving how well monetary policy works,” says Professor Jiang.

This finding aligns with the policy initiative introduced in September 2024  by the People’s Bank of China, which aims to further strengthen monetary policy transmission through the household channel. The policy initiative features a new mortgage rate pricing scheme, which allows local margins to adjust to market conditions and shorten the LPR adjustment period from one year to as little as one quarter.

These measures enable the mortgage interest rates to respond more quickly to changes in the benchmark interest rate, reducing rigidities in the mortgage system. “As a result, mortgage prepayment activity has slowed remarkably since September 2024,” Professor Jiang adds.

The post How interest rate cuts could hurt consumer spending first appeared on China Business Knowledge.

Featured faculty: Andrew Yuen
Written by Putro Harnowo

Donald Trump has returned to the helm of the world’s largest economy. The 47th president promised to make America great again, and his policies would impact beyond the border. Looking at his first term, which was quite controversial, the world watches whether his new term will lead to disruption or pave the way for unexpected progress.

“When analysing someone’s behaviour through the lens of economic mindset, we shouldn’t listen to what they say but pay attention to their actions and, more importantly, to what they care about,” says Dr. Andrew Yuen, Director of EMBA Programme and Principal Lecturer of Department of Decisions, Operations and Technology at the Chinese University of Hong Kong (CUHK) Business School. “We are lucky to have a historical record of Trump’s previous term to see what he has done and gain some insight into what he would do.”

In February’s EMBA masterclass titled Navigating uncertainty: Where is Trump leading the US and the world economy? Dr. Yuen suggests that the answer to the topical question can be seen from his most important appointments: the vice president and the secretary of state. Vice President JD Vance has a presiding role in backing up and taking over the role if the president is unable to perform his duties, while the Secretary of State Marco Rubio is the principal advisor in all foreign affairs.

Including Vance and Rubio, the Trump 2.0 administration is manned by those in their mid-40s, while the Trump 1.0 cabinet was filled with older members, including the 59-year-old vice president and 65-year-old secretary of state when elected.

“As Trump now has more experience, he is more confident in leading the team to govern the country,” says Dr. Yuen. “It seems that Trump is looking for something beyond himself and thinking about succession by appointing younger staff and cultivating them to make his legacy sustainable.”

On the other hand, known for his hawkish stance on China, Rubio is currently on the list of sanctions by the Chinese government for his role in proposing and supporting sanctions on China when he was a congressman. “The relationship between China and the US will be challenging in the next few years,” Dr. Yuen adds.

One of the key highlights of Trump’s campaign is his stance on imposing hefty tariffs. After all, it was during his previous term that the trade war against China broke out. During his campaign for the 2024 election, he promised tariffs of as much as 10 per cent on global imports and 60 per cent on Chinese goods, plus a 25 per cent surcharge on Canadian and Mexican products. Many worry that this move will lead to higher prices and, eventually, inflation.

Can tariffs make America great again and again?

“Tariffs could, but not necessarily, lead to inflation,” says Dr. Yuen. In his first term, Trump had increased tariffs yet inflation was mild, around 2 per cent, and even almost dropped to zero in 2020. After Biden became president in 2021, inflation increased to more than 8 per cent before falling to around 3 per cent by the end of 2024, likely due to the pandemic relief and the central bank’s policies, among many other things.

“The basic understanding of inflation is the year-over-year price change. After tariffs are introduced, inflation will only happen in the first year,” he adds. “After the following years, the impact will be diminished as tariffs only have a one-off impact on inflation.”

“It seems that Trump is looking for something beyond himself and thinking about succession by appointing younger staff and cultivating them to make his legacy sustainable.”

Dr. Andrew Yuen

A 2021 academic paper published in American Economic Review analysed the impact of the 20 per cent tariff on consumer inflation in the US and found no significant effect. The study discovered that Chinese manufacturers increased their prices after the tariffs, but American importers did not pass through the costs to their consumers. The US firms lowered the profit margin and practically paid the tariff, cushioning the impact on consumer inflation.

However, inflation could rise due to unprecedented factors. As Trump pledged to deport illegal immigrants, which stood at 8.3 million in 2022 or five per cent of the 170 million US working population, having this significant workforce left will have a negative unemployment rate, where the demand exceeds the supply of labourers. “Consequently, when companies cannot hire people, they need to increase salaries, which would trigger higher inflation,” says Dr. Yuen.

Putting caps on inflation and debt

As inflation rises, the central bank often responds by increasing interest rates to encourage saving, which reduces consumer spending and business investment. Trump has demanded that interest rates drop immediately to drive investment and consumption in January 2025. However, there are clear regulations about how the central bank issues its monetary policy.

The US Federal Open Market Committee decides the interest rate policy, and the president can appoint seven or 60 per cent of its members. Nevertheless, the president cannot replace anyone in the committee or the Federal Reserve Board of Governors unless they resign or retire. “Although Trump wants to lower interest rates, the institutional arrangement forbids him from influencing the central bank,” says Dr. Yuen.

Wasteful spending by the previous administration, as Trump blamed many times, allegedly led to a record high of US$36.22 trillion in outstanding borrowing by the US federal government. “The US has a high 124 per cent debt-to-GDP ratio as of December 2024, while the international benchmark for a healthy level is 90 per cent,” says Dr. Yuen.

Yet, there is much confidence in the US government bonds being not default. Such a faith may also be reasonable as the Wharton School of the University of Pennsylvania analysed that the threshold for the debt-to-GDP ratio to default the government bond is about 200 per cent. “Although the US Government is not likely to go ‘bankrupt’, we need to pay attention to the crowding out effect and US dollar dominance in the global economy.”

In addressing wasteful spending, a celebrated businessman, Elon Musk, was tasked to lead a new Department of Government Efficiency to cut expenditure by US$2 trillion from the US$6.4 trillion federal budget. As a result, the department decided to freeze international aid and dismantle the US Agency for International Development, in addition to laying off tens of thousands of federal workers.

The true face of Trumponomics

Despite the fanfare of the masterplan for a radical reformation, Dr. Yuen sees Trump’s ideas as not new. “In the past, US president Ronald Reagan had his ‘Reaganomics’, or what the economists call the supply-side economics. What Trump is doing with Trumponomics now is exactly what Reagan did before.”

There are four major areas of supply-side economics, Dr. Yuen explains, namely cutting government spending, tax reduction, trickle-down economics, and deregulation. In 2017, Trump signed the Tax Cuts and Jobs Act into law, significantly lowering corporate tax rates from 35 to 21 per cent. The general idea is by lowering taxes, the company will be more profitable and then could pay more profit tax for federal revenue. Trump proposed a further tax reduction of 15 per cent for businesses focused on US-based operations.

Trickle-down economics involves less regulation and tax cuts for those in high-income tax brackets and corporations to make them spend more, trickle down the money to the broader population and stimulate the economy. Unfortunately, many studies and analyses have shown that tax cuts and trickle-down concepts never materialised as intended.

Deregulation is the same song that Trump played in his first term by removing several regulations in finance, environmental protection, and healthcare. A couple of weeks after moving to the White House in January, Trump signed the executive order to withdraw the US from the Paris Climate Agreement.

However, a new pattern emerges. Trump currently aims to eliminate 10 regulations for each new regulation issued, or the so-called 10-to-1 deregulation initiative. This is a dramatic change from his previous 2-for-1 deregulation in his first term. “In the past, Trump’s major objective was to remove old regulations,” Dr. Yuen says. “This time, he wants to minimise the new regulations so that significant changes can be made to the technology and artificial intelligence industries.”

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Keeping the legacy alive

Since the new industries have no regulations to remove, Trump is not intended to over-regulate them. Similar hopes can be seen in digital assets and cryptocurrency. Trump has announced that five digital assets will be included in a new crypto strategic reserve. “Many Bitcoin holders like Trump because he’s a friend of digital currency and is open-minded about the strategic positioning of digital currency at the national level.”

Overall, Dr. Yuen sees that Trump is leaning more toward pro-business, emphasising small government, lower taxes, deregulation, and government downsizing while promoting protectionism through tariffs and immigration control. “The possible impact is a short-term economic boost,” he adds.

“However, deregulation raises concerns about whether the market has enough protection during economic downturns, but if not, it will lead to an economic crisis. This could result in high inflation and high interest rates, as well as deglobalisation and weakening the US dollar’s international status.”

The post Will Trump 2.0 be wiser or stronger? first appeared on China Business Knowledge.

By Pan Jingyi, Principal Writer, China Business Knowledge@CUHK

Following a series of 10 consecutive hikes, the U.S. Federal Reserve voted to pause its aggressive campaign of interest rate increases in mid-June. The Federal Open Market Committee (FOMC) decided to maintain its benchmark lending rate at a range of 5.0 to 5.25 percent. However, the rate-setting committee also hinted at the possibility of further monetary tightening before the end of the year.

Given that the United States is the world’s largest economy and the U.S. dollar is the world’s primary reserve currency, fluctuations in the U.S. interest rate have immediate effects on global markets. Acting as the central bank of the nation, the Federal Reserve’s primary objective is to maintain a stable U.S. economy. When the economy booms, issues such as inflation and asset bubbles can arise and threaten economic stability. To cool down an overheated economy, the Fed has traditionally stepped in and raised interest rates. When interest rates are raised, the costs of borrowing money (e.g., mortgage, car loans, and credit cards) increase, and consumers tend to pull back on spending. This can reduce the supply of money in circulation, which is a way to lower inflation.

“The most difficult but rewarding strategy to forecast the U.S. interest rate is to ‘do your own economic analysis’, which would help people ‘beat the market’ and gain more significant returns.”

Dr. Andrew Yuen

As the U.S. interest rate directly affects people’s spending habits and investment returns, it would be helpful to forecast whether the U.S. government will increase or decrease it in the coming month. An educated forecast can help consumers find clues and make wiser investment decisions.

Andrew Yuen, Senior Lecturer at the Department of Decision Sciences and Managerial Economics,  The Chinese University of Hong Kong (CUHK) Business School, shared his thoughts on these questions in a masterclass for the school’s EMBA programme titled “U.S. Interest Rate Outlook 2023” which took place in May 2023 .

Utilising Public Information Effectively

According to Dr. Yuen, people with varying degrees of economic knowledge can use different methods to forecast the U.S. interest rate. “The easiest and most effective way for those who don’t have any knowledge about economics is to look at the financial market data and follow the predictions of investment analysts,” he said. To obtain the latest probabilities of the U.S. interest rates, he recommended using the CME FedWatch Tool.

However, rather than just obtaining information passively from the market, people can pursue a more advanced strategy. Dr. Yuen proposed analysing information from the FOMC. The FOMC is the branch of the Federal Reserve System that determines the U.S. interest rate. By analysing the information on the FOMC website, such as their meeting dates, after-meeting statements and projection materials, people can gain insights into the future trends of the U.S. interest rate.

Dr. Yuen illustrated how people can extract key information by comparing different statements from the committee. He highlighted a sentence in the March statement: “The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy.” He explained that this sentence indicated a further increase of the interest rate in FOMC’s May meeting. This was confirmed when the committee members met in May. Noticeably, the same sentence was deleted in the May statement, which suggested that the FOMC would not increase the interest rate in the upcoming meeting. As he anticipated, the Fed voted to maintain the interest rate in June, validating the initial inference.

Besides information from the FOMC website, people should also pay attention to what the FOMC members say in news reports. “The views of the voting members are quite important, especially [those of] Jerome Powell, the Chair of the Federal Reserve,” Dr. Yuen said.

Understanding the Causes of Interest Rate Fluctuations

In addition to the two strategies mentioned above, Dr. Yuen noted that the most difficult but rewarding strategy to forecast the U.S. interest rate is to “do your own economic analysis”, which would help people “beat the market” and gain more significant returns.

Before attempting to make a forecast, however, one must first understand the primary objectives of the FOMC — maximum employment and stable prices. Therefore, Dr. Yuen said, individuals should examine the labour market and inflation trend to forecast the interest rate. “If the unemployment rate is very high, the interest rate will be reduced, and if the inflation rate is very high, the interest rate will be increased,” he explained.

While the FOMC’s decision-making process is theoretically straightforward, conducting one’s own forecast can be quite challenging. “When you forecast the interest rate, you need to forecast the inflation rate and unemployment rate in the future, just like the Fed would,” said Dr. Yuen. He further explained that interest rate decisions are forward-looking because any monetary policy takes time to become effective.

Dr. Yuen then discussed some indicators that individuals can use to analyse inflation trends. As an abstract concept, inflation can be reflected in commodity prices. He noted that housing, food and services are three major factors influencing inflation. More specifically, if the latest rental cost is trending down in the coming year, inflation is likely to also decrease. As such, the Fed would not increase the interest rate hastily. Likewise, decreasing food prices is also a sign of lowering inflation. Other indicators of U.S. inflation include the U.S. Producer Price Index (PPI) and China’s inflation figures. In general, interest rates will likely decrease if inflation rates decrease, Dr. Yuen summarised.

“Besides commodity prices, the U.S. labour market trends also affect the interest rate,” he said, adding that people should pay attention to U.S. salaries. If salaries decrease, people can expect lower inflation and lower interest rates.

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In the masterclass, Dr. Yuen shared his latest forecast of the U.S. interest rate for the end of 2023. After his sharing, he emphasised the importance of adjusting the figure based on the latest developments in the market. “The most important thing here isn’t for me to tell you my conclusion, but to show you how to conduct your own analysis.”

Dr. Yuen also encouraged attendees to put theory into practice. “Practice makes perfect. Try to apply what you have learned in this class and see if those methods are effective,” he advised.

The post Unlocking the Secrets of the U.S. Interest Rate: How to Forecast Like a Pro first appeared on China Business Knowledge.

By Jaymee Ng and Raymond Ma, China Business Knowledge @ CUHK

Perhaps no other event in modern history illustrates the growing economic might of China than the global financial crisis of 2008. Facing a slowdown to its domestic economy despite cutting interest rates three times in less than two months, Chinese leaders opted to dump 4 trillion yuan in stimulus into the economy.

This stimulus, which was spent on upgrading infrastructure including roads, railways, airports and the power grid; on raising rural incomes through land reforms and on social welfare projects such as affordable housing and environmental protection, revitalized the country’s own sputtering growth and has been widely credited to helping to stabilize the world economy.

More than a decade later, the legacy of this massive stimulus remains mixed – its benefits came at the expense of a vast increase in debt, but for Dr. Paul Kitney, an Adjunct Professor at the Department of Decision Sciences and Managerial Economics at The Chinese University of Hong Kong (CUHK) Business School, the moment marked a coming to age of sorts for China in the arena of international monetary policy.

“China’s influence on global monetary policy has grown. One of the key reasons why the global economy avoided a major recession in 2009 was the expansionary monetary policy adopted in China,” said Dr. Kitney, who specialises in macroeconomics, monetary policy and financial linkages, in referring to the country’s high profile shift to a “moderately easy” monetary policy at the time to boost the economy after an extended period focused on fighting inflation.

“So long as the Chinese economy grows at a faster pace than global growth, which it still is, so their influence in the global economy must still go up. Hence its monetary policies will have greater influence as its share of the global economy increases.”

Dr. Paul Kitney.

As a result, lending growth and credit growth more than doubled to around 35% between 2009 and 2011. “The People’s Bank of China, the Chinese central bank, together with their U.S. Federal Reserve and European Central Bank counterparts, played a very important role in helping support the world economy.

“China played an important role that was commensurate with its emerging influence on the global economy. It was an important role that 20 years ago it couldn’t have done or wouldn’t have had as much influence,” says Dr. Kitney, who is also Chief Equity Strategist at Daiwa Capital Markets.

This influence is expected to continue to rise, matching China’s increasing dominance in the global economic order, says Dr. Kitney. “So long as the Chinese economy grows at a faster pace than global growth, which it still is, so their influence in the global economy must still go up. Hence its policies will have greater influence as its share of the global economy increases.”

Monetary Policy Tool of Choice

Dr. Kitney says he expects Chinese policy makers to continue to favor adjusting the reserve requirement ratio, or RRR, over other monetary tools at its disposal. The RRR refers to the amount of money that banks must hold to ensure they can handle customer withdrawals. Lowering the RRR means that banks would have more money to lend to businesses and individuals and vice versa. In January, the PBOC announced it would lower the RRR by 50 basis points, essentially releasing 800 billion yuan into the financial system. The move, which analysts say signals a tilt towards easier money for 2020, comes after China cut the reserve ratio three times in 2019.

On the other hand, raising or lowering policy interest rates is more effective in managing economic growth as it directly affects borrowing costs and money demand. However, it must be done in lockstep with the U.S. Federal Reserve to avoid narrowing the interest rate gap between the renminbi and the U.S. dollar, which would weaken the former currency, he says.

This is especially relevant against the backdrop of the ongoing Sino-U.S. trade war, with the U.S. Treasury having labelled China as a currency manipulator in August 2019 after a sharp drop in the value of the renminbi.

While at the time of writing, the two countries signed a phase one trade deal – constituting the first step that hopefully would lead to an end to the trade war, the vast bulk of tariffs between the two countries remain in place. “The policy response that China is trying to enact as monetary and fiscal policy is a way to try and mitigate the near-term effect of these trade war measures. But what they have to be very careful about is not weakening the renminbi and be further labelled as a currency manipulator by the U.S., “says Dr. Kitney.

“We will see interest rate cuts. It will be baby steps. They will be referenced to U.S. interest rates,” Dr. Kitney says, noting comments by the Fed that it intends to hold rates steady until at least the end of 2020. “The Fed may change its mind and it will be data dependent; if the data weakens they will start cutting again. The U.S. cutting rates provides cover for the PBOC; it provides scope for them to cut rates,” Dr. Kitney adds.

And while the PBOC’s website lists several tools it uses to make adjustments to its monetary policy, the remaining measures are related to macroprudential policy, which seeks to limit systematic risk to the financial system as a whole and have far less impact on growth, he added.

“Of course, China can join the ECB, the Bank of Japan and the Fed in quantitative easing at some point in the future by purchasing long bonds or other securities. But they don’t need to because their interest rates are still well above zero. We will just have to see what happens in the future,” Dr. Kitney says.

The Global Economy in 2020

According to the IMF, the global economy for 2019 is forecast at a 3 percent growth rate, which is the lowest level since 2008. The outlook for the global economy 2020 remains pessimistic as it is forecast at a 3.4 percent growth rate. However, Dr. Kitney explains that the situation for 2020 might not be as bad as others imagined.

“The global economy is not going to hit recession or anything like that because China and India are going to have mid-single-digit-plus growth. Some of the developed markets might hit or get close to recession. In the near term, based on our tactical economic view, we see two factors that we perceived as positive as coincident economic indicators.

“The first one is we expect to see purchasing managers’ index, or PMI, stabilize due to near term monetary policy coordination that 60% of global central banks have cut rates. We’ve also seen the Fed cut rates three times now, and in addition to that the Fed’s balance sheet has been rebuilt, following the quantitative easing phase in India in the beginning of 2018,” says Dr. Kitney.

The IMF also predicted China’s economic growth at 5.8 percent in 2020, which is slower than the 6.1 percent forecast for 2019. Despite the forecasted slower economic growth, PBOC governor Yi Gang announced that Beijing should maintain positive interest rates.

The post The Rising Importance of Chinese Monetary Policy first appeared on China Business Knowledge.