Macro & Micro economics - Essay Example

? Macro & Micro economics Introduction This paper presents an analysis of an article d “China economic growth lower than forecast” published on 15 April 2013 by BBC. This report explains that China’s growth rate has been lesser than the growth rate that the country had experienced in last three months of 2012 (in the first quarter of 2013 Chinese economy grew at the rate of 7.7% while it was 7.9% in October-December quarter of 2012). The report also comments on the Government of China’s policy actions that are aimed at boosting the growth rate of the country’s economy (BBC, 2013). China's economy is the second-largest economy in the world. Currently, the country’s GDP has been estimated to be $12.38 trillion (according to the 2012 estimate) (CIA, 2013). However, recently the growth rate of the economy has slowed down significantly. After noting the declining performance level of the economy for the past few months, government has adopted certain policy prescriptions to improve the health of the economy. This paper discusses the main causes that lead to this issue and the level and pattern of impact that the problem casts on Chinese economy and society. The aggregate demand as well as the supply of goods and services in the economy is affected by this change in growth rate. The government is following expansionary monetary policy to improve investment climate in the economy and has increased level of public spending in order to increase domestic demand in the economy. Discussion on the economic problem issue China has depicted “soft growth momentum in the first quarter” (BBC, 2013) of 2013. According to Wei Yao from the Societe Generale of China, the figures measuring the different economic aspects are indicating a delicate performance by the economy and that it is not in a state of quick recovery. Between January and March in the current year (2013), economists forecasted growth rate of 8%, but, actual annual growth of China has been 7.7%. Rise in industrial output was a meager 8.9% in March and investment in fixed assets increased at the rate of 20.9% in this quarter. Data on some other key variables also reflected lesser growth than the market expectations. When all these phenomena are raising questions regarding the growth prospect in the country, the government has actively adopted policy changes to spur economic growth. Causes of the problem The article on BBC highlights two major concerns over the declining growth rate of the Chinese economy. Firstly, the economy has been heavily dependent on the export of various commodities and the major exports markets for the country are the USA and the European countries. The major items exported by the country are transport equipments, garments, accessories, toys, plastic products, machinery, rubber, textile, metallurgical products, Chemical products, fuel materials such as crude oil and refined oil, and food items (Peopledaily, 2001). China follows an export led growth and it has remained the largest contributor to the output of the global economy and accounts for nearly 3 percent of the global output. Although according to the International Monetary Fund, Chinese contribution to the global output is set to exceed that of USA, Germany and Japan; some economists have claimed in the past that the country would not be able to sustain its growth rate on the basis of exports for a long time. After the financial crisis of 2009 that had hit the USA and the European countries hard, economic growth in these countries slowed down. These countries faced serious financial crunch and their import demand decreased. Therefore, the Chinese economy experienced a loss of in export market. This had a major impact on the economy and its performance. Since the exports in the Chinese economy weakened, different sectors in the economy slowed down their production rates and the total output in the economy decreased that is reflected in the country’s gross domestic product. The constant sluggishness of economic performance in these advanced countries, particularly Europe and US, which are the key export markets for the country, fades a traditionally significant source of demand. At this same time, China also started facing the problem of widening of the wealth gap in the country. This is explained by the counter argument that has predicted that China’s export led growth would not be sustainable in the long run. It is elaborated by the concept of “Middle Income Trap” (Castells, Caraca and Cardoso, 2012). According to some economists, the country would inevitably experience economic slowdown after the Chinese GDP crosses the $17,000 mark (Eichengreen, Park and Shin, 2011). As the dollar becomes stronger against the Yuan, as a result of rise in real exchange rate, export level declines. Net output in the economy is affected by the net exports. Fall in net exports reduce the aggregate demand in the economy. Therefore price level falls and aggregate supply further contracts. Figure1: Fall in Aggregate demand in China (Source: Author’s creation) Impact on economy, society or even political stability Many developing economies, including China, have made economic ‘take off’ few decades back and at present are into their maturity stage. These are the middle income economies and presently are either passing through a stage of stagnation or are facing plummeting growth rate (Wang and Zheng, 2012). Hence they fail to grow into full fledged developed economies. They have already exhausted the technological advantage of their production process and the institutional sources to high growth have diminished. For China, the economic and social impacts of the over dependence on the policy of export led growth is that there has been over investment paired with under consumption. This has made the investment pattern unsustainable. This is one of the causes that the country has stagnated and has fallen into the middle income trap. The one child policy of the Chinese government has reduced the fertility rate of the population that very soon would affect the labor force in the country. With the aging population there would be shortage in the labor input which would reduce the economy’s total output (Wang and Zheng, 2012). Due to the rising income gap between the wealthy and the low income class, social unrest might be triggered in the economy. Government policies to solve the problem The Chinese economy is showing a fall in production levels since the beginning of the 2013. Therefore the country’s policymakers are now following expansionary monetary policy. This policy of the central bank aims at increasing the money supply in the Chinese economy. Lower interest rate would allow banks to keep more liquid money reserve with them, which they would extend as loans (NASDAQ, 2011). Under accommodative policy the central bank has reduced the rate of interest, which would make a greater supply of loanable funds to the economy. It would facilitate investors and allow them to make higher amounts borrowing. This would create higher demand for loanable funds by investors thereby swelling up the level of output in the economy. The interest rate prevailing in the economy indicates “the opportunity cost of holding money” (Arnold, 2008). When the rate of interest is lowered, opportunity cost of holding money reduces. Therefore, households switch from financial assets to liquid money. Since there is an inverse relationship between interest rate and demand for money, the government has reduced interest rate to spur higher demand for money by the common households which would ultimately lead to higher demand in the economy. Besides reducing interest rates, the government’s fiscal policy shows a higher level of public spending. Discretionary fiscal policy aims at increasing public spending which would positively affect the investment climate in China. To this end, the government has send approval to “more than $150bn (?94bn) worth of infrastructure projects” (BBC, 2013). As a result, there would be an expected real GDP growth in the country. Rise in government spending raises aggregate demand level by a more than the initial level of increase in spending. This is the multiplier effect. Higher government spending creates higher consumption through ‘induced spending’ (Schiller, 2011). Figure: Shift in aggregate demand at constant prices (Source: Author’s creation) With the initial increase in spending of amount $Y billion, aggregate demand curve moves rightwards from AD1 to AD2. At a given MPC (marginal propensity to consume), this shift represents the first round consumption hike. It creates additional income for all participants in the market, which is again invested for higher production activities. Thus more income is earned by the employees and the general level of demand in the economy rises. The aggregate demand curve shifts rightwards to AD3 due to this second round of multiplier induced increase in consumption. Price level in short run remains constant. Reasons for the policies With the financial downturn in the global economy, China has considered a major shift in their pattern of market. They now shifted their attention from the international market to the domestic market in China. The article published by BBC says, cites that policymakers now aspire “to increase domestic demand to reduce its dependence on exports and achieve more sustainable growth” (BBC, 2013). On the face of declining exports, demand-led growth stimulates expansion of productive activities in the country. Reduction of interest rates stimulates investment activities by investors. Since the 1980s, China has seen significant rise of the middle income population group. It majorly supports the demand side growth in the economy (Fewsmith, 2007). However, it must also be noted that although a large number of people is entering the ‘middle class’, ever since the rocketing growth of the country’s GDP, a stark rural urban income gap is becoming vivid. It reflects the rising wealth gap in the country (Sicular, et al., 2007). In such a scenario, the rise in government spending aims to inspire demand from all sections of the society. Domestic demand plays the role of a growth supporting engine helping the economy to pull up the level of domestic demand and thereby the level of supply; and government spending acts as a catalyst to boost domestic demand. It aims at developing an “inclusive growth model” (BBC, 2013). Comment on effectiveness & shortcomings/side effects Expansionary fiscal policy is an effective way to increase aggregate demand in the economy. Higher government spending leading to higher demand is a short run phenomenon in which prices are sticky. Therefore, adjustments in level of consumption occur at fixed price level. So, aggregate demand can be effectively increased without increasing the prices. Figure: Increase in real GDP at constant prices (Source: Author’s creation) With greater public spending, real output in the economy rises in short run. Prices can only adjust in the long run. Secondly, the reduction of interest rates along with approval of infrastructure projects creates greater employment opportunities in the country. Reduction of unemployment level would help to reduce the wealth gap in the economy. Hence a more inclusive growth pattern can be followed. However, easy monetary policy adopted at length might harm the economy in the long term. Some analysts have notified that promotion of such aggressive easing policies might create asset bubbles in the economy. Due to the low interest rates home loans would be available easily and people would invest more on real estate property. This might “overheat the economy” (BBC, 2013). Conclusion China has experienced significant economic growth in the past three decades based on its export sector. However, collapse of exports after the global financial downturn, after the 2008-2009 financial crises in the USA and the European countries, has reduced the economic performance in the country. At present China is facing a fall in real GDP and further expansion of the industrial sector has become difficult. Fall in net exports has led to fall in real national income which in turn is affecting the aggregate demand negatively. Lack of demand has further slowed down the productivity levels in the economy. This explains the need for rebalancing the economy and emphasis more on boosting the sources of domestic demand. This issue has become a priority for policymakers. Therefore the country has adopted expansionary monetary and fiscal policies to strengthen the manufacturing sector by bringing in higher investment and therefore creating higher employment opportunities on one hand, and raising the level of aggregate demand on the other. Reference List Arnold, R. A., 2008. Macroeconomics. Connecticut: Cengage Learning. BBC, 2013. China economic growth lower than forecast. [online] Available at: [Accessed 24 June 2013]. Castells, M., Caraca, J. and Cardoso, G., 2012. Aftermath: The Cultures of the Economic Crisis. Oxford: Oxford University Press. CIA, 2013. The World Factbook. [online] Available at: [Accessed 24 June 2013]. Eichengreen, B., Park, D. and Shin, K., 2011. When fast growing economies slow down: international evidence and implications for China. [pdf] Available at: [Accessed 24 June 2013]. Fewsmith, J., 2007. The Political Implications of China’s Growing Middle Class. China Leadership Monitor, 21, pp. 1-8. NASDAQ, 2011. Accommodative monetary policy. [online] Available at: [Accessed 24 June 2013]. Peopledaily, 2001. China's Main Export Commodities. [online] Available at: [Accessed 24 June 2013]. Schiller, B. R., 2011. The Macro Economy Today. New York: Tata McGraw-Hill Education. Sicular, T., Ximing, Y., Gustafsson, B. and Shi. L., 2007. The urban–rural income gap and inequality in China. Review of Income and Wealth, 53(1), pp. 93-126. Wang, G. and Zheng, Y., 2012. China: Development and Governance. London: World Scientific. Read More