Given China’s significant role as a key player in the global economy, I maintain a vigilant and analytical approach to Professor Michael Pettis’ insights on its economic strategies. Pettis has long maintained that China’s reliance on supply-side stimulus is a misstep. This is pivotal as China, being the world’s second-largest economy, grapples with sluggish growth and tepid inflation.

The common consensus among many economists is for the People’s Bank of China (PBoC) to ramp up the money supply. Pettis, however, underscores a critical nuance: merely increasing the money supply doesn’t guarantee a rise in prices. Price hikes are a consequence of demand outstripping supply, a situation where monetary expansion fosters inflation by accelerating demand relative to supply, a phenomenon commonly observed in the U.S. but not necessarily replicable in China’s context.

In China’s case, monetary expansion predominantly bolsters the supply side, echoing Japan’s approach in the 1980s. This results in enhanced capacity and trade surpluses, rather than stimulating demand relative to supply, thereby not translating into inflation despite substantial monetary expansion.

Pettis argues that simply enlarging the money supply isn’t a panacea. He advocates for a redirection of monetary and fiscal policies towards bolstering the demand side of the economy. Increasing the consumption share of GDP, via direct and indirect transfers to households, is suggested. This shift in focus from manufacturing and investment to consumption is a critical pivot.

However, this approach is not without its trade-offs. Elevating household consumption will likely entail cutting subsidies to manufacturing and investment, historically buoyed by a relatively low household income share. This recalibration could pose short-term competitive challenges for China’s manufacturing sector.

Pettis points out a vital, yet often overlooked, aspect: certain types of monetary expansion might actually be disinflationary, leading to lower inflation. This counterintuitive perspective is crucial in understanding China’s unique economic landscape. While realigning resources towards household consumption is essential for long-term economic stability, it’s a delicate balance that might temporarily impair manufacturing competitiveness.