Dynamic Efficiency Redux: Evidence from China

Abstract

Dynamic efficiency is an essential issue in macroeconomics, central to the analyses of consumption, asset pricing, and fiscal policies for both academia and policymakers. We first use a simple model to illustrate the connection between dynamic efficiency conditions and the interplay of consumption, welfare, and fiscal policy. With the condition that $r_f<g$, an active fiscal policy can increase consumption and welfare. Then, we offer an integrated analysis of metrics from the perspective of interest rates and capital returns, examining the relationship between varying rates of return $r$ and the growth rate $g$ in China. We compare the risk-free rate $r_f$, the returns on assets $r_e$, and the returns on capital $r_k$ with the growth rate $g$. Our findings indicate that, in general, $r_f<g$, $g<r_e$, and $g<r_k$. This condition suggests that fiscal policy can play a positive role in stimulating consumption. As the economy decelerates, the gap between $r_f$ and $g$ continues to narrow. Meanwhile, returns to capital appear to be declining slightly more slowly than the rate of economic growth. Furthermore, we use a state-space model to estimate China's natural rate of interest $r^*$ and potential output growth rate $g^*$, showing that $r^*<g^*$ and the gap between them has gradually narrowed over the past two decades.

Keywords: Dynamic Efficiency, Capital Returns, Natural Rate of Interest, Asset Bubbles, Financial Markets, China's Economy

JEL Classification: E43, E62, P51