Contribution of interest rate control to China’s economic development

Abstract

China’s economy has grown at an unprecedented pace since 1978, which has resulted in a sustained improvement in the average living standard in China. A theoretical model is developed in the present study to analyze the role of interest rate control in China’s economic growth, where investment is primarily determined by interest rates available to firms and entrepreneurs. When the central bank regulates the interest rates and makes them below the equilibrium rate, high-level investment activities boost economic growth and introduce new technologies into the economy, which in turn promotes growth in labour productivity. As the current marginal product of capital is much higher than the interest rate, the output growth is much faster than consumption growth and exports become an important part of the economy. To maintain competitiveness of exports over a longer period, it is necessary to keep exchange rates low, which results in large foreign exchange reserves. When the export sector is losing its competitiveness edge due to increased labour costs and exports cannot digest the difference between output growth and consumption plus investment growth, interest rate control may lose its positive impact on economic growth.