Chinese Economic Reforms - Research Proposal Example

Chinese Economic Reforms, the Current Central Bank Monetary Policy And How This Policy might Control the Inflation Rate and Exchange Rate. Introduction The core spirit of the proposed dissertation is contextually aligned with two general economic manifestations namely: economic reforms and monetary policies in China on one hand and, inflation and exchange rates on the other hand. Ever since the late 1970's, China has implemented radical and phased economic reforms which have seen massive and unprecedented reduction in poverty levels. The reforms have seen government ceding control of market structures to private sector which has led to a higho much of GDP (as higher as 80%) to be in private sector, and a stronger Chinese economy, "which has enabled insurance companies and banks to make substantial investments with encouraging returns. The agreement presents significant competitive opportunities in the financial sector." (Ostry, et.al., 2003). As the Chinese economy continues to growopens up and competes with other industrialized economies, around the world, effective market and monetary policies and objectives demand close attention. Sustainable growth of the economy will be possible if viable macro and micro economic policies are in place and take into account such variables such as inflation objectives, flexibility of lending institutions in the face of changing interest rates, rate of credit growth, continuing economic reforms and exchange rates. These economics dynamics are partially controlled by the central bank of China (People's Bank of China). The dissertation will first examine Chinese economic reform and compile a body of literature offering objective analysis of key elements of the reform process, with a bias towards monetary policies, exchange rates and inflation. This work aims toe sole significance of this endeavor is to investigate unearth the main economic reforms and monetary policiescardinal arteries informing and shaping the Chinese economic status especially in regard to short term and long term inflation and exchange rates. Secondly, the dissertation will examine the monetary policies adopted by PBC in controlling inflation and exchange rates. The dissertation will investigate how the bank's monetary planning control exchange rates and inflation and how the efficacy of the bank's measures in controlling exchange rates and inflation. Theory1 The monetarist theory posits that mismanagement of the primary cause of inflation is how the money in supply is the primary cause of inflation. is managed. Inflation can also be linked toPrincipally, the cause of inflation is pegged on the flexibility of the lending process. As such, inflation will largely depend to a large extent, on how flexible or inflexible the lending institutions are and the levels of interest rates levels as well. Monetarists do no't believe that fiscal policies and taxation have very as having little effect on to do with controlling inflation control (Paul, 2000). Mathematicallaccording to the my, monetarists' theory, a product of the total value of money in circulation and the velocity of the money is directly proportional to the product of the average price level and the index of the real values of expenditures. expounds that M.V=P.Q In the formula: M is the total value of money in circulation, V is the velocity of money, P is the average price level and Q is the index of the real values of expenditures. Key highlights: a) the average price level is a variable influenced by the magnitude of economic activities(Q), total value of money(M), and the velocity of money(V) b) The key influencing variable of prices level is fluctuations in the amount of money available. c) If the velocity of money is constant (though in reality it is not possible) , the supply of money will determine value of nominal output. d) Assuming that the velocity of money is fairly constant, then the level of inflation will be equal to the difference between long run growth rate of money supply and long run growth rate of real output. In Keynesian economics, inflation is caused by market pressures to the economy in form changes in prices. Principally, inflation is caused by: a) Increased demand due to increased government and private sector spending. b) Drop in supply due to increased cost of production. c) increased wages resulting in price increases passed to consumers Exchange rates 1. Monetarists expected 'domestic prices and wages to be flexible enough to adjust to real and monetary policy shocks, they advocated an additional exchange rate flexibility as a Substitute for the lack of international price and wage flexibility. 2 Keynesian approach was based on stickiness of wages and prices. With insufficient flexibility of wages and prices in general, the Keynesian approach asked for a buffer to smooth international shocks or to avoid domestic misalignments leading to external imbalances. Thus, in a Keynesian approach too, exchange rates should be flexible: flexible enough, if not floating freely, to avoid real cost inhibited by adjustment to unforeseen external events' (Flassbeck, H 2001)(Flassbeck, 2001) Literature Review The rapid growth of China's economy has spurred credible body of literature addressing key fundamentals shaping up and driving this booming economy. Main economic issues addressed by examined literature include the government's monetary policies, domestic growth, capital inflows, central bank's policies and its independence, valuation if the renminbi , exchange rate policies , inflation, exports and imports dynamics amongst other issues. (See for instance Goodfriend, M and Eswar Prasad, 2007)Prasad & Ggoodfriend, 2006). Two Mmain economic aspects of the Chinese economy are given prominence in the examined strands of literature which rhyme with the spirit of the proposed study: inflation and exchange rates. (Goodfriend Prasad & Prasad Goodfriend (20076) elaborate the fast economic growth that has characterised the Chinese economy. The authors argue that as this economy is transformed into a modern ., market oriented phenomenon, it is inevitable that there be in place an independent monetary regime (read i.e. central bank) to ensure monetary planning is solely based on market and economic fundamentals. Goodfriend & Prasad The authors specifically identify inflation as a major hindrance in facilitating economic prospects and job creation. They also authors madke several recommendations that would help in stabilizing inflation. Firstly, they authors recommend 'low long run inflation objective' via implementation of viable macro economic policies rhyming with the exponential growth of the economy. Secondly, the authors advocate for independence of the central bank so that it can effectively adopt monetary policies reflective of a growing albeit inflation prone economy. Thirdly, there is a authors posit on the need for financial reforms so as to ensure that Chinese banking system can withstand shocks arising from changes in interest rates. Still, Goodfriend & Prasad the authors recommend an 'explicit' need for PBC to tie its monetary policies with 'inflation objectives' in an attempt to contain inflation. Generally, the authors have credibly made key recommendations on managing inflation- though there lacks enough empirical data to further solidify their views- and their contribution will definitely be a good skeletal foundations of the proposed study in as far as understanding inflation in China is concerned. (Zhang, C 2008) Zang (2007) Sstatistically documents inflation in China for the last few decades. Results indicates a 'decline in inflation pass-through accompanied with low inflation since the end of the 1990s'. Zhang The author then argues for the need of a new monetary framework which should guide the new economic realities such as tremendous economic growth, economic reforms and opening up of the Chinese economy to international investors. Additionally the author propose 'a discrete inflation-targeting framework for monetary policy, which is likely to be suitable for the regime of low inflation and inflation pass-through'. The statistics provided by the author will be of integral importance to the proposed study in as far as statistically understanding Chinese inflation is concerned. Zhang eZang (2008) examines capital inflows into China for the last ten years. The author , and attempts to shows that due to massive investment in China by foreign investors, excessive liquidity has become synonymous with the Chinese economy. The author develops an econometric model for inflation to show that excess liquidity has 'imposed significant pressure on inflation in China over the past 10 years. This finding suggests that "excess liquidity in China has not only contributed to the rise in stock prices and the real estate market boom, but also affected the consumer goods market" (Zhang, C 2008)'. The proposed study will seek to dig deeper into the issue and outline how the central bank deals with excessive liquidity and the short term and long term monetary and economic implications of any measures taken by the central bank. Liu&Tsang (2008) examine Chinese inflation from the perspective of changes in international prices of commodities. The author uses two-step approach to estimate 'the pass-through effects of changes in international commodity prices and the RMB exchange rate on domestic consumer price inflation in China'. Firstly, the author examines the pass through effects of fluctuations of international commodity prices on producer prices and then estimate the pass through effects of producer price inflation on consumer price inflation. A correlation between increase in international prices and increase in china's domestic inflation rate is detected. However, the author's findings indicate that 'a 10-percent appreciation of the RMB exchange rate against the US dollar would help to reduce increases in producer prices by 4.4 percent over the following 3 months, which in turn would lead to a 0.89-percent decline in consumer price inflation over the same period.' . Further, the author argues that appreciation of RMB and a weak US dollar would be effective in containing inflation in China . The significance of this work is twofold: firstly, the author offers a good explanation of hw international dynamics influence inflation in china thusly, allowing for an objective focus into the role of central bank policies in as far as international trading is concerned and how the adopted polices influence inflation in china. Secondly, international prices as tools of influencing inflation in China will be examined using the cited work as the epicentre of the examination. He(2008) models the policies of PBC in dealing with macro-economic issues. The author points out that PBC core policy has been to deal with inflation rates, principally as a strategic objective. This has been through radical changes in monetary policies and domestic economic changes meant to forestall massive inflation. This can only happen if the central bank enjoys massive operational freedom . However, Chung&Tongzon(2008) show that PBC is still not immune to government interference and as such its independence in as far as monetary policies are concerned is still highly compromised- an aspect that will be examined in greater detail by the proposed dissertation. Wong &Fujii(2007) argue that with massive transformation of Chinese economy, millions of Chinese have been lifted from a life of abject poverty. Chinese high level of growth, the authors discusses, has radically transformed the dynamics informing international trade, and this has raised concerns amongst the industrialised nations, notably due to cheap Chinese exports that flood international markets. Of great concern globally is Chinese foreign exchange policies which is not flexible. The authors contend that if Chinese exchange policies are highly flexible, it would temper domestic inflation and enable a more orderly solving of global trade imbalances. The authors conclude that china would benefit greatly through flexible exchange rates. The proposed dissertation will dig deeper and understand the measures that the central bank is undertaking to ensure more flexible exchange rates and the short term and long term implications of the measures. Roberts et al(2003) notes that the benefits of Chinese's government 'de facto peg to the US Dollar has been the subject of widening debate.'. Through examining different perspectives informing exchange regime in China, the authors advance the need for the Chinese government to adopt a more flexible approach in exchange rates . The authors use a comparative static macroeconomic model to examine different consequences under different exchange rates regimes and different degree of capital mobility. Results show that more flexibility in exchange rates would be beneficial for the Chinese, especially with increase in capital mobility . Clearly, the case of greater flexibility will inform a key perspective of the proposed study, with the consequences of more flexibility documented. Summers et al (2008) shows that China's exchange rate regime continues to influence global trade in variety of ways notably through volume of trade, foreign investments, trade tariffs and so on. The authors document the policy framework informing China's exchange rates decisions and how such decisions influence domestic markets and international markets as well. Further, the authors discuss the short term and long term implications of reforming the exchange rate policies in China and, like other quoted authors, they support greater flexibility of exchange rates. The succulent discussions presented in the book will no doubt inform substantially the proposed endeavour and ,hopefully, help understanding china's exchange rates regime. Dees(2001) show that in the long term, exchange rate appreciation decreases exports. How this will influence the exchange rate policies adopted by the People's Bank of China will be examined. This is further solidified by Shu&Yip(2006) who show that currency appreciation reduce exports due to 'expenditure-switching effect' resulting in 'a moderate contraction in aggregate demand.' . At this point in term, a pertinent question inevitably arise: Will PBC implement measures that will see currency appreciation at the expense of reduced exports. To answer this question, it will be inevitable to amalgamate all salient issues informing exports and exchange rates policies so as to arrive at an objective conclusion - one of the key boundary of the proposed study. Chapter Outline 1. Page titleA brief and clear description of the topic being addressed. 2. Acknowledgment Thanking those who helped the dissertation succeed. 3. Abstract.A summary of the dissertation plus the key findings, recommendations. 4. Table of contents. A table with relevant chapters and corresponding pages. 5. List of tablesA list of tables contained in the report. 6. List of abbreviationlist of all abbreviations used plus their full meaning. 7. IntroductionA general discussion of subject matter, then narrowing down to the dissertation's focus(1000 words) 8. Hypothesis: tentative theory advanced to be proved by the study(300 words) 9. Research questions: Questions that the dissertation seeks to answer.(500 words) 10. Literature review: A review of works done on the subject being investigated and how the current study adds up to their contributions.(2000 words) 11. Methodology: specific methods, data collection procedures, to be used to get data. (600 words) 12. Data analysis: Methods used to analyse data.(600 words) 13. Evaluation: examination of findings(2000 words). 14. Conclusions and recommendations: a brief summary of main findings, their implications and any relevant recommendations(500 words). 15. References: alphabetical listing of all sources quoted. References Chengsi Zhang (2007): Low Inflation, Pass-through, and a Discrete Inflation-targeting Framework for Monetary Policy in China Chinese Academy of Social Sciences. 15 (2007) Chengsi Zhang(2008): Excess Liquidity and Inflation Dynamics in China: 1997-2007 , Chinese Academy of Social Sciences Volume (Year): 16 (2008) Issue (Month): 4 Cheung, Yin-Wong & Chinn, Menzie D. & Fujii, Eiji, 2007. "The overvaluation of Renminbi undervaluation," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 762-785, Connie Wee-Wee Chung &Jose L. Tongzon(2004): A paradigm shift for China's central banking system. Volume (Year): 27 (2004) Issue (Month): 1 (October) Pages: 87-104 Dees, S. (2001), The Real Exchange Rate and Types of Trade - Heterogeneity of Trade Behaviours in China. Paper presented at the Workshop on China's Economy organised by the CEPII in December 2001 Heiner Flassbeck, H (2001): The Exchange Rate: Economic Policy Tool Or Market Price Retrieved From http://www.unctad.org/Templates/Download.aspdocid=1758=1&intItemID=2101.10th December, 2008 Flassbeck, H - Financial Times Deutschland, 2001 Goodfriend, M and Eswar Prasad (2007) A Framework for Independent Monetary Policy in China. CESifo Economic Studies, Oxford University Press, vol. 53(1), pages 2-41, March . Online Lagass, Paul (2000). Monetarism. The Columbia Encyclopedia (6th ed.). New York: Columbia University Press Larry Summers(2008): Debating China's Exchange Rate Policy. The Peterson Institute for International Economics; 1 edition. ISBN-10: 0881324159 Ligang Liu & Andrew Tsang (2008): Pass-through Effects of Global Commodity Prices on China's Inflation: An Empirical Investigation. Chinese Academy of Social Sciences Volume (Year): 16 (2008) Issue (Month): 6 () Pages: 22-34 Liping He(2008): Has Fiscal Federalism Worked for Macroeconomic Purposes The Chinese Experience 1994-2003. , Chinese Academy of Social Sciences. Volume (Year): 16 (2008) Issue (Month): 1 () Pages: 17-33 Marvin Goodfriend & Eswar Prasad, 2007. "A Framework for Independent Monetary Policy in China," CESifo Economic Studies, Oxford University Press, vol. 53(1), pages 2-41, March Ostry, Sylvia, Alan S. Alexandroff and Rafael Gomez (2003) China and the Long March to Global Trade: The Accession of China to the World Trade, Routledge Courzon, New York Roberts, Ivan &Tyers, Rod(2003): China's Exchange Rate Policy: The Case for Greater Flexibility. Asian Economic Journal, Volume 17,Number 2, June 2003 , pp. 155-184(30)Publisher: Blackwell Publishing Shu C. and Yip, R. (2006), Impact of Exchange Rate Movements on the Chinese Economy, Hong Kong Monetary Authority, No. 3/06, July 2006 Summers, L(2008): Debating China's Exchange Rate Policy. The Peterson Institute for International Economics; 1 edition. ISBN-10: 0881324159 Zhang, C (2008): Excess Liquidity and Inflation Dynamics in China: 1997-2007 , Chinese Academy of Social Sciences Volume (Year): 16 (2008) Issue (Month): 4 Roberts, Ivan &Tyers, Rod(2003): China's Exchange Rate Policy: The Case for Greater Flexibility. Asian Economic Journal, Volume 17,Number 2, June 2003 , pp. 155-184(30)Publisher: Blackwell Publishing Shu C. and Yip, R. (2006), Impact of Exchange Rate Movements on the Chinese Economy, Hong Kong Monetary Authority, No. 3/06, July 2006 . Read More