Game Theory Perspective on China’s Recent Move to Cut Interest Rates
China recently reported its latest quarterly economic growth, and people raised concern about China’s economic outlook because it is one the lowest growth rates that China has reported since the 2008 financial crisis. In order to encourage more investment activities and spur economic growth, Chinese government announced that it will decrease its interest rates and also lower capital reserve requirement for banks. Chinese government’s new actions will allow banks to have more capital that they can lend to private companies, and the decrease in interest rates will help lower financial costs and borrowing costs for companies. Decreased borrowing costs will allow companies to invest and grow with more ease.
In regards to the Federal Reserve’s plan to raise its interest rates, China’s decision to decrease interest rates is a very strategic move. Recently, the Federal Reserve expressed its intent to increase interest rates, and the increase in the Federal Reserve’s interest rates can negatively affect the rest of the world, including China, because if the Federal Reserve raises interest rates, many U.S investment assets, such as the 10-year treasury bond, will be more attractive. Subsequently, many investments are likely to flow out of the rest of the world and go into the U.S financial markets. The Federal Reserve believes that raising interest rates will be a good way to keep inflation in control.
Raising interest rates is the dominant strategy that the Federal Reserve is choosing to play sooner or later. Given the Federal Reserve’s plan on interest rate hike, Chinese government can choose to maintain its interest rates, increase its interest rates, or decrease its interest rates. Maintaining the current level of interest rates is not the best strategy because China’s growth rate is currently decreasing, and once the Federal Reserve raises its interest rates, China can lose even more invested capital. Increasing interest rates is also not the best strategy that Chinese government can play because higher interest rates are likely to increase borrowing costs for private companies. Chinese government should choose to decrease its interest rates because the positive effects of lower interest rates will partially offset any negative impact of the Federal Reserve’s interest rate hike on Chinese economy.
Sources:
http://www.wsj.com/articles/chinas-central-bank-cuts-rates-1445601495
http://www.nytimes.com/2015/09/25/business/janet-yellen-says-fed-is-likely-to-raise-interest-rates-this-year.html?_r=0