Nomura Institute of Capital Markets Research

How major macroeconomic variables move around their medium-term trends

13 November, 2012

The Business Cycle in China since the Lehman Crisis

Nomura Institute of Capital Markets Research

Senior Fellow

C. H. Kwan

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6

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12

14

16

Q3

01 02 03 04 05 06 07 08 09 10 11 12

CPI

Real GDP growth rate

8.07.4

(Year-on-year, %)

1.9

(Year, quarter)

12.1

14.8

6.6

-1.5

6.3

Economic Growth versus Inflation in China

1

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC database.

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0 2 4 6 8 10 12 14 16 Economic growth rate lagged three quarters (Year-on-year, %)

10Q1

10Q2

10Q3

10Q411Q1

11Q2

11Q3

11Q412Q1

12Q2

12Q3

Inf lation rate (Year-on-year, %)

Correlation between the Economic Growth Rate and the Inflation

Rate (2001Q1～2012Q3)

2

Note: Estimation results:

Inflation rate = －5.70 ＋ 0.82 × economic growth rate lagged three quarters （6.54） The number in parentheses denotes t-value. = 0.48

Estimation period: Q1 2001 through Q3 2012.

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC database.

2R

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0

5

10

15

20

25

0 5 10 15 20

Economic growth rate lagged three quarters (Year-on-year, %)

2011Q22011Q1

2011Q3

2011Q4

2012Q1

2012Q22012Q3

Rate of increase in food prices (Year-on-year, %)

Correlation between the Economic Growth Rate and Increase in

Food Prices (2001Q1-2012Q3)

3

Note: Estimation results:

Rate of increase in food prices = －14.00 ＋ 2.00 × economic growth rate lagged three quarters (6.62)

The number in parentheses denotes t-value, = 0.48

Estimation period: Q1 2001 through Q3 2012.

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC database.

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Phases of the Business Cycle Defined by the Relationship

between the Economic Growth Rate and the Inflation Rate

4

Boom Bust Boom

Economic growth rate

↓

Inf lation rate→

(Growth rate)a) Without time lags

b) With time lags

↓Economic growth rate↓Inf lation rate

(4)Stagflation

(1)Recession

(2)Recovery

(3)Overheating

(Growth rate)

Low growthHigh inflation

Low growthLow inflation

High growthLow inflation

High growthHigh inflation

Average(benchmark)

Average(benchmark)

Source: Compiled by Nomura Institute of Capital Markets Research.

Boom Bust Boom

Economic growth rate

↓

Inf lation rate→

(Growth rate)a) Without time lags

b) With time lags

↓Economic growth rate↓Inf lation rate

(4)Stagflation

(1)Recession

(2)Recovery

(3)Overheating

(Growth rate)

Low growthHigh inflation

Low growthLow inflation

High growthLow inflation

High growthHigh inflation

Average(benchmark)

Average(benchmark)

Business Cycle Described by the Interaction between Economic

Growth and Inflation

5

Source: Compiled by Nomura Institute of Capital Markets Research.

Economic growth rate down

Economic growth rate up

Infl

atio

n ra

te u

p

Infl

atio

n ra

te d

ow

n

Economic growth rate High →← Low

Infl

ati

on

rate

H

igh

→

Benchmark

←Lo

wThe inf lation rate turns downward following a

decrease in the economic growth rate.

The economic growth rate turns downward

following monetary tightening.

The economic growth rate turns upward following

monetary easing.

The inf lation rate turns upward following an

increase in the economic growth rate.

(4) Stagflation

(3) Overheating

(1) Recession

(2) Recovery

Benchmark

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Q2

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Q3

Q4

Q1

Q2

Q3

2008 2009 2010 2011 2012

(Year, quarter)

Inf lation rate 1.9％

7.4%Economic growth rate

（Year-on-year, %）

(1)Recession (2)Recovery (3)Overheating

average: 9.1%

average: 2.7％

(4)Stagflation (1)Recession

Phases of the Business Cycle in Post-Lehman China

6

Note: Phase (1): low growth and low inflation; phase (2): high growth and low inflation;

Phase (3): high growth and high inflation and phase (4): low growth and high inflation.

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC database.

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4 5 6 7 8 9 10 11 12 13 14

09Q2

09Q1

09Q3

09Q4

10Q1

10Q210Q3

08Q4

11Q2

10Q4

11Q1

11Q3

12Q1

11Q4

12Q2

Inf lation rate (Year-on-year, %)average: 9.1%

(4)Stagflation

(3)Overheating

(1)Recession

(2)Recovery

Economic growth rate (Year-on-year, %)

average:2.7%

12Q3

Cyclical Changes in the Economic Growth and Inflation Rates in

Post-Lehman China

7

Note: Phase (1): low growth and low inflation; phase (2): high growth and low inflation;

phase (3): high growth and high inflation and phase (4): low growth and high inflation.

The economy circulates counterclockwise in the order of (1) → (2) → (3) → (4) → (1).

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC database.

8

The Taylor rule proposes that the policy interest rate should be determined in response to the divergence of

actual inflation from the long-term inflation target and the divergence of current economic activity from its

equilibrium level (measured by the GDP gap).

General form

The optimal level of the policy interest rate ＝ actual inflation rate ＋ equilibrium real interest rate

＋ 0.5 × (actual inflation rate － target inflation rate)

＋ 0.5 × (GDP gap).

The case of the United States

The optimal level of the FF rate ＝ actual inflation rate ＋ 2%

＋ 0.5 × (actual inflation rate － 2%) ＋ 0.5 × (GDP gap)

＝ 1.5 × (actual inflation rate) ＋ 0.5 × (GDP gap) ＋ 1%

Taylor principle

– The policy interest rate must be raised by more than the rise in the inflation rate in order to stabilize the macro

economy.

The Taylor rule can be treated as a reaction function showing how the policy interest rate actually responds

to changes in the inflation rate and the GDP gap.

The Taylor Rule

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Q3

Q1

Q3

Q1

Q3

Q1

Q3

Q1

Q3

Q1

Q3

Q1

Q3

Q1

Q3

2005 2006 2007 2008 2009 2010 2011 2012

（Year, quarter）

（％）

Actual value

Estimated value

Changes in the One-Year Base Lending Rate

— Actual versus Predicted Values —

9

Note: The predicted value is based on the following regression equation.

Base lending rate＝ 1.68 ＋ 0.11 × inflation rate ＋ 0.06 × economic growth rate ＋ 0.57 × base lending rate lagged one quarter （3.70） （2.43） （5.66） Figures in parentheses are t-values. ＝ 0.84 The base lending rate has a one-year maturity.

Estimation period: Q3 2005 to Q3 2012

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC database.

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2005 2006 2007 2008 2009 2010 2011 2012

(%)

(Year, month)

Inf lation rate (year-on-year) Nominal base lending rate

Real base lending rate

Real Base Lending Rate Inversely Correlated with the Inflation

Rate

10

Note: The base lending rate has a one-year maturity. Real base lending rate = Nominal base lending rate

－ inflation rate (year-on-year) Source: Compiled by Nomura Institute of Capital Markets Research Based on CEIC database.

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Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3

2005 2006 2007 2008 2009 2010 2011 2012

(Year-on-year, %)

(Year, quarter)

Actual value

Estimated value

RMBappreciation

Changes in RMB Exchange Rate against the U.S. Dollar (USD/ RMB)

— Actual versus Predicted Values —

11

Note: The predicted value is based on the following regression.

USD per RMB ＝ －3.30 ＋ 0.53 × inflation rate lagged one quarter ＋ 0.29 × economic growth rate ＋ 0.62 × USD per RMB lagged one quarter (7.23) (4.53) (9.47)

Figures in parentheses are t-values. ＝0.93 Figures for the RMB rate are based on period averages.

Estimation period: Q3 2005 to Q3 2012

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC database.

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2005 2006 2007 2008 2009 2010 2011 2012

(Year-on-year, %)

CPI →

US dollar per RMB

(Year, month)

RMBappreciation

Rate of RMB Appreciation Moving in Tandem with the Inflation Rate

12

Note: Monthly average of the RMB exchange rate (U.S. dollars per renminbi).

Source: Compiled by Nomura Institute of Capital Markets Research based on data from the

National Bureau of Statistics and the State Administration of Foreign Exchange (SAFE) of China.

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2005 2006 2007 2008 2009 2010 2011 2012

(Quarter-on-quarter, %)

(Year, quarter)

←Actual value

Ris

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sh

are

pric

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Fallin

gsh

are

pric

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↓Estimated value

Changes in the SSE Composite Index

— Actual versus Predicted Values —

13

Notes: The predicted value is based on the following regression.

Shanghai Composite Index (QoQ) =

－36.90 ＋ 4.91 × economic growth rate (YoY) － 3.52 × inflation rate (YoY) （4.98） （－4.01） Figures in parentheses are t-values. = 0.53

Figures for Shanghai Composite Index are based on period averages.

Estimation period: Q3 2005 to Q3 2012

○ indicates the predicted value rises or falls with the actual value.

× indicates The predicted value moves in the opposite direction from the actual value.

Source: Compiled by Nomura Institute of Capital Markets Research based on CEIC Database.

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1 7 1 7 1 7 1 7 1 7

2008 2009 2010 2011 2012 (年、月)

Money supply (M2)

（Year-on-year, %）

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1 7 1 7 1 7 1 7 1 7

2008 2009 2010 2011 2012

CPI

(年、月)

（Year-on-year, %）

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101214

1 7 1 7 1 7 1 7 1 7 9

2008 2009 2010 2011 2012 (Year, Month)

Home prices in 70 large and medium-sized cities（Year-on-year, %）

Soaring Inflation and Home Prices Following the Sharp Increase in the

Money Supply — Situation after the Collapse of Lehman Brothers—

14

Note: Home prices in large and medium-sized cities are based on the sales price indices of residential buildings until December 2010

and on the average sales price indices of newly constructed homes from January 2011.

Source: Compiled by Nomura Institute of Capital Markets Research based on data from the National Bureau of Statistics of China.

Collapse of Lehman Brothers

30

35

40

45

50 (Share, %)

Investment ratio (a)

Average 39.2

Average 48.2

6

8

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12

14

16 (%)

Economic growth rate (b)

Average 10.5

Average 9.6

2

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4

5

6

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

(Times)

Marginal capital coef f icient (a/b)

(Year)

Average 3.7

Average 5.0

Changes in the Investment Ratio, Economic Growth Rate, and

Marginal Capital Coefficient

15

Note: The larger the marginal capital coefficient, the less efficient the investment.

Source: Compiled by Nomura Institute of Capital Markets Research based on data from the

China Statistics Abstract 2012 of the National Bureau of Statistics of China.

0.60

0.65

0.70

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0.95

1.00

1.05

1.10

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Q1 Q3

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

(Year, quarter)

(Times)(Year-on-year, %)

Job offers-to-job seekers ratio in the urban areas

(Right axis)↓

↑ Economic growth rate

Job Offers-to-Job Seekers Ratio Diverging from the Economic

Growth Rate

16

Note: The job offers-to-job seekers ratio in the urban areas of China is calculated by dividing the number of job offers by the number of

job applicants registered in public employment service organizations in approximately 100 cities. It is based on “The Analysis on Supply

and Demand of Labor Market in Some Cities” published quarterly by the China Labor Market Information Network Monitoring Center,

which operates under the Ministry of Human Resources and Social Security.

Sources: Compiled by Nomura Institute of Capital Markets Research based on data from the National Bureau of Statistics of China and

the Ministry of Human Resources and Social Security.