Macroeconomic Issues: Inflation and Economic Growth - Literature review Example

Macroeconomic Issues: Inflation and Economic Growth by: Presented to: John Farris Course/ Class: EC 1210 – Macroeconomics University: College of the North Atlantic City and state: Qatar Due date: Wednesday, June 27 2012 Table of Contents Introduction 2 “China’s Inflation Slowed in May” 2 Relationship with the course 3 “Second Month of Slow Economic Growth in China” 5 Relationship with the Course 7 Conclusion 8 References 8 Appendices 9 Introduction This paper seeks to identify two macroeconomic issues and discuss how they relate with the course. The first issue is China’s inflation, which slowed down in the month of May 2012. This information is contained in the article by Back (2012) entitled China’s Inflation Slowed in May. Before highlighting relationship between the macroeconomic issue and course work, details of China’s inflation will be addressed. Secondly, the paper will focus on an article by Bradsher (2012) titled Second Month of Slow Economic Growth in China. This article tackles the declining economic growth in China. It identifies various sectors that are underperforming i.e. electricity generation and steel production. Comparing with the month of April, Auto sales and cement manufacturing increased by a small percentage in May. “China’s Inflation Slowed in May” Back (2012) presented an article with the title China’s Inflation Slowed in May. The piece of writing brought to surface how inflation had reduced consequently allowing policy makers to loosen policy and at the same time draw strategies to encourage growth. According to the article, the increase in inflation was 3.0% in May compared with 3.4% inflation increase in April (Para. 2). The difference of 0.3% demonstrates inflation easing. This article attributed the easing inflation to weakening economy not only in China but also in many parts of the world. It is anticipated that inflation will further decline in the future, presenting an opportunity to stimulate the economy. In response to the falling inflation, policy agencies in China are focusing on instituting cuts on interest rates, which will be the first since 2008. Back (Para. 9) clarified that major policy makers have access to economic data before they are publicized. This forms a reason why People’s Bank of China pushed for low interest rates. Some of the measures taken by China’s central institution include reduction of benchmark lending and deposit rates by 0.25% (Back, Para. 10). The government of China has gone ahead to support the economy by availing incentives for the purchase of energy-efficient household appliances. Other initiatives aimed at stimulating the economy in the face of declining inflation are fast approval for investment projects in addition to tax cuts. These initiatives were supplemented by a move towards increasing spending on railway construction. It is apparent from the article that food prices, which were the major contributor of inflation, stabilized. In the same line, producer price index declined by 1.4% as compared with previous year’s decline of 0.7%. Relationship with the course The course clarified how persistent increase in price level culminates into inflation. To measure inflation, change in price from one period to the next is obtained. This can be done by examining changes in price of a basket of goods from one period to the next. To succeed in doing this consumer price index is obtained and percentage change is calculated. The outcome is the inflation as stated by Back (2012). In the classroom discussion, various determinants of price level and inflation rate were identified. Long run price level is determined by money in circulation. This is factored in quantity theory which equates supply and velocity of money to price level and output in the economy, which is otherwise stated as M*V=P*Y. Definitely, a change in money supply leads to a corresponding shift in price level. The People’s Bank of China, through its monetary policy reduced the lending and deposit rates with an intention to stimulate money supply in the economy. This step improves demand. Central bank for example, regulates deposits accepted by commercial banks. The central authority often calls upon commercial banks to store some of their customer deposits with the central reserve. At the same time, financial institutions hold some funds for purposes of taking care of unexpected needs. All these initiatives affect money supply and demand. Depending on rate of inflation, a central bank may use open market operations to regulate money in circulation. In the short-run, inflation and price are determined by aggregate demand and supply. Central bank can employ monetary policy to change aggregate demand and supply. This is a reason why authorities in china supported the declining inflation by reducing interest rates, which had the eventual effect of building aggregate demand and supply. When interest rate is reduced, people are motivated to borrow money. More money is therefore in circulation. If this is not checked, inflation will creep in given that more money will be chasing the same good. The People’s Bank of China further considered slashing taxes so that disposable income is increased. An increase in disposable income means that people will demand for more goods and services. After the global downturn of the economy, inflation rate was very high while unemployment remained low as indicated in the Philips Curve of Wage inflation against Unemployment attached as appendix A. The graph in appendix A aids in understanding the effect of easing inflation on employment. As the economy grows, there is no doubt that aggregate demand will increase consequently increasing employment. In the beginning, people will press for more wages but as the economy grows, more labour force is employed and wage start rising slowly. This theoretical observation is comparable to China whose inflation is decreasing whilst employment face upward trend. “Second Month of Slow Economic Growth in China” Bradsher (2012) carried out an analysis of the deteriorating economic growth in China. According to the writer, the Chinese economy was previously viewed as a strong economy capable of emancipating global economy from recession. This is not the case as Bradsher alludes that China registered feeble growth in the month of May. The nation’s performance was even worse compared with other economies. Although sectors i.e. industrial production, retail sales, and investment in fixed assets were underperforming, they were expected to change once Chinese government took steps to stimulate the economy. In relation to fixed asset investment, Bradsher (Para, 3) clarified that the months of April and May were the weakest since 2001. Conversely, retail sales remained stronger following adjustment made for inflation in the month of May. In the same vein, Industrial production registered a 9.6% growth rate in May as compared with 9.3% growth in April. To add on this, imports and exports improved by 15.3% and 12.7% respectively in the Month of May, which was double the growth rate recorded in April. Bradsher (par, 7) reiterated the possibility of improving the economy by keeping demand for China exports at a higher level, which would enable the nation to pursue its infrastructural project. Higher level of demand for export also reduces worker layoff. Similarly, fine-tuning economy policies as opposed to the use of stimulus package has the capacity to generate economic growth close to 8%. Bradsher (Para. 10) affirmed that China’s poor performance took place during a period of bad global economy. The writer gave examples of economies at the edge of Europe that had already stagnated. Besides, economies that supported Europe were already struggling. The author clarified that unemployment in United States was already rising while growth in Brazil and India continued to weaken. Bradsher (Para. 11) brought to light the role played by local, provincial, and national government agencies in tempering with business cycle through a process of misreporting booms and downturns. An example is Chinese Officials at the local level who miss to report actual economic problems to the provincial leaders. These local officials overstate growth with a hope that tax will be levied on the actual rate. Electricity generation contributes immensely to growth of Chinese economy. Temporary closure of several export factories during the global financial crisis affected generation of electricity. On the contrary, since China generates most of its electricity from coal, about 80%, low level of electricity growth means that carbon emissions and eventual global warming is reduced by certain percentage. A supplementary statistic to support the deteriorating economy of China was a report by China Iron and Steel Association, which clarified that steel production, had reduced by 3.9% (Bradsher, Para. 16). Cement production, which is pertinent to construction industry improved in the month of May by only 4.3%. Similar improvements were reported in auto sales where growth of 22.6% was registered (Para. 20). Relationship with the Course GDP of a country is the aggregate economic production of a country. This represents value of goods and services produced during a specific period. From the classroom discussion, personal consumption, government purchases, private inventories, and foreign trade balances contribute to a country’s GDP. The article by Bradsher conclusively stated that China was underperforming simply because fundamental sectors including industrial production, retail sales, and investment in fixed assets were operating below their optimal levels. The measure of real GDP is vital to investor because it indicates health of an economy. On average, a GDP of 2.5-3.5% is believed to be the best rate that leads to overall benefits i.e. yielding corporate profits and job creation. This fact is reflected in the article where exports are stimulated with an intention of reducing worker lay off and improving infrastructure in the country. When calculating GDP, imports are excluded hence consumer purchases from foreign countries are not included in GDP. Para (11) of the article brings to light attempt by government agents to manipulate business cycle of a nation. Business cycle has four successive stages starting with trough followed by expansion and prosperity. From the peak stage, declining stage of recession is registered, which leads to depression. These fluctuations are repeated through a cycle as shown in appendix B. The literature by Bradsher brought to light the role played by local, provincial, and national government agencies in tempering with the business cycle above. By misreporting booms and downturns, government agency has already affected the business cycle. A Chinese Official at the local level missed to report actual economic problems to the provincial leaders. These local officials overstate growth to benefit from tax incentives. In the long run, actual economic performance is not registered. This affects economic planning and forecasting. Conclusion This paper discussed how two articles that reflect content discussed in class. The article China’s Inflation Slowed in May presented details of the declining Chinese inflation in the month of May compared with April. The declining inflation means that employment in the economy will increase as shown by the Philips curve. The second article on Second Month of Slow Economic Growth in China elaborated effect of various sectors on country’s GDP. Electricity generation and steel production, which are the country’s backbone, were underperforming thus yielding low GDP. The paper also discussed how government agencies misreport economic data with an intention of smoothening out business cycle for their own benefit. References Back, A. (2012, May 9). China’s Inflation Slowed in May. Retrieved 20 June 2012, from, http://online.wsj.com/article/SB10001424052702303665904577455252019721194.html. Blanchard, O., & Galí, J. (2007). "Real Wage Rigidities and the New Keynesian Model". Journal of Money, Credit, and Banking 39 (1): 35–65. Bradsher, K. (2012, June 10). Second Month of Slow Economic Growth in China. Retrieved 20 June, 2012, from http://query.nytimes.com/gst/fullpage.html?res=9501E2DB1030F933A25755C0A9649D 8B63&ref=china. Appendices Appendix A: Wage Inflation against Unemployment Source: Blanchard (2007). Appendix B: Business Cycle Read More