CITIC Securities Co., Ltd.: The necessity of introducing an unconventional monetary policy framework is increasing

Financial and Real BS: The Monetary Credit System Formed Based on Financing Demand Private sector deposits correspond to bank liabilities, while government sector deposits correspond to central bank liabilities. Indirect financing in the private sector corresponds to bank asset-side credit, and in direct financing, the bond-form liabilities correspond to the assets of the banking system; government sector liabilities are one of the main assets of financial institutions such as commercial banks. Under the statutory deposit reserve system, indirect financing is based on the logic of credit-derived deposits, which constructs the foundation of the monetary credit system. Central Bank and Bank BS: The Intermediary System for the Transmission of Narrow Money to Broad Liquidity The financial system is divided into monetary authorities (central banks), deposit-taking financial institutions, and non-deposit financial institutions. Reserve assets such as commercial bank reserve deposits are stored on the liability side of the central bank, and the central bank's regulation of the statutory deposit reserve ratio can directly affect the scale of excess reserves. The liquidity increments provided by the central bank to the banking system are reflected in excess reserves, and the transmission of narrow liquidity to broad liquidity must be based on the financing system. In a weak credit cycle, the effectiveness of the central bank's monetary tools for counter-cyclical adjustment will inevitably be affected. Private Sector: The Gap Between the Monetary Multiplier and Theoretical Extremes Widens, Restricting the "Inflation" Efficiency of "Currency" The monetary nature of inflation is often overlooked. In a credit currency system, there is a certain correlation between credit and price cycles. By taking the limit of the monetary multiplier at each stage and multiplying it by the base currency of the same period, we can obtain the maximized M2 (referred to as limit M2). By comparing limit M2 with actual M2, we derive the multiple of current broad money inflation after maximizing credit demand and reaching the limit of the monetary multiplier, in other words, the extent of inflation caused entirely by monetary growth. We assume that the credit environment returns to the level of 2019 during the pandemic and estimate the inflationary uplift caused by monetary growth optimization. Government Sector: The Symbiotic Dilemma of Borrowing and Low Interest Rates In a downward credit cycle, private sector demand contracts while the fiscal sector bears the task of counter-cyclical adjustment. To avoid the risk of high fiscal leverage accumulation, it is necessary for monetary policy to remain loose to maintain low interest rates, which in turn will make the interest margin and operational issues of the banking system a norm. Without considering 0% interest rates or even negative interest rate policies, the traditional monetary policy space will be significantly constrained; in other words, the dilemma of high fiscal leverage and low monetary interest rates largely challenges the marginal regulatory capacity of the traditional monetary policy framework. Financial System: Changes in Asset Structure and Misalignment of Interest Rate Cuts Despite the continued weak credit cycle post-pandemic, the real sector and banking system have not reduced their balance sheets, but the rate of balance sheet expansion has decreased, and the structure of bank assets and liabilities is changing. The proportion of resident credit on the asset side is declining while the proportion of bond assets is rising; on the liability side, the proportion of deposits has slightly decreased, while the proportion of liabilities to the central bank has increased. Based on the main item weights of the bank's balance sheet, we have calculated the main changes in asset returns and liability costs, concluding that the misalignment of declining asset returns and liability costs is the main source of pressure on interest margins. The Spiral Reinforcement of Weak Credit, Weak Inflation, and Low Interest Rates Urgently Requires Active Policy Intervention The widening gap between the monetary multiplier and extremes in a weak credit cycle weakens the pull of monetary supply on inflation; the reliance of loose fiscal policy on loose monetary policy constrains future conventional monetary policy space; in a low interest rate cycle, the misalignment of the declines in asset and liability interest rates increases operational pressure on the banking system Breaking the cycle of weak credit, weak inflation, and low interest rates requires targeted policies such as proactive interventions in broad credit and stable prices. The necessity of introducing an unconventional monetary policy framework is also increasing, and there may be greater room for reform in the future monetary policy framework. Source: CITIC Securities Research Risk Warning and Disclaimer The market has risks, and investment should be cautious. 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