Macro & Micro economics - Essay Example

? Macro & Micro economics Introduction China is one of the fastest growing economies in the world. Being the second-largest economy, China has shown tremendous growth in the last three decades. According to the estimate of 2012, China’s GDP is US $12.38 trillion (CIA, 2013). In the last quarter of 2012, growth rate in the economy was estimated to be 7.9% (BBC, 2013). However, immediately in the first three months of the current year (2013) the growth rate dropped notably. The government of China noticed this fluctuation early in 2013 and decided to take expansionary policies to pull up the growth rate. This paper aims at studying an article titled “China to continue ‘proactive fiscal, prudent monetary’ policy” written by Siwu and Zhi and published in Xinhuanet on March 5 2013. The article presents a report on the present growth rate of China and discusses the government’s policy prescription with regard to this growth situation in the country. At present annual growth rate of the country is 7.7% and the central bank has taken expansionary monetary policy to boost up economic activities in the country (BBC, 2013). The fiscal policies adopted by the government have also been discussed in the article. The discussion presented in this paper identifies the major causes that have affected the growth rate of the Chinese economy and comments on the policy adaptations of the government as discussed in the news article. The impact faced by the Chinese society on account of this economic slowdown has also received light in the scope of this discussion, alongside the discussion on the aggregate demand and supply in the economy. Aggregate demand in the Chinese economy has declined as a result of this declining growth rate. The government has focused on improving domestic demand conditions in order to boost up the economy. Discussion on the economic problem The growth momentum in the country has been showing a lack of vigour since the beginning of 2013. The measures of various economic variables in the country are indicative of a low performance level in the economy, which implies that there is no strong point of evidence that might show that the economy has any prospect for recovering soon. In 2013, estimate of the growth rate of the economy has been 7.7% from January to March, while economists had forecasted that growth rates would reach 8%. In response to this economic situation the government of China has declared that it would sustain the “proactive fiscal policy and a prudent monetary policy” (Siwu and Zhi, 2013) throughout the year in 2013. Proactive monetary policies have been maintained by the Chinese government since the 2011, with the aim of bringing stability in the economy, to make the economic structure flexible for future improvements and more forward-looking and target-oriented. This would ensure steady economic growth. While bringing economic growth the government aims at keeping the price level in the economy stable and guard against the occurrence of any regional or systemic financial risk. The government has vowed to guide the financial institutions, to make them operate prudently, oversee the financial activities of the institutions and take account of the risks associated with off-balance sheet activities, so as to make the financial sector's more sustainable and capable of supporting long term economic development. Causes of the problem The article by Siwu and Zhi (2013) reflects that the government of China has been actively making policy prescriptions that are aimed at improving the economic conditions of the country. Further research on this issue reveals that growth of the Chinese economy has been highly dependent on its export sector. The major markets for Chinese exports are the USA and the European countries. The country mainly exports, garments, toys, accessories, other plastic products, machinery, transport equipments, rubber, metallurgical products, textile materials, chemical products, refined oil and crude oil, as well as food items (Peopledaily, 2001). China follows an export led growth since the last three decades and it maintained the position of the largest contributor to global output. According to report of the International Monetary Fund, China would account for greater share of the total output of the world economy by 2020, and would exceed the share of the developed nations, like the USA, Japan and Germany (Castells, Caraca and Cardoso, 2012). However, according to some analysts, such an export driven growth rate would not be sustainable and the economy would face economic downfall once the GDP rises too high (BIS, n.d.). At present the estimated GDP of the economy is $12.38 trillion and economic growth has already started to slowdown (CIA, 2013). The USA and the countries in Europe have been hit hard by the financial crisis of 2007. Economic growth has therefore declined in these nations. Due to their economic downfall import level by these countries has fallen. Obviously, it has affected the export market in China. Since the Chinese economy has been dependent on its export market for a long period of time, fall in exports have had a significant impact on the performance of the economy. All sectors in the economy are interrelated and with the weakening of the export sector, the other sectors have also been adversely affected. Poor performance by these sectors is shown by their lowered rates of production, due to which the real GDP (gross domestic output) in the economy has fallen. China maintains a flexible exchange rate. With a rise in the real rate of exchange, value of dollar rises against the Yuan and export falls. The level of net exports directly affects the net output in the economy. Declining exports reduces the overall income of the economy and the level of aggregate demand decreases. Falling demand signifies falling price level which reduces the aggregate supply in the economy further. Figure1: Fall in aggregate demand in China (Source: Author’s creation) High dependence on exports is just one part of the story. The problem of widening wealth gap has been engulfing the economy. There is a rapid emergence of ‘middle class’ in the economy and difference of income between the middle income group and the low income group is rising. An explanation for this phenomenon has been provided by the prior prediction regarding China’s economic growth rate; once the Chinese economy reaches the $17,000 mark it would start slowing down on economic growth (Eichengreen, Park and Shin, 2011). The notion of ‘Middle Income Trap’ explains this phenomenon of wealth gap (Castells, Caraca and Cardoso, 2012). China has come across its ‘take-off’ stage and exhausted its technological advantage, due to which it is not being able to fully develop like the other developed nations (Wang and Zheng, 2012). Impact on economy, society or even political stability The advanced countries are the major source of import demand in the international market. Therefore, sluggish economic growth in these countries, especially, the US and Europe, reduces scope of export for China. Since the country is facing an economic downfall, productive activities in the economy is also declining. For the last few decades when the economy had been experiencing soaring growth rates, it indulged in over investment. There has been over utilization of resources compared to the level of production. Over dependence on export sector created negative impact on the socio-economic scenario. Since the investment pattern has become unsustainable, economic growth in China has stagnated and the country is trapped in the middle income zone. Besides, government policy of one child has social and economic implication. Low birth rate combined with the aging population would lead to scarcity in the labour force few years down the line. This would further reduce productivity (Wang and Zheng, 2012) and affect the total economic output. Low productivity would imply lower income levels and the income gap between the middle income earners and the poor would be augmented. This creates the chance for occurrence of social unrest within the economy. Government policies to solve the problem The Chinese government has declared that it follow a “proactive fiscal policy” (Siwu and Zhi, 2013) that would stimulate growth in the economy and facilitate demand creation within the economy. This measure would be complemented with a strong oversight over the financial institutions in the economy so as to reduce the off-balance sheet activity related risks in different sectors in the economy. Chinese policymakers have adopted expansionary monetary policy. Under this policy the Central Bank of China reduces the interest rate with the purpose of increasing money supply in the economy. At lower rate of interest banks would have higher amount of liquid reserve and investors would borrow more than before (NASDAQ, 2011). With rising investments, real GDP would ultimately rise. Interest rate is a measure of “the opportunity cost of holding money” (Arnold, 2008). When interest rate falls, opportunity cost of holding money also declines. An inverse relationship exists between demand for liquid money and rate of interest. Hence, common households make higher demand for liquid money. This would swell up the economy’s aggregate demand level. The government has also adopted expansionary fiscal policy. It has increased public spending and implemented tax cuts. For example, an infrastructure project worth of higher than $150bn has been approved by the government in 2013 (BBC, 2013). In 2013, the government would combine tax reform with higher budget deficit to maximise domestic demand (Siwu and Zhi, 2013). Government spending creates a multiplier effect, which is a series of rises in income in the economy. Initial rise in public spending increases aggregate demand by a greater amount than the amount of spending. The aggregate demand curve moves rightwards form AD1 to AD2. Figure: Shift in aggregate demand at constant prices (Source: Author’s creation) At a given marginal propensity to consume (MPC), this movement shows first round of raise in consumption. Due to this rise in demand, production rises and additional income is generated in the economy. This income is further invested in the economy for increasing production activities. This is the effect of ‘induced spending’ which would further increase consumption level in the economy (Schiller, 2011). The aggregate demand further increases to AD3. This happens in the short run when prices remain unadjusted. Reasons for the policies The macroeconomic controls ensure economic growth by creating employment opportunities, stabilizing prices and maintaining trade balance. The policies have been designed to reduce China’s dependence on exports and boost domestic market. Higher public spending increases productive activities thereby increasing employment opportunities. Lowering of interest rates increases money supply, thereby increasing demand. The growth of middle income class supports this demand side growth (Fewsmith, 2007). However, a strong difference in income of middle income and lower income population groups is visible. It mirrors the expanding wealth gap between the rural and urban population (Sicular, et al., 2007). Increase in public spending is directed towards balancing the income growth in the economy by inspiring all the social classes to increase their demand thereby developing an “inclusive growth model” (BBC, 2013). Comment on effectiveness & shortcomings/side effects Higher government spending creates higher demand in the short run when prices are fixed. Hence, adjustments in consumption happen at constant price level. Figure: Increase in real GDP at constant prices (Source: Author’s creation) Expansionary fiscal policy can effectively raise aggregate demand. Therefore, real output rises in the short run. Prices however adjust only in long run. Secondly, higher public spending increases employment opportunities that help to shrink the existing wealth gap. Thus, an inclusive growth pattern is implemented in the economy. However, excessive easing of monetary policy would lead to extremely high level of money supply. This can potentially create asset bubbles in the economy. High availability of loans would induce people to make high investment in real estate which could “overheat the economy” (BBC, 2013). Conclusion China’s economic growth story is based on the high contribution of its export sector to the GDP. But the recession in the world economy since 2009 has hurt the export sector in the country, which has in turn affected productivity in other sectors. Therefore, sustaining the economic performance has become difficult and growth rate in China is falling. Due to reduction in net exports real national income has fallen, which has reduced the economy’s aggregate demand. This shows that the economy seriously needs policy changes that would readjust the macroeconomic goals. The country is currently putting emphasis on environmental protection and the government has declared that its efforts to increase demand would be made in an environmental friendly way (Siwu and Zhi, 2013). The expansionary monetary and fiscal policies are aimed at stabilizing the economy and developing a more sustainable growth structure for the economy (Emerging markets, 2013). Reference List Arnold, R. A., 2008. Macroeconomics. Connecticut: Cengage Learning. BBC, 2013. China economic growth lower than forecast. [online] Available at: [Accessed 25 June 2013]. BIS, n.d. Monetary policy, fiscal policy and public debt management. [pdf] Available at: [Accessed 25 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 25 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 25 June 2013]. Emerging markets, 2013. China monetary, fiscal policy easing to continue: Moody's. [online] Available at: [Accessed 25 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 25 June 2013]. Peopledaily, 2001. China's Main Export Commodities. [online] Available at: [Accessed 25 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. Siwu, C. and Zhi, W., 2013. China to continue "proactive fiscal, prudent monetary" policy. [online] Available at: [Accessed 25 June 2013]. Wang, G. and Zheng, Y., 2012. 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