Macro & Micro economics - Essay Example

? Macro & Micro economics Introduction The Chinese economy has been growing at a significantly high rate since the last three decades. It is the second-largest economy in the world and is one among the fastest growing economies (Chiang and Standing, 2013). Last year (2012), in the fourth quarter, the Chinese economy grew at the rate of 7.9% (BBC, 2013). However, the growth rate slipped immediately in the next year. This fluctuation in the growth rate of the economy has been a cause of concern for the government of China. It prompted the government to make policy changes that would boost up economic activities in the country. This paper has been presented with the purpose of representing an analytical study of an article named “China May CPI slows, gives room for easy monetary policy” written by Chiang and Standing and published by One America News on June 8, 2013. The article is a report on the Chinese economy, its economic growth and the responses of the government with regard to such fluctuation in the growth of the economy. The Central Bank of China has adopted easy monetary policy as well as expansionary fiscal policy to heighten productive activities. This paper revolves around the major issues that have been identified as the primary reasons behind slackening of the country’s growth rate and presents a discussion of the relevant government policies. The effect of the economic downturn on the Chinese society has also been discussed in this paper. Discussion on the economic problem issue China showed an average growth rate of 7.7% in the first three months in 2013 (BBC, 2013). Although this is not a very poor growth rate, the main concern is fall in growth rate and weak aggregate demand as shown by the country’s purchasing power index (PPI) (Chiang and Standing, 2013). Q2 has reflected slower growth rate than Q1 in the current year (2013). In May 2013, annual inflation rate of consumer price index (CPI) has reduced to 2.1% from 2.4% in April (Chiang and Standing, 2013). This has aroused concern that the economy might further slowdown in the third quarter of 2013. According to forecasts by some economists, it would become difficult to attain the target annual growth rate of 7.5% (Chiang and Standing, 2013). The measure of different variables representing the output of different sectors in the economy is showing a downward trend. This implies that there is not much chance for the economy recover immediately. Private investors are facing high cost of financing business activities which is discouraging entrepreneurs to make new investments. This highlights the room for possible interest rate cuts by the Central Bank of China. It has decide to “pursue interest rate liberalization” (Chiang and Standing, 2013) in the latter half of 2013 with the aim of protecting and increasing consumption growth and supporting private investment. Causes of the problem The article considered for the study, highlights certain issues that have led to the fall in economic growth rate in China. At present the rate of infest in the economy is high, due to which investment activities are being suppressed. This has led to low income for the workers in the economy resulting in lower demand. On the other hand warm weather conditions have led to good agricultural produce and high supply of vegetables. Therefore price of vegetables has fallen by 13.8 % in May 2013 (Chiang and Standing, 2013). Figure1: Fall in Aggregate demand in China (Source: Author’s creation) Aggregate supply (of food items) has increased in the short run (owing to good harvest). But the consumers are left with less disposable income, therefore demand for the produce has fallen (as shown by the shift in aggregate demand curve form AD1 to AD2). Hence prices have fallen from P1 to P2. This has led to fall in the amount of contribution of the agricultural sector in the total GDP and overall GDP has declined. Another important reason behind the fall in GDP growth rate is the over dependence of China on its export sector. China has followed export led growth policy for the last three decades and has occupied the highest position in terms of contributing to the global output. China contributes almost 3 percent of the total output traded in the international market. Experts forecast that China would become the highest contributor in the global economy in the coming years, exceeding the developed countries like the USA and European countries. But they also warn that growth in this economy would be unsustainable in long run (BBC, 2013). The entire world has faced the negative effects of the financial crisis that had hit the USA and the Europe between 2007 and 2009; the USA and Europe are still on the process of slow recovery. After the crisis, these countries show slow economic growth and their import demand has declined by a large amount. The USA and the European Union form the biggest export market for China, followed by the ASEAN countries, Japan and South Korea (Trading economics, 2013). Fall in import demand by the USA and the European Union resulted in huge loss of China’s export market. This has created a major downside impact on the Chinese economy and economic growth has been hit badly. Since all sectors in the economy are interlinked, weakening of export sector disbalances the equilibrium in the market economy. Presence of excess of exportable items in the economy has reduced price level which has reduced production activities further. Therefore, the GDP has declined considerably. Impact on economy, society or even political stability In the last decade China has over exploited its resources and there has been over investment in the spree of earning higher amounts of foreign currency. Excessive influence of the export sector has also brought impacts on the socio economic scenario of the country. Over the last few years investment pattern in China has become unsustainable. After a soaring economic growth for the past thirty years, growth in the country has inevitably stagnated. With over exploited resource base, unsustainable investment practices and unfavourable investment climate, at present China has entered the ‘middle-income trap’ (Woo, et al., 2012). Besides, there is a rising difference between the income of the low income class and the middle income class. This rising wealth gap has become a major concern for the economists since it goes against the objective of building an ‘inclusive growth model’ (BBC, 2013). Besides, in the current economic scenario the one child policy of the government casts negative implication on the society. This policy is decreasing the average birth rate in China, while on the other end the existing labour force population is ageing. This implies, after a few years a scarcity in the labour force would further reduce productivity (Wang and Zheng, 2012) and consequently the total output in the economy would decline. Low productivity would be transformed into lower income. This would work towards further increasing the income gap in the economy. Further increase in this problem might seriously disturb the stability in the society and become the cause of social unrest in the country. Government policies to solve the problem The current economic downturn in China shows that there is strong cause for the government to adopt easy monetary policy to strengthen investment prospects and expansionary fiscal policy to support aggregate consumption in the economy (Chiang and Standing, 2013). Proactive fiscal policy would motivate growth within the economy by facilitating demand generation from the different sections of the society. Under expansionary monetary policy, the Central Bank of China has planned to reduce interest rate in the second part of the current year. This would increase level of money supply within the economy. When rate of interest is low, banks possess higher liquid reserve and extend more loans. Investors would therefore borrow more at lower rates of interest (NASDAQ, 2011). This increase in investments would push up the real GDP. Interest rate shows the level of “opportunity cost of holding money” (Arnold, 2008). With the fall in interest rate, opportunity cost of holding money declines. There exists an inverse relationship between interest rate and demand for liquid money. Therefore, demand for liquid money by common households rise. This ultimately swells up aggregate demand in the economy. The government also plans to follow expansionary fiscal policy. It includes increase in public spending and tax cuts. For instance, in 2013, the government has granted $150bn for an infrastructure project (BBC, 2013). It would also increase level of budget deficit along with tax cuts; all these are aimed at maximising domestic demand (Siwu and Zhi, 2013). Government spending causes multiplier effect. It is a series of increases in income throughout all cross-sections of the economy. The initial increase in public spending pushes aggregate demand. This rise in aggregate demand is more than the amount of public spending. Therefore, the aggregate demand curve moves to the right from AD1 to AD2. Figure: Shift in aggregate demand at constant prices (Source: Author’s creation) When the marginal propensity to consume (MPC) is given, movement of AD1 to AD2 is the first round of rise in aggregate consumption. The subsequent effect of this increase in demand is increase in production. It generates additional income which circulates within the economy and augments production activities. China would be facilitated from this second round of investment which is known as ‘induced spending’. Higher income generates higher consumption demand and the AD curve moves to AD3 (Schiller, 2011). While aggregate demand increases in short run, prices remain unchanged since prices cannot be adjusted in the short run. Reasons for the policies Government policies are directed towards controlling different macroeconomic variables and certify that economic growth remains unhindered in the nation. Higher spending raises productive activities and increases employment opportunities. The fiscal policy changes adopted by the government stabilize price level, create employment opportunities, and help the government to maintain trade balance. Lowered interest rates raises money supply and increases aggregate domestic demand, primarily demand from the emerging middle income group grows (Fewsmith, 2007). Domestic demand plays the role of growth engine in the Chinese economy and government policies are directed to boost domestic demand so that it further motivates domestic production. After decline of exports, rise in domestic demand restricts production activities in the country from falling. Fall in interest rates stimulates investment by investors. However, along with the expansion of the middle income class, income gap between the middle income and the low income groups is becoming more vivid (Sicular, et al., 2007). Government spending is aimed at generating income for all sections of the society and supporting an overall demand generation. This helps to develop an “inclusive growth model” that would benefit the Chinese economy during this current economic downturn (BBC, 2013). Comment on effectiveness & shortcomings/side effects Expansionary fiscal policy includes higher levels of government spending that effectively increases the economy’s aggregate demand. In short run demand can be adjusted but prices remain sticky. Figure: Increase in real GDP at constant prices (Source: Author’s creation) Therefore, government can increase effective demand without inflating short run prices. Also, the combination of lowered interest rates and higher spending on infrastructure development improves employment opportunities. Decreasing unemployment along with appropriate spending positively affects income distribution thereby reducing the existing wealth gap in China. However, excessive use of expansionary monetary policy would increase level of money supply and provide excessive credit facilities to the consumers. This might lead to the creation of asset bubbles. Examples of the European Union and the USA show that asset bubbles are unsustainable and bursting of these bubbles disrupts the market equilibrium (BBC, 2013). Conclusion China has been over dependent on its export sector for a very long time and has reached a phase in which contribution of export sector to the country’s GDP has reduced due to global financial downturn. Performance of the export sector has affected all other sectors in the economy hurting economic growth in the country. Fall in income due to fall in net exports has reduced aggregate demand in the economy. Policy prescriptions by the central bank and the government aim at boosting the domestic market and encouraging domestic production so as to serve the emerging domestic market. As of now, the government has concentrated on easing its monetary policies, since the CPI inflation is consistently falling over the months in 2013 (Chiang and Standing, 2013). New policy changes are made with the purpose of making the growth process sustainable (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 26 June 2013]. Chiang, L. and Standing, J., 2013. China May CPI slows, gives room for easy monetary policy. [online] Available at: [Accessed 26 June 2013]. Emerging markets, 2013. China monetary, fiscal policy easing to continue: Moody's. [online] Available at: [Accessed 25 June 2013]. Emerging markets, 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 27 June 2013]. 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 27 June 2013]. Trading economics, 2013. China exports. [online] Available at: [Accessed 26 June 2013]. Wang, G. and Zheng, Y., 2012. China: Development and governance. Singapore: World Scientific. Woo, W. T., Lu, M., Sachs, J. D. and Chen, Z., 2012. A new economic growth engine for China: Escaping the middle-income trap by not doing more of the same. Singapore: World Scientific. Read More