He Xiaobei: Beijing should put price rebound at the centre of monetary policy

PKU economist says monetary policy should target a rebound in prices, lower borrowing costs, and stop conflating price stability with financial stability.

On 28 December 2025, the 74th session of the China Economic Outlook Report Forum was held at the National School of Development (NSD), Peking University. He Xiaobei, Associate Research Fellow and Deputy Director of Macro and Green Finance Lab at the NSD and principal author of the report, presented the China Economic Outlook Report for the Fourth Quarter of 2025. This article is an abridged version of the report’s key findings, originally published on the NSD’s official WeChat blog on 24 February 2026.

She argues that monetary policy should make a rebound in prices a binding objective, shift back towards aggregate demand management, lower risk-free interest rates more decisively, and reform the banking system in ways that improve monetary transmission rather than subordinating policy to concerns over banks’ NIM or overcapacity in certain sectors.

何晓贝：促进物价合理回升有必要成为货币政策的硬指标

He Xiaobei: Promoting a Reasonable Rebound in Prices Should Become a Binding Target for Monetary Policy

Looking back at 2025, the global trade landscape experienced unprecedented and profound changes. Confronted with a complex and rapidly evolving international environment, China’s economic growth not only successfully withstood external pressures but also achieved a record high in export volume. Annual GDP growth is expected to have reached the government’s initial target of around 5 per cent. This outcome was made possible by a series of proactive policy measures adopted by the Chinese government, which effectively responded to the challenges and uncertainties of the international market.

However, it is noteworthy that since the second half of 2025, both investment and consumption have exhibited signs of weakening growth. More importantly, price indicators suggest that aggregate output has remained below potential for several consecutive years.

As 2026 marks the first year of the Fifteenth Five-Year Plan period, the Central Economic Work Conference explicitly noted that “the contradiction between strong domestic supply and weak domestic demand remains prominent,” and emphasised that “promoting stable economic growth and a reasonable rebound in prices should be an important consideration of monetary policy.” Nevertheless, significant challenges remain regarding how macroeconomic policy can facilitate a reasonable rebound in prices. In particular, there exist considerable divergences of opinion regarding the role that monetary policy should play.

This report analyses China’s macroeconomic performance and policy environment in 2025 and, on the basis of forward-looking assessment, proposes policy recommendations on how monetary policy can support a reasonable rebound in prices.

I. Macroeconomic Performance and Policy Dynamics

(1) Three Core Features of Economic Performance

China’s macroeconomic performance in 2025 exhibited clear structural characteristics, with growth drivers and potential risks coexisting.

First, exports played a significant role in driving growth. Although the effective tariff rate imposed by the United States on Chinese goods increased from 11% to 29%, China’s total exports still recorded a year-on-year growth of 5.4% as of November 2025. Net exports contributed 29% to GDP growth, reaching the highest level since 1997 (excluding the pandemic period in 2020). This development reflects both the strong competitiveness of Chinese products and the gradual adjustment of China’s export market structure since 2018. In particular, part of China’s export share has shifted from the U.S. market toward ASEAN and other emerging markets, effectively offsetting the impact of trade barriers in a single market.

Second, economic momentum weakened over the course of the year. GDP growth reached 5.2% in the first three quarters of 2025, but momentum slowed toward the end of the year. Value-added industrial output and the Index of Services Production both decelerated in October and November relative to earlier months, and market expectations suggest fourth-quarter GDP growth may fall to around 4.5%. Domestic demand remains the primary weakness. By November, fixed-asset investment had declined by 2.6% year-on-year, the first contraction since the pandemic year of 2020. Meanwhile, seasonally adjusted month-to-month growth of the total retail sales of consumer goods was negative for most of the second half of the year, with cumulative growth reaching only 4% by November.

Third, a striking divergence emerged between real activity and price indicators. Perhaps the most unusual feature of China’s economy in 2025 is the coexistence of steady GDP growth with persistently weak inflation. CPI inflation remained below 1% for 33 consecutive months through November, while PPI has been contracting for 38 months in a row. Even more notable, the GDP deflator—a broad measure of price dynamics—has remained negative for ten consecutive quarters, the first such occurrence since China began publishing comparable data in the 1990s. This prolonged price weakness has also affected the exchange rate in real terms. Although the renminbi appreciated by about 4% against the U.S. dollar in nominal terms during 2025, China’s persistently lower inflation relative to major economies has caused the real effective exchange rate of the RMB to decline by roughly 20% since 2022.

Overall, China’s growth rate of around 5% remains relatively strong in the global context. However, judging from price indicators and labour market conditions, actual output is clearly below the economy’s potential, implying a negative output gap. A persistently negative output gap deserves particular attention. A large body of research shows that prolonged negative output gaps can generate hysteresis effects. For example, long-term unemployment can lead to skill deterioration (human capital depreciation) and detachment from the labour market, making it difficult for unemployment to return to its previous equilibrium level. In other words, even when economic downturns originate primarily from demand shocks, severe and prolonged recessions often produce long-term negative effects on the supply side. Through channels such as human capital loss and declining labour force participation, they can lead to a permanent reduction in potential output.

(2) The Strength of Macroeconomic Policy in 2025

In 2025, China’s fiscal policy showed a more proactive shift compared with previous years, while monetary policy remained relatively conservative.

Specifically, in terms of fiscal policy, both the official deficit ratio and the broadly defined deficit ratio—which includes local government special bonds and special treasury bonds—were two percentage points higher than in 2024 and even exceeded the level observed during the pandemic in 2020. More importantly, the orientation of fiscal policy has begun to change. Instead of the previous model of “investing in things,” which focused primarily on infrastructure investment, fiscal policy has partly shifted toward “investing in people,” emphasising consumption and social welfare.

Key measures include issuing 300 billion yuan in ultra-long-term special treasury bonds to support consumer goods trade-in programs; providing interest subsidies for personal consumption loans; introducing an annual 3,600 yuan childcare subsidy per child; and promoting policies such as free preschool education. In addition, 500 billion yuan in special treasury bonds were issued to replenish the core Tier 1 capital of large state-owned commercial banks, providing strong support for financial system stability.

However, China’s monetary policy stance in 2025 remained relatively conservative. Although the 2024 Central Economic Work Conference clearly emphasised a policy orientation of “moderately loose monetary policy,” the policy interest rate declined by only 10 basis points in 2025. Given the very low inflation rate, real interest rates remain relatively high. For example, although the nominal yield on ten-year government bonds has been declining since 2023, the inflation-adjusted real yield remains higher than the average level of the past decade. Similarly, the real lending rate—after adjusting for inflation—has remained roughly in line with its past-decade average, even though real GDP growth has slowed significantly during the same period. This implies that despite a decline in the economy’s average rate of return, borrowing costs have not fallen correspondingly in real terms. In other words, monetary policy has not played an especially countercyclical stabilising role.

II. Policy Debate: Price Recovery and the Role of Monetary Policy

China’s fiscal policy should play a key role in promoting economic growth and a recovery in prices. However, there remains significant debate regarding the effectiveness and necessity of monetary easing, with disagreements largely centred on three core issues.

(1) Debate One: Can Persistently Weak Prices Self-Correct?

Some argue that subdued prices are a temporary phenomenon resulting from structural economic adjustment, and that the economy will gradually move out of low inflation through market self-correction. However, international experience does not support this view.

From a theoretical perspective, persistently weak prices are a direct reflection of a negative output gap, and a prolonged negative output gap can cause irreversible damage to the economy. In a deflationary environment, the real debt burden of borrowers increases, prolonging the deleveraging cycle and suppressing investment and consumption. At the same time, falling prices can easily interact with wages to produce a downward spiral: declining corporate profits make wage increases difficult, slower income growth weakens household consumption, and the economy ultimately falls into a vicious cycle of “stagnant prices—stagnant wages.”

Japan provides a particularly instructive example. Inflation expectations among households became anchored at zero for a prolonged period; firms were reluctant to raise prices, and wage growth remained weak. This eventually produced a zero-inflation equilibrium that proved extremely difficult to break even after many years of policy intervention.

China is beginning to exhibit similar signs. Data from the National Bureau of Statistics show that the growth rate of average wages in urban units has declined significantly since 2021, closely mirroring the trend of persistently weak prices.

More importantly, one of the key determinants of inflation is expectations of future inflation. Inflation, therefore, has a self-fulfilling effect. Once firms and households form entrenched expectations that “prices will not rise,” they tend to postpone consumption and reduce investment, turning expectations into reality. Reversing such expectations is often very difficult. In recent years, Japan and Europe managed to exit prolonged periods of low inflation largely due to external shocks such as the pandemic and geopolitical conflicts, which pushed prices upward. This further demonstrates that market self-adjustment alone is unlikely to break a low-inflation equilibrium.

(2) Debate Two: Would Monetary Easing Worsen Overcapacity and Price Decline in a “Strong Supply, Weak Demand” Economy?

In its Q1 2025 Monetary Policy Implementation Report, the People’s Bank of China argued that under a development model emphasising investment and supply, increasing the money supply may lead to continued expansion of capacity and supply, thereby exacerbating the problem of excess supply and ultimately hindering a recovery in prices. Some scholars also contend that China’s investment and financing structure is unbalanced. In their view, monetary easing tends to channel funds into the production sector rather than the household sector, which may further aggravate the imbalance between excess supply and insufficient consumption.

This view, however, should be evaluated in a balanced and objective manner. It is undeniable that market distortions can affect the transmission efficiency of monetary policy. Problems such as soft budget constraints among some state-owned enterprises and the continued presence of “zombie firms” may lead to capital flowing into inefficient sectors and exacerbate localised overcapacity. However, these factors are not the root cause of economy-wide deflation, nor do they negate the overall effectiveness of expansionary monetary policy.

First, investment itself is an important component of aggregate demand. The assumption that “monetary easing stimulates investment and therefore worsens excess supply” is based on the premise that a large share of funds flows into sectors with soft budget constraints. Yet this situation has improved significantly. Local governments were once the main source of soft budget constraints, but with the ongoing local debt resolution process, they have instead become a source of tightening pressures. At the same time, overcapacity in certain industries cannot by itself trigger economy-wide deflation. Malignant competition in specific sectors should be addressed through sectoral regulatory policies, while monetary policy should focus on the overall price level. Localised problems should not constrain macroeconomic demand management.

Second, the benefits of monetary easing for the household sector should not be judged solely by the scale of newly issued household loans. More importantly, attention should be paid to the debt-relief effects of lower interest rates for households. International experience shows that after a sharp decline in housing prices, household deleveraging is a normal process. China’s household sector is currently undergoing such a deleveraging cycle: the ratio of mortgage balances to GDP has fallen from 33% in 2020 to about 27% today. For households with existing mortgages, interest rate reductions can significantly ease debt burdens. At present, outstanding personal housing loans in the banking system amount to roughly 37 trillion RMB. If mortgage interest rates were reduced by 100 basis points, households could save approximately 370 billion RMB in interest payments each year.

(3) Debate Three: Does Monetary Easing Threaten Financial Stability by Compressing Bank Net Interest Margins?

A key factor constraining the People’s Bank of China (PBOC), China’s central bank, from further interest-rate cuts is concern about the narrowing of banks’ net interest margins (NIM). Over the past decade, the NIM of Chinese commercial banks has gradually declined from 2.5% in 2015 to 1.4% in 2025. Since profits are the primary source through which banks replenish their core Tier 1 capital, the compression of interest margins has raised concerns about the financial soundness of the banking sector.

However, these concerns involve two misconceptions.

First, a low-interest-rate environment does not necessarily lead to an extreme compression of NIM. After the 2008 financial crisis, the United States implemented a seven-year zero-interest rate policy, yet the banking sector maintained an NIM of over 3%. By contrast, during the interest-rate tightening cycle from 2002 to 2006, U.S. banks’ NIM actually declined from 4% to 3.5%.

In essence, NIM reflect banks’ risk-pricing capability, that is, their ability to cover real-sector risks by raising risk premiums. China’s current interest rate system contains distortions: in some cases, corporate lending rates are even lower than government bond yields. This is not an inevitable consequence of low interest rates but rather the result of multiple factors, including the fragmentation of the monetary policy framework.

Second, the “safety floor” for NIM is not absolute. Cross-country comparisons show that over the past decade, banks in the Eurozone have maintained NIM of 1.4%–1.6%, while in Japan, margins have been even lower, at 0.5%–0.7%, without triggering systemic financial risks. A key reason Japanese banks have been able to sustain such low margins is that, following the banking crisis of the 1990s, the government used fiscal resources to recapitalise banks, thoroughly resolved non-performing assets, and repaired bank balance sheets. China’s issuance of special treasury bonds in 2025 to replenish the capital of large state-owned banks represents a step in this direction, though further work remains necessary to address potential non-performing assets.

More concerning is the approach of maintaining high interest margins to protect bank profitability. This approach creates cross-subsidisation, forcing high-quality borrowers to subsidise inefficient firms, and blurs the functional boundary between monetary policy and financial stability policy. Financial stability should rely on macroprudential regulation and risk-resolution mechanisms, rather than sacrificing the independence of monetary policy.

III. Policy Recommendations: How Monetary Policy Can Promote a Reasonable Rebound in Prices

To ensure that economic growth remains within a reasonable range during the 15th Five-Year Plan period and to achieve the goal of raising China’s per capita GDP to the level of moderately developed countries by 2035, it is essential to prevent the economy from operating below its potential output level for an extended period, which could cause permanent damage to potential growth.

Looking ahead to 2026, the economy will continue to face significant challenges. Promoting a reasonable rebound in prices and narrowing the output gap should therefore become the central task of macroeconomic policy. This requires effective coordination between fiscal and monetary policy. Monetary policy must break through its current constraints and play a larger role. To this end, the following four policy recommendations are proposed.

(1) Make “Price Rebound” the Primary Objective of Monetary Policy

The key reason monetary policy remains constrained at present is the ambiguity of policy objectives, which makes the policy stance vulnerable to interference. The objective framework should therefore be clarified on three levels.

First, “promoting stable economic growth and a reasonable rebound in prices” should be established as the primary objective of monetary policy. The 2025 Central Economic Work Conference described this goal as an “important consideration.” It should be elevated to the level of a “primary” objective to prevent policy stance from being weakened by conflicts among multiple targets.

Second, a binding inflation target should be established. At the 2025 Two Sessions, the inflation target was lowered from within 3% to 2%, a more pragmatic adjustment. This target should be treated as a binding policy indicator. Government authorities, including the PBOC, should make clear commitments and take concrete actions to prevent the market from forming entrenched expectations of persistently low inflation.

Third, monetary policy should return to its aggregate policy orientation. The core responsibility of monetary policy is to address inflation, which is a macroeconomic issue affecting the economy as a whole. Overcapacity in specific industries should be addressed through sectoral regulation and credit-structure adjustments, and should not become a constraint on aggregate monetary policy.

(2) Monetary policy should focus on lowering risk-free interest rates and reduce its emphasis on quantitative indicators.

Monetary policy should shift from a focus on quantitative management—such as credit scale—to a price-based framework centred on interest-rate adjustments. This includes the following measures:

First, further reduce short-term risk-free interest rates. At present, China’s short-term risk-free rates still have considerable room to decline. Lowering policy rates in the interbank market could push down deposit rates, reduce banks’ funding costs, ease pressure on NIM, and effectively lower corporate financing costs.

Second, reduce emphasis on credit quantity targets. Against a downturn in the real estate sector and ongoing household deleveraging, slower credit growth is a normal cyclical phenomenon and should not be interpreted as evidence of ineffective monetary policy. Credit expansion driven by quantitative targets may force banks to assume excessive risk, which would undermine financial stability and efficient resource allocation.

Third, place greater emphasis on interest rate adjustments for existing debt. For household mortgages and outstanding corporate loans, market-based mechanisms can be used to push interest rates downward, thereby alleviating the debt—deflation cycle.

(3) Encourage banks to compete through differentiation and avoid homogeneous and rigid performance targets.

Currently, banking business models are highly similar, and performance evaluation metrics are largely homogeneous, which weakens banks’ ability to price risk and reduces the effectiveness of monetary policy transmission. The policy environment should therefore be improved by reducing industry-wide assessment targets and encouraging differentiation. Excessive sector-specific policy targets—for example, mandated credit growth in certain sectors—can cause credit resources to become overly concentrated and increase the accumulation of risk. Banks should instead be encouraged to compete based on their own institutional endowments, customer bases, and risk preferences, thereby expanding their autonomy in risk pricing. The establishment of independent bank risk-pricing mechanisms is also a key step in advancing interest-rate marketisation reforms.

(4) Clarify the policy boundary between “price stability” and “financial stability”.

Under the dual-pillar framework of monetary policy and macroprudential management, the PBOC should clearly delineate the policy boundaries between the objectives of price stability and financial stability. Price stability should fall under the responsibility of monetary policy, while financial stability should be addressed within the macroprudential regulatory framework. Issues such as narrowing bank NIM, exchange rate volatility, and risks in the interbank market should be managed through improvements in the macroprudential policy toolkit, stronger financial supervision, and well-established risk-resolution frameworks, rather than through monetary policy adjustments. The PBOC should further expand and refine the macroprudential toolkit and strengthen its ability to identify and prevent financial risks. In doing so, monetary policy can be freed from the burden of maintaining financial stability and focus on its core objectives: stabilising economic growth and maintaining price stability.