Since the second quarter of this year, some economic indicators have been weaker than expected, reflecting that the current economic recovery in our country is still unbalanced. In June, the central bank lowered the policy interest rate, and the Loan Prime Rate (LPR) also followed suit. Some market voices believe that this move means that the policy interest rate has opened a downward channel. However, can further interest rate cuts in the short term really effectively stimulate consumption and investment? This is the key to the question. We believe that due to the lack of substantial improvement in the expectations of economic entities, the decline in risk preference, and the relatively low asset prices, the interest rate elasticity of consumption and investment in our country is not high at present, and the role of further interest rate cuts in the short term to stimulate consumption and investment is limited. In particular, the coupling relationship between consumption and investment will further weaken the interest rate elasticity of total demand. Although for individuals, consumption and savings (corresponding to investment) are mutually exclusive, in the macroeconomic cycle, investment and consumption are not isolated relationships. Both are important components of the economic cycle, and they promote each other and complement each other. That is to say, the interest rate elasticity of total demand is not a simple addition of the interest rate elasticity of consumption and the interest rate elasticity of investment, but more likely has a multiplier effect. Weak consumer spending will reduce corporate investment demand, weak investment will further lead to weak employment, income, and consumption, and finally be transmitted to total demand. Considering the current social, economic, and livelihood environment, our country does not have the macro conditions and foundation for continuous interest rate cuts.

I. During the economic upswing period, consumption and investment are often more sensitive to interest rate changes

"Interest rate elasticity" refers to the degree of impact of a unit change in interest rates on other economic variables (such as consumption and investment). Economic theory describes interest rate elasticity simply, but in real life, interest rate elasticity is subject to many factors, which ultimately affect and determine the implementation effect of interest rate policy tools.

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Interest rates are the price of money, and the level of interest rates directly affects the demand for money by economic entities, specifically manifested as the demand for resident savings and corporate financing, and thus affects resident consumption demand and corporate investment demand. Resident income is disposable for consumption and savings. Given a certain level of income, the interest rate elasticity of consumption is symmetrical to the interest rate elasticity of savings. Theoretically, the impact of real interest rate changes on savings has both a "substitution effect" and an "income effect", and the direction of change of the two is opposite, so the impact of interest rates on savings is uncertain. The substitution effect, simply put, is that when interest rates rise, current consumption becomes more expensive, so consumers will reduce current consumption and increase future consumption, thus saving more; the income effect, simply put, is that when interest rates rise, people expect future income to increase, so they choose to increase current consumption, leading to a decrease in savings. The impact of real interest rate changes on savings (or consumption) depends on which effect is dominant. For businesses, financing is an important source of funds for investment. Theoretically, given the rate of return on capital, interest rates are an important factor affecting investment decisions. When interest rates rise, financing costs increase, and financing demand will decrease.

To measure the interest rate elasticity of savings and financing during the economic upswing and downswing periods in our country, we divide from 1997 to the present into four stages, which are: (1) the East Asian financial crisis period (1997 to 1999), our country first experienced a real effective demand shortage, accompanied by deflation, increased unemployment, gradual exposure of domestic financial risks, and difficult state-owned enterprise reforms; (2) the high-speed growth period (2000 to 2007), our country maintained high-speed growth for many years, accompanied by gradually increasing inflation levels; (3) the stable growth period (2008 to 2019), our country's economic growth and inflation levels were relatively stable; (4) the post-epidemic period (2020 to the present), our country's economic growth fluctuated significantly and declined, and inflation levels showed a more obvious downward trend. Stages one and four can be considered as economic downswing periods, and stages two and three can be considered as economic upswing periods.

After calculation, the correlation coefficients between the actual deposit interest rate and the monthly incremental trend of savings in the above four stages are -0.02, 0.45, 0.44, and 0.02[1]. This indicates that during the economic upswing period (stages two and three), the savings interest rate elasticity is high and significant, while during the economic downswing period (stages one and four), the savings interest rate elasticity is low and not significant. Generally speaking, during the economic upswing period, resident income increases rapidly, and investment willingness is strong. With rising interest rates, residents are more willing to pursue investment returns, and the "substitution effect" of savings interest rate elasticity is more obvious, thus showing a high savings interest rate elasticity. An increase in savings also leads to a decrease in consumption, so the consumption interest rate elasticity is also high. During the economic downswing period, resident income expectations weaken and become more risk-averse. With falling interest rates, residents expect future deposit returns to decrease, choose to increase savings to improve future income levels, thus delaying current consumption, the "income effect" of savings interest rate elasticity is more obvious, so both savings interest rate elasticity and consumption interest rate elasticity are at a low level.

Table 1: Estimation results of savings interest rate elasticity and financing interest rate elasticity during the economic upswing and downswing periods

In the above four stages, the correlation coefficients between the actual loan interest rate and the monthly incremental trend of loans are -0.33, -0.40, -0.68, and 0.33. It can be seen that during the economic upswing period (stages two and three), the loan interest rate elasticity is high and significant, which is in line with the general theoretical law, while during the economic downswing period (stages one and four), the loan interest rate elasticity is low and not significant, which may be contrary to the general theoretical law. Overall, during the economic upswing period, corporate capital returns are high, investment and financing willingness is strong, corporate financing demand is sensitive to interest rates, and thus investment demand interest rate elasticity is high. During the economic downswing period, corporate capital returns are low, investment and financing willingness is not strong, coupled with differences in financing environments between state-owned and private enterprises (which will be analyzed below), corporate financing demand is not sensitive to interest rates, and investment interest rate elasticity is not high.

In addition to the economic fundamentals, market entities' expectations for future interest rate trends will also affect interest rate elasticity. During the economic upswing period, the central bank can continue to raise interest rates to curb inflation, and theoretically, there is no upper limit to interest rate hikes. The market will also raise expectations for future interest rates, thereby adjusting current consumption and investment demand choices, so monetary policy regulation shows obvious effects. During the economic downswing period, the central bank's interest rate tools will face the restriction of the "zero lower bound," which means the central bank cannot continue to lower interest rates to stimulate consumption and investment. Market entities, based on this expectation, also have some concerns about increasing consumption and investment at present, leading to a slower economic recovery, which is manifested as a "pushing the rope" situation in monetary policy regulation.

II. The current risk-avoiding sentiment has reduced the interest rate elasticity of consumption in the household sectorRecently, several banks have announced a reduction in the interest rates for demand and time deposits, and the deposit interest rates (including the returns on wealth management products) have entered a downward trend. Concurrently, data indicates that the growth rate of consumer spending has significantly slowed down after the pandemic. Specifically, the total retail sales of consumer goods in the first quarter of 2023 grew by about 5.8% year-on-year, which still lags significantly behind the pre-pandemic growth levels (with an average growth rate of around 9% from 2015 to 2019). In April and May, the total retail sales of consumer goods continued to recover, but only increased by 0.2% and 0.42% month-on-month (seasonally adjusted), respectively. The coexistence of declining interest rates and reduced consumption growth implies that relying solely on lowering deposit interest rates may not be sufficient to boost consumer spending, for various reasons.

Firstly, the expected decline in income and falling prices lead to insufficient immediate consumption demand. During economic downturns, when the expectation of future income decreases, residents will cautiously consider their current consumption choices. Data released by the National Bureau of Statistics shows that the consumer income expectation index in March was only 104.3, the lowest on record for the same period, which will have a certain impact on immediate consumption. At the same time, from January to May 2023, the CPI growth rate year-on-year was 2.1%, 1%, 0.7%, 0.1%, and 0.2%, respectively, with the growth rate declining and remaining at a low level. People's expectations for further price declines may become more entrenched as prices continue to fall, even delaying consumption in anticipation of more favorable prices, especially for non-essential or durable goods. This could lead to further price declines, resulting in a "self-fulfilling prophecy."

Secondly, low asset prices will reinforce residents' willingness to deleverage, further suppressing consumption. Currently, the overall real estate market in China is relatively sluggish, which will drive adjustments to residents' balance sheets and ultimately affect consumption. Residents typically choose medium to long-term mortgage loans to purchase housing. When the increase in real estate prices slows down, the expected returns on the residents' asset side begin to decrease, and may even be lower than the cost on the liability side (although the interest rates on personal housing loans have decreased but the extent is limited), while the returns on residents' savings are also declining. Therefore, reducing debt levels (deleveraging) can effectively reduce the interest burden on residents, and the willingness to repay loans in advance increases. This means that some residents' savings are used to repay debts, rather than increasing consumption. For residents in poor economic conditions, falling real estate prices may also trigger insolvency or even loan defaults, which can directly dampen consumption demand. Looking at the data on the scale of residential housing loans, in the past year (from June 2022 to May 2023), the average monthly increase in medium to long-term loans by households was 217 billion yuan, which is 284.3 billion yuan less than the average monthly increase from 2020 to 2021 (excluding the impact of the spring 2022 pandemic). This not only reflects the current weak real estate sales market but is also related to the large amount of early loan repayments by residents. Like the "self-fulfilling" expectation of falling prices, the decline in asset prices may also lead to a self-fulfilling expectation, further intensifying the risk of asset price volatility.

Lastly, the gradual decrease in residents' risk preferences and the continuous accumulation of precautionary savings will also drag down current consumption. The recovery of the real economy after the pandemic still requires time, and the friction in the economic cycle has not been eliminated, with employment pressure and unemployment risks remaining high. In the face of increased future uncertainty, residents choose to increase precautionary savings, and the amount of cash held continues to rise. From the data, from the beginning of 2020 to May 2023, the average monthly increase in residents' deposits was 1.2 trillion yuan, nearly 0.6 trillion yuan more than the average monthly increase from 2017 to 2019. Among them, the proportion of time deposits has risen from 63.3% in January 2020 to 71% in April 2023. For the demand for precautionary savings, the most critical factors are the safety and convenience of funds, not the level of interest. Therefore, interest rate cuts will not lead to a decrease in the scale of precautionary savings, and thus it is difficult to achieve the expected goal of stimulating an increase in consumption. Instead, it may encourage people to further increase savings. This is consistent with the phenomenon of consumption lacking interest rate elasticity during economic downturns. During the East Asian financial crisis in the 1990s, China's central bank adopted an expansionary monetary policy of continuously lowering interest rates, but the final effect was minimal—residents still chose precautionary savings despite low savings interest rates.

It is worth noting that there are differences in the interest rate elasticity of savings among different groups of residents. For middle and low-income groups, their consumption expenditures are mostly for necessities, relatively rigid, and they lack investment and insurance tools, with weak risk resistance, so they prefer to save their income. Especially during economic downturns, the interest rate elasticity of savings is naturally low. The marginal propensity to consume for high-income groups is relatively lower. Therefore, if interest rate cuts cannot promote middle and low-income groups to increase consumption, then the overall consumption driving effect is also limited.

III. Private enterprise financing supply and demand are weak on both sides, financing is difficult to transform into effective investment, and the elasticity of investment interest rates is reduced.

Since the pandemic, China's central bank has always maintained a reasonable and sufficient liquidity, and the overall fund supply of commercial banks has also been relatively sufficient. The social financing scale and the growth rate of broad money have always been maintained at around 10%. In March of this year, the weighted average interest rate for newly issued corporate loans was only 3.95%, 0.41 percentage points lower than the same period last year, a new low in recent years. Despite this, the decline in interest rates has not led to a significant increase in investment growth. From January to May this year, the cumulative year-on-year growth rate of fixed investment in the whole society was only 4.0%, 2.2 percentage points lower than the same period last year; the slowdown in private investment growth was even more obvious, with a cumulative growth rate of only -0.1%, and the growth rate was 4.2 percentage points lower than the same period last year. At present, the marginal effect of further reducing interest rates to stimulate investment and financing may be limited.

From the perspective of financing demand, private enterprises have relatively small asset scales and weaker abilities to resist risk shocks. During economic downturns, the reduction in investment and financing demand is more significant than that of large enterprises. In addition, the objective existence of the "difficulty and high cost of financing" for small and medium-sized enterprises, their investment decisions mainly depend on whether they can obtain loans, not the level of interest rates. Therefore, interest rate adjustments will not have a significant impact on the investment decisions of small and medium-sized and private enterprises. Large enterprises, especially state-owned enterprises, have relatively large asset scales and stronger abilities to resist shocks. At the same time, the level of interest rates is not the core consideration for state-owned enterprises' investment and financing decisions, so their loan decisions are not sensitive to interest rate levels. State-owned enterprises still achieved profits of more than 1 trillion yuan in the first quarter of this year (a year-on-year increase of 12.4%), and their financing demand has been stable under the annual economic growth target.

From the perspective of fund supply, during economic downturns, asset price adjustments usually occur, which to some extent reduces the willingness of fund providers to provide funds to enterprises, leading to a decline in corporate financing capabilities. Specifically, when asset prices fall, the reduction in corporate net asset value will lead to an increase in external financing premiums, and when enterprises are obstructed in external financing, they often reduce investments, resulting in a decline in output and an increase in unemployment. The contraction of economic activities further reduces corporate net assets, and investments continue to decrease. This is the "financial accelerator" mechanism proposed by former Federal Reserve Chairman Bernanke and a specific manifestation of the "balance sheet recession" after the Japanese bubble economy. Compared with state-owned enterprises, which can obtain financing from multiple channels (including bond financing, credit loans, etc.), private enterprises have more single channels to obtain funds, most of which are mortgage loans, and the collateral is mostly real estate, land, and other immovable properties. The above mechanism will be more evident in their business processes.

There is a lack of statistical data on the loan scale of state-owned and private enterprises, but we can see some clues from bond financing data. From January to May 2023, the net bond financing scale of private enterprises was reduced by 84.32 billion yuan compared to the same period last year, and the credit spread (AAA level) increased by 59 basis points; the net bond financing scale of state-owned enterprises was only reduced by 5.74 billion yuan compared to the same period last year, and the credit spread (AAA level) only increased by 4 basis points. The slowdown in private investment growth is not unrelated to the poor financing situation of private enterprises.IV. The Distributional Effects and Side Effects of Continuous Interest Rate Cuts Are Worthy of Attention

The current low elasticity of consumption and investment in our country limits the effectiveness of policy interest rate tools. At the same time, considering that our financial system is primarily bank-based, the marketization of interest rates is still in progress, the financial market is not yet developed, the international status of the renminbi is not high, the average income level of residents needs to be improved, and the policy positioning of "housing for living, not for speculation" will be adhered to for a long time, our country does not currently have the social, economic, and livelihood foundation for continuous and substantial interest rate cuts.

From a deeper perspective, due to the low interest rate elasticity, the impact of continuous policy rate cuts on consumption, savings, and investment and financing scale is not strong, but rather manifests as profit distribution among economic entities. Although policy rate cuts will guide the LPR (Loan Prime Rate), the benchmark interest rate for loan pricing, to move downward, leading to a reduction in corporate interest expenses, this is ultimately only a partial, static, short-term phenomenon. We urgently need to think from a holistic, dynamic, long-term perspective about the profit distribution among enterprises, commercial banks, and the residential sector under the background of continuous interest rate cuts.

On the one hand, considering that commercial bank loans are mainly directed to state-owned enterprises, on the surface, interest rate cuts can reduce interest expenses and increase the profits that state-owned enterprises contribute to the fiscal revenue. However, continuous interest rate cuts guiding the LPR downward will narrow the interest spread of commercial banks, leading to a decline in bank profits. As an important part of our country's banking system, the six major state-owned commercial banks and the three policy banks also have the obligation to contribute profits to the fiscal revenue. The Ministry of Finance's arrangement for certain state-owned financial institutions and specialized institutions to contribute profits is also a conventional practice in our country, an important means of coordinating fiscal resources and regulating funds across years. This means that continuous interest rate cuts may lead to a "left pocket in, right pocket out" result in the "national account book," and cannot achieve the expected effect of enriching the national treasury funds. At the same time, our country's national debt and local government debt are mainly held by commercial banks (data shows that at the end of May 2023, 68.8% of our country's national debt was held by commercial banks, and 85.5% of local government debt was held by commercial banks). Continuous interest rate cuts can indeed reduce the interest burden of the central and local governments and improve fiscal conditions, but this will also damage the interests of banks as creditors to a certain extent, which will offset the extent of fiscal condition improvement brought about by the downward movement of bond interest rates. From this, it can also be seen that the key and essence of improving our country's fiscal conditions lies in boosting economic growth, not in reducing the level of policy interest rates.

On the other hand, to maintain a certain interest spread, commercial banks are also inclined to slowly reduce deposit interest rates. This operation will shift the pressure of the decline in commercial bank interest income to residents, leading to a reduction in residents' deposit returns. This is not conducive to stimulating resident consumption, and thus it is difficult to increase the willingness of enterprises to invest.

In addition, the side effects of continuously lowering policy interest rates should not be ignored. First, it is not conducive to the stable operation of the banking system and damages the enthusiasm of banks to support the development of the real economy. Continuously adjusting the MLF (Medium-term Lending Facility) policy interest rate, the LPR is also likely to continue to move downward, and as the "ballast stone" of our country's interest rate system, the deposit interest rate has also declined, of course, the change is relatively slow, and the interest spread and income of banks are not optimistic, which will have an adverse impact on the enthusiasm and stability of banks. Our country's economy is still in the process of warming up and urgently needs to avoid the occurrence of financial risks and instability. Second, it may lead to liquidity accumulation in the financial system. When the financing demand of our country's real economy is relatively weak and the bank credit quota is relatively sufficient, continuous interest rate cuts may lead to funds accumulating in the financial system, causing a certain degree of "idle capital turnover." Once there are unexpected fluctuations in the short-term capital market, regulatory policy adjustments, or unexpected events, the financial market and financial institutions will be impacted. Third, it increases the potential risk of inflation. Keeping interest rates too low for a long time will increase the risk of future inflation, and the low- and middle-income groups, which have a high proportion of daily consumption expenditure in their income, are particularly sensitive to inflation. Fourth, it may exacerbate the problem of overcapacity and supply exceeding demand. Our country has strong production capacity and organizational mobilization ability. Keeping interest rates too low for a long time may delay the exit of inefficient enterprises from the market, which is not conducive to our country in forming effective supply and matching effective demand, thus delaying the transformation and upgrading of our country's economy and the process of high-quality development.

In summary, due to the unstable expectations of economic entities, the decline in risk preference, and the low asset prices, the interest rate elasticity of our country's consumption and investment is not high at present. Continuously lowering policy interest rates has a limited effect on promoting residents to reduce savings and increase consumption, and the marginal effect on stimulating real enterprises to expand investment and financing is also not strong. Instead, it will show a more obvious distribution effect, leading to a "left pocket in, right pocket out" phenomenon in the "national account book," and residents transferring payments to commercial banks and enterprises. Keeping interest rates at a low level for a long time may also have adverse effects on financial stability and price stability, and exacerbate the contradiction of overcapacity and supply exceeding demand. All these indicate that monetary policy is "effective but limited." At present, China's economy is still in the process of returning to normal operation, and in the future, it is necessary to introduce and implement various reform and innovation policies and measures to solve the deep-seated problems that lead to low interest rate elasticity, provide a good environment for economic operation, and boost the confidence of economic entities.

[1] The actual deposit interest rate is the 3-year nominal deposit interest rate minus the inflation level. Considering the changes in our country's policy interest rate system, our country's deposit benchmark interest rate has not been adjusted after October 2015, but as a new policy interest rate, the reverse repurchase and medium-term lending facility interest rates have been adjusted many times, which will affect residents' savings returns through interest rate transmission. Therefore, the deposit interest rate here combines two types of interest rates, the 3-year fixed deposit interest rate before October 2015, and the 7-day reverse repurchase interest rate after that.

To reasonably estimate the change in savings, considering the long-term upward trend of savings deposits, we first use the filtering method to calculate the cyclical change of savings deposits. Since the cyclical change of savings deposits also has a certain monthly effect, we use the filtering method on this basis to calculate the trend of the cyclical change of savings deposits, as the "savings monthly incremental change trend."

The calculation method for the actual loan interest rate and the loan monthly incremental change trend is similar. Among them, the benchmark interest rate for loans from 1 to 3 years was used before October 2015, and after that, it was the weighted average interest rate of financial institutions' RMB loans in the "China Monetary Policy Implementation Report."