(Yicai) Dec. 19 -- To achieve the goal of 'promoting a reasonable recovery in prices' set at the Central Economic Work Conference held on Dec. 10 and 11, monetary policy may need to place greater emphasis on interest rate cuts, and their extent should be significant.

The inflation rate can be seen as the temperature of the economy; it should not be too high or too low. A moderate inflation rate is the foundation of economic vitality and is essential for economic growth and employment.

Developed countries often set a target inflation rate of 2 percent, while high-growth developing countries typically experience inflation rates above 3 percent. During China's high-growth period from 1992 to 2010, the average annual inflation rate was about 5.2 percent. In those years, the average annual growth rate of the country’s real gross domestic product, after accounting for price factors, was about 10.3 percent.

In the first 11 months of this year, China's average consumer price index remained flat from a year earlier, influenced by the slower recovery of domestic demand and intensified market competition.

In response, monetary policy can increase the money supply and cut interest rates, with the latter being key. A rate cut can increase the supply of low-cost money, fundamentally enhancing investment returns and consumer willingness to spend, activate the banking system and the private money supply, converting idle deposits into investments and consumption, and improve market expectations.

A significant rate cut is an active signal of monetary easing from the central bank, conveying a policy intention and determination to boost the economy, thereby enhancing the confidence of businesses and households.

However, the effectiveness of interest rate cuts depends not only on whether the rates are lowered but also on the extent of the reduction. In particular, the magnitude of the decrease in real interest rates.

For an easing monetary policy to be effective, the rate cut must exceed the decline in the inflation rate, which can lead to a genuine reduction in real interest rates. The goal should be to drive the CPI back to a reasonable range of around 3.5 percent. Only in this way can the financing burden on businesses and residents be truly alleviated, thereby stimulating the vitality of the real economy.

In addition, interest rate cuts can reduce the government's financing costs, supporting the implementation of a more proactive fiscal policy as proposed in the Central Economic Work Conference. This creates a synergistic effect between monetary and fiscal policy.

The author of this article is Ruan Jia, director of the China Financial Research Center at Beijing Jiaotong University.

Editor: Futura Costaglione