Wang Anyu, Peng Yiyun, Wu Yueze, Yuqiyao

Case Study Report China’s Macroeconomic Policies

INTRODUCTION The Chinese economy experienced astonishing growth in the last few decades that

catapulted the country to become the world's second largest economy. In 1978—when China

started the program of economic reforms—the country ranked ninth in nominal gross

domestic product (GDP) with USD 214 billion; 37 years later it jumped up to second place

with a nominal GDP of USD 9.2 trillion. However, since recording its last double-digit

growth (10.4%) in 2010, the Chinese economy has effectively decelerated 30% in five years.

In the last two years, growth deceleration moderated largely due to a variety of stimulus

measures - The People’s Bank of China cut interest rates and reserve requirements to make

more credit available, and financial deleveraging—reducing the growth of debt—has been

put on hold. Without such policy support, China’s GDP growth would have fallen further.

In this report, we aim to account for such economic slow down and identify out the

main macroeconomic problems. Analysis on the policies implemented will be conducted,

along with proposing alternative measures to resolve these problems.

ABSTRACT Apart from looking at the background informations, we will also focus on the collapse of

the stock market in China, the unemployment rate in both main cities and countryside, and

the fluctuation in exchange rate and balance of payment. In order to obtain a thorough

understanding of the respective issues, we will firstly address the formation of the problem,

followed by the evaluation of current policies and finally, solutions and suggestions to

overcome the shortcomings of existing policies.

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LITERATURE REVIEW

Unemployment in China Wu Yueze 1

This Youth Unemployment in China: a crisis in the making article is done by Terence

Tse, an Associate Professor in Finance at ESCP Europe Business School in London. This

shows his specialization in the field of economics, and thus we can assume that this paper is

reliable and is an informative piece of work. This article aim to discuss about the

unemployment issue in China, and the various reasons that caused such problem.

Firstly, the article inferred data from the Ministry of Human Resources of China and

China Household Finance Survey to arrive at the actual unemployment rate in China. After

addressing this, the writer raised the issue about the inverse correlation between educational

attainment and ease of finding a job, and believes that this is structural unemployment, where

there is a mismatch of skills between the employees and the employers.

This is exactly true for China. In the past decades, China aimed at boosting in

economic growth through expanding its manufacturing sectors, which weighs more than 48%

of the total economy. This has limited the number of high leveled jobs, which is unable to

satisfy the large group of unemployed graduates. These graduates are unable to switch to

other low paid jobs as the expected return will be much lower. Thus, they would remain

unemployed and seek for higher paid jobs.

An economy with unemployment is not producing to its maximum capacity and results

in the actual amount of goods and services produced in the economy being less than its

potential output.,as an unemployed has no income and security,which means a lower standard

of living. Also, unemployment is linked to a lower level of social stability in the economy in

terms of higher incidence of domestic violence and crime.

In overall, it is important for us to look at the problem of unemployment, as it is a

crucial problem which affects everyone in the society. In the content of China, China’s

unemployment is mainly caused by the economic structure which does not provide enough

white collar jobs to graduates. Thus, just as what the author said, China need to move quickly

to reform its economic foundations, and improve in industries in professional service sectors

Article:http://www.cnbc.com/2014/02/20/youth-unemployment-in-china-a-crisis-in-the-making.html1

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to meet the demand of the unemployed graduates. Else, it will lead to social discontent and

unrest in society.

Literature Review on China’s Stock Market Wang Anyu

The Chinese stock market crash began with the popping of the stock market bubble on

12 June 2015. A third of the value of A-shares on the Shanghai Stock Exchange was lost

within one month of the event. Major after shocks occurred around July 27 and August 24's

"Black Monday.”

In the year leading up to the crash, encouraged by state-owned media, enthusiastic

individual investors inflated the stock market bubble through mass amounts of investments in

stocks often using borrowed money, exceeding the rate of economic growth and profits of the

companies they were investing in. Investors faced margin calls on their stocks and many were

forced to sell off shares in droves, precipitating the crash.

By 8–9 July 2015, the Shanghai stock market had fallen 30 percent over three weeks as

1,400 companies, or more than half listed, filed for a trading halt in an attempt to prevent

further losses. Values of Chinese stock markets continued to drop despite efforts by the

government to reduce the fall. After three stable weeks the Shanghai index fell again on 27

July by 8.5 percent, marking the largest fall since 2007.

In response to the crisis, the Central Bank lowered both the interest rate and deposit-

reserve ratio, meanwhile conducting open market operations to improve liquidity and control

the damage. 

After three months of massive government intervention to halt diving stocks, the stock

market correction has left the Shanghai Composite nearly 40 per cent below its June high. In

the days since, the Shanghai Composite has barely moved, rising 1.2 per cent this week.

Having tumbled from a peak of 5,100 points in mid-June, the index seems to have found a

new equilibrium just above 3,000 points since the last week of August.

Even if China has succeeded in putting a floor under share prices, it has done so at

great expense. The government itself has deployed as much as 1.5 trillion yuan to support the

stock market in the past three months, according to estimates from Goldman Sachs.

Besides, the government is still supporting the market at a relatively high level. From 21

November last year, the Central Bank has been establishing policies to lower the interest rate.

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There was an increasing amount of investment flowing into the stock market. High leverage

became the primary pushing force for the boosting stock market. This would also cost a

severe downturn when the the forth is cleared.

After the stock market plunge, the government immediately lowered the barrier of

margin trading and short selling , which refers to the activities where investors borrow (with 2

collaterals) from qualified companies money (margin trading) to trade or borrow their stock to

trade directly (short selling). The easing of requirement to conduct such activity and the

lowering of trading fee would greatly encourage investment. However it appears to me that

this policy is not feasible in the long term due to the following considerations.

Firstly, the ceiling of borrowed leverage is 40,000 billion yuan, double of the previous

20,000 yuan ceiling. Systemic risk becomes greater. Tracing back the history, in 24 September

of 1988, the Treasury department of Taiwan declared stamp duty on buying shares, followed

by a sever plunge of the stock market. Till January the market loss was up to 45 percent in

total. To stabilize the market, the government canceled the stamp duty and issued similar

shorting policy to lift up the ceiling. In February the stock price showed significant increment

and established the highest peek in record. Since then, the Taiwan stock market index kept

falling from 12000 points to 2000 points in the following 7 months.

The Chinese government also allowed companies to set their own stop-loss limit. The

limit indicates an amount of money that a portfolio’s single-period market loss should not

exceed. Despite stimulating the market in short term, investors are not protected by the

damage control system. The benefit it carries cannot compensate for the risk.

The above analysis indicate the lack of insight in China’s response policy to the stock

market crisis. The stock market crisis amidst several quantitive easing policies, some listed

above, would change in liquidity demanded throughout the economy, where there will be a

large decrease in demand for assets with low liquidity, leading to large decrease in its price.

Meanwhile the increase in demand for assets with high liquidity will pull up its price. For

banks, the value of liabilities tied up in low liquidity assets drops and the bank equity also

declines. In turn, to bolster balance sheets, banks would sell assets, and reduce lending due the

the low liquidity and higher risk of loans. Through out the economy, the availability of funds

for assets with low liquidity decreases, with increase in investment in highly liquid assets.

Overall a decline of liquidity in the economy is observed. It has become harder for buyers

and sellers to transact without causing sharp price movements.

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In conclusion, the side-effect of central banks’ low interest rate and quantitative easing

policies is to reduce volatility, risk premia and trading volumes with it. Both make bond

markets more vulnerable to shocks, and could exacerbate future moves in spreads.

Literature Review on Stock Market Condition Qiyao

The article has been discussing about the recent stock market crush happening in China

starting from August, 2015. The main focus is the effectiveness of the monetary polices

adopted to handle the crisis and their implications on China and global economy. The author

has also examined China’s economy model, calling out an reform in financial sector.

The measures adopted by the government in this small crisis have mostly been

monetary policies to increase the liquidity in the financial market. The central bank has been

cutting interest rate and carrying out open market operations. More mandatory measures

such as forcing brokers to buy shares and prohibit stated-owned enterprises selling shares of a

certain list of anchor companies in various industries. Other than that, 260 billion RMB had

been lent to major brokerage firms via China Security Corporation. Although such

compulsory measures can temporarily prevent further plummeting of the stock price, the

author believes that they have actually negated China’s previous effort in building a

transparent and less-controlled finance industry and will eventually reduce the liquidity in the

market.

By cutting interest rate, the government wanted to encourage both retail investors and

finance institutes to borrow more money from the bank and inject it into the stock market.

On average, the retail investors in China are relatively conservative about investing in equity

compare to properties. In China, stocks account for less than 15% of household financial

assets and in fact, just 5 to 10% of Chinese citizens are actually exposed to the stock market.

Thus, by encouraging more citizens into the market, the government actually bears a risk of

potential social instability. Since China’s economy is still at a fluctuating stage, persuading

citizens to invest more in equities instead of properties will cause great discontent if people

lose more money due to the unpredictability of the stock market. Thus, blindly encouraging

investors into a potentially unstable market is not advisable without a reform of stock market

actually taking place.

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By limiting the transaction of stocks by large state-owned enterprises, billions of RMB

are excluded from the stock market and the liquidity of the market decreases. Ironically, the

government has also been trying to increase the liquidity by injecting money into the stock

market. Since the first measure has severely jeopardized the effectiveness of the second one,

the author concluded that those “exceptional” measures are not suitable in medium or long

term.

Although the stock market crash seems very dramatic this time, the effect on the “real

economy” is actually not as significant. Investors actually did not lose a lot of profits because

even after the plummet, current Shanghai Composite Index is still higher than that at the

same time of last year, when the stock market price started to soar and investors actively

entered the market. Moreover, the Chinese stock has been largely overpriced so the decrease

here may only brings the stock price to the reality level. Unlike the economic crisis brought by

the US in 2008, this stock market crash did not have prominent effect on the rest of the world

because Chinese stock market is relatively confined in mainland China with limited links to

the finance sectors in other countries. However, one important issue to take note is that the

instability that Chinese stock market has demonstrated has made investors realize that they

have indeed overestimated the economic outlook of China. Foreign investors may start to lose

confidence in the sustainable growth and withdraw part of their investment. This is essentially

a vicious cycle where the withdrawal of investment will in return decrease the AD in the

economy and result in a lower GDP or GDP growth rate. Lower growth rate will further

confirm investors’ belief that the economy is indeed slowing down and continue to withdraw.

Functioning as a opposite effect to accelerator, the long term consequences of this issue are

worrying if left unaddressed.

I agree with the author that in order to be a integral part of the world economy, the

government has to loosen their control over the market and let Chinese finance sector be

exposed to the rest of the world. However, such decisions also bear the risk that the

interdependence of the economic entities in the world will trigger a chain reaction similar to

what happened during the financial crisis in 2008. China has actually played an essential role

in helping the rest of the world to recovery from the post crisis recession because of its relative

independence from the US economy. The integration would thus imply less resistance to the

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fluctuation in the global economy and weaker ability to recover from a world wide financial

crisis.

I also agree that a major reform in Chinese economy is necessary in order to counteract

the slowdown. China should shift away from over-depending on export and towards higher-

end technologies. Private finance institutions can be introduced into the stock market to

reduce the control of China Security Corporation over the market and increase the

competitiveness. Other than that, in order to prevent future formation of stock market

bubbles, stricter regulations on stock transactions should be applied to prevent illegal boosting

of stock price by certain major shareholders.

In conclusion, a steadily growing economy is the prerequisite for a healthy stock market.

In order to achieve stability in the future, the Chinese government should reconsider the

economic model they are using and deftly adapt to the new situations in the world economy.

Literature Review on Exchange Rate Yiyun

Over years, China has competing goals for exchange rates. On the domestic front, it

wants to help exporters with a cheaper currency, but it also wants to maintain a strong

currency to prevent capital outflows that may weaken the country’s economy further. On the

international side, China wants to avoid a trade war with the U.S., which it would have if it

severely weakened the currency. It also wants to boost international use of the yuan for

political purposes, as China asserts itself more strongly around the world. China desires a

stronger currency; however it faces inevitable challenges along the journey of striking a

balance.

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The chart shows that the overall real relative price of worldwide Chinese exports has

risen more than 50% in the past decade, with almost 40% of this increase in the past two

years. This has occurred because of the yuan’s appreciation against the dollar, the yuan’s

appreciation against the currencies of its other trading partners (as the dollar has

appreciated), and the higher rate of inflation in China than among its trading partners.

For the most part, China has wanted its currency to steadily rise against trade-weighted

partners, for political reasons and to keep capital from flowing out of China. Since the new

governmental leadership assumed office, the yuan real effective exchange rate has raised by

15%. However, to keep that appreciation gradual, as the dollar rockets upwards, it may have

to devalue a little to be more in line with trading partners’ currencies, which have lost value

relative to the U.S. dollar over the past decade. As a result, there is an imbalance on exchange

rate of yuan against other world’s major currencies. It shows that China’s existing exchange

rate system is flawed, leading to a severe imbalance in China’s Balance of Payments (BOP).

In the last two quarters of last year, an estimated $188 billion of capital left China. As a

result, the country’s foreign exchange reserves declined $150.0 billion during the period.

Moreover, the capital account deficit widened to $91.2 billion in Q4, the biggest shortfall

since 1998. And the situation could be even worse than these numbers indicate. Citibank

thinks capital outflows in the last three quarters of the year averaged $50 billion per month.

In conclusion, a cut in exchange rate will surely help boost the economy, as aggregate

demand increases due to more net exports. However, it would cause heavy capital outflows

that are devastating to the economy. Hence, the Chinese government needs to strike a balance

between having a strong currency or a fast-growing economy, which is crucial in the progress

of China’s economic restructure.

Summary China has competing goals for exchange rates. Domestically, it wants a cheaper

currency to help exports, but it also wants a strong currency to prevent capital outflows.

Internationally, it wants to boost international use of the yuan as China asserts itself more

strongly around the world. It faces inevitable challenges along the journey of striking a

balance. There is an imbalance on exchange rate of yuan against other world’s major

currencies. It shows that China’s exchange rate system is flawed, leading to a severe

imbalance in China’s Balance of Payments (BOP) and foreign exchange reserves. Therefore,

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it is urgent for the Chinese government to balance between having a strong currency or a fast-

growing economy, which is crucial in the progress of China’s economic restructure.

MAIN REPORT

PART I: STOCK MARKET CRISIS

The issue is addressed because of the

important part it plays in the entire China

economy. The instability in the stock market

will affect the expectation and financial

decisions of foreign investors, which are

crucial to a country like China who is

experiencing an economy slowdown.

Background According to official quarter financial report in 2015, China’s economy has been

growing at a “sustainable” 7-8% over the past three years.(Figure. 1) External economic

entities suspect that the growth is largely contributed by government expenditure. Unaware

of such possibility, retail investors expecting steady growth invested heavily in the stock

market driven by the herd behaviour. The government has also encouraged the investors to

invest freely without over-concerning about the potential bubble through media . Banks 3

followed up by loosening up credit to provide cheaper loans. In June, the total market value of

China’s publicly traded stocks briefly surpassed $10 trillion, second only to the United States.

While macroeconomics indicators have impact on markets, market itself becomes some

kind of big casino where everybody is winning (when economy is on the rise), creating lots of

inefficent busiseneses that rely on high prices and high consumption levels that are already not

matching real situation in economy. The markets started to turn in late June. Investors are

The People’s Daily3

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afraid of share price drop due to the slowdown of the economy and started to sell the shares

to minimize the loss, which results in shares lost more than $3 trillion in a matter of weeks.

The burst of the stock market bubble has thus initiated the crash in July and August.

!

Effect According to the wealth effect, autonomous consumption spending tends to move in

same direction as stock prices. When stock prices fall, autonomous consumption spending

falls. Changes in stock prices through the wealth effect cause both equilibrium GDP and price

level to move in same direction, aided by the multiplier effect. 4

Figure.2 demonstrates the effect of lower stock prices on the economy.4

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Aggregate Expenditure

Real GDPY2 Y1

AEhigher stock proces

AElower stock proces

45º

Price Level

Real GDP

AS

ADhigher stock prices

ADlower stock prices

Y2 Y1

P1

P2

As a rule of thumb, a 100-point rise in Dow Jones China Total Market Index — which

means a rise in stock prices in general — causes household wealth to rise by about 500 billion

yuan. This rise in household wealth will increase autonomous consumption spending by

between 15b and 25b yuan. 5

On the other side of the two-way relationship, China’s economy also affects stock prices.

When real GDP rises and a typical expansion occurs, there will be higher profits and

stockholder optimism. As a response to the stock market crisis, the government of China has

established several expansionary policies to alleviate the downturn.

Policies The Chinese government’s major tool to interfere the economy is the Central Bank, also

known as People’s Bank of China (PBOC). PBOC is second only to the Federal Reserve

System of the United States in terms of overall central bank assets. Its operational objectives

include promoting financial stability, maintaining the stability of the internal and external

value of the currency and fostering economic development.

Among all monetary policy tools, open market operations are the most important and 6

flexible tool of the Central Bank. The Central Bank can directly influence the amount of

reserves and the level of interbank call-loan market interest rates through such operations . 7

Open market operation instruments include government securities, and negotiable

certificates of deposit (NCDs) issued by the Central Bank. The bank issue or sell those

instruments either on an outright basis or under repurchase agreements to mop up excess

liquidity. Conversely, it can purchase those securities to release funds into the market as loans

to individuals and businesses. Since more money is available for lending, the rates on these

loans became lower, which caused more borrowers to access cheaper capital. This easier

access to capital leads to greater investment and in turn stimulates the overall economy.

Economic research shows that marginal propensity to consume out of wealth is between 0.03 and 0.05. 5

buying and selling securities by the Central Bank for its own account in the open market6

In response to the the stock market crisis, 5 billion yuan of funds was injected into the banking system in 7

August via open market operations.

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Another monetary policy is the direct lowering of interest rate by the central bank to

stimulate investment and increase the expenditure. At a low point in the stock market,

investors may wish to buy in more shares. With lower cost of loans, they will tend to borrow

more from the bank and inject more money into the stock market, acting as a counterweight

to the plunging of the share price.

The Chinese government has encouraged investment by lowering required reserve

ratios (RRR) and thereby improve the ability of the banking system to extend credit or loans. 8

The Central Bank lowered RRR for all banks by 100 basis points to 18.5%, effective from 20

August. This policy is likely to have a significant effect on the economy due to the multiplier

effect. As the available loan increases, investors will invest more and consequently increases

the demand. This will in turn raise the stock market value and the companies will have more

fund to upgrade infrastructure and increase production efficiency. As a result, the final

increase in national income will be far larger than the increase in loan initially. Adjustment of

RRR is coupled with open market operations to lessen the impacts.

However, the damage control policies mentioned above are mostly short term policies.

Fundamentally, the shortcoming of the current system need to be identified and stock market

reform needs to be carried out. For example, replace the existing Daily-fluctuation-limit

mechanism with circuit-breaker mechanism. Daily-fluctuation-limit mechanism only confines

daily movement of securities prices but does not prohibit trading. This does not give the

The portion (expressed as a percent) of depositors' balances banks must have on hand as cash. 8

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Interest rate

Amount of money

ir1

ir2

S1 S2

DD

Price

Output

ADstock

ADstock’

investors enough time to reanalyze the information to make the rational choice. In the

contrary, trading halts measurement allows exchange officials to incorporate related 9

information into their trading-halt decision. This reconsideration will largely prevent drastic

panic selling and in return, reduce the risk of stock market crash. Other than that, stricter

internal rules of financial institutions should be applied to address credit risk concerns. Hence

the Central Bank should continue to monitor banks' management of real estate-associated

credit risk and the enforcement results of targeted macro-prudential measures, and undertake

appropriate policy actions to further ensure financial stability.

PART II: UNEMPLOYMENT

From the figures released by National Bureau of Statistics, Ministry of Human

Resources of China, despite fluctuation in the real GDP growth China has a relatively stable

unemployment rate of 4.1% . 10

!

Figure 1: Taken from National Bureau of Statistics, Ministry of Human Resources of China

circuit-breaker mechanism in the United States9

4.1%: This official figure was calculated by only considering workers who redeemed their unemployment 10

benefits, which does not provide the full picture of the population. Migrant workers that did not register as a local residence is unable to apply for unemployment benefits and they covered nearly 20% of China’s entire working population.

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However, the Household Finance survey‑ provided a more reliable surveyed 11

unemployment rate of 8.1%. In comparison, the actual unemployment rate is estimated to be

7~10%.

Unemployment rate is able to indicate the health of the economy. Since China has a

large population base, such high unemployment rate reflects China’s underlying economic

and social problem. China has been primarily focusing on expanding its manufacturing

industry due to its high return-to-cost ratio. Such industries requires much more hard labors

rather than white collars, thus they do not provide sufficient white collar jobs for the higher

educated graduates.This clearly reflects the structural unemployment China is facing,

resulting from a mismatch between skills possessed by the population, and the requirement of

jobs. The low average household income is partially caused by the large number of

unemployed labors, with graduates in majority, who rely on their family for living.

Since the consumption on non durable goods remains the same, but the household

income decreases, the household consumption on durable goods is reduced. Thus, the market

demand will encounter a downward shift, as shown below:

When market demand decreases, fewer consumer goods are demanded and produced,

hence the fall in consumption is likely to have an adverse effect on entrepreneurs’

by Texas A&M University and China Southwestern University of Finance and Economics11

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Autonomous Consumption (Non-durable goods, basic necessities)

Induced Consumption (Durable goods)

Income (Y)

Consumption (C)

Y1

Y2

C1

C2

expectations. In addition, the factor of income of the households is lower. Therefore, the rate

of economic growth is much slower. This situation that China has was exaggerated by the

stock market crash in August, which drives the public to overestimate the impact of recession,

and thus motivate people to save more, and cause the mps to increase. 12

China raised a few policies to lower the unemployment rate in China. In the eleventh

and twelfth Five Year Plan, the government decided to emphasizes on investment in

innovation sectors to increase domestic consumption. To provide more job opportunities for

graduates, China encourages foreign investments on high tech and environment protection

industries, by projects such as Sino-Singapore TianJin Eco-city (SSTEC) and Suzhou Industrial Park

(SIP), It does not only provides incentives for enterprises to set up and innovate, but also

aimed to create 45million more jobs to address the employment issue in the next few years.

The above policies are referred as supply side policies . However, the effects of such 13

policies take a long time to be visualized. China’s policies are more focused on solving the

problems in the long run, such as increasing the number of higher sector industries to provide

jobs for those unemployed graduates.

The marginal propensity to save (MPS) is the fraction of an increase in income that is not spent on an increase 12

in consumption. That is, the marginal propensity to save is the proportion of each additional dollar of household income that is used for saving. It is the slope of the line plotting saving against income.

focus on increasing the aggregate supply or shifting the PPC outwards. This increases the long term 13

productive capacity and achieves potential growth.

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Real GDP

Price Level AS1 AS2

Y1 Y2

P1

Thus, we believe that China should also aim at urban development in second and third

line cities, which are capable of providing large number of jobs in the future. Many second

and third line cities are having a net outflow of residents annually, as people expect to obtain

a higher achievement in first tier cities. For instance, in 2014, the numbers of new migrants

were more than 455,000 in Beijing, and 512,000 in Shanghai.Despite the large number of

vacant jobs in second and third tier cities, people are still more willing to move into first tier

cities and fight for the limited higher paid jobs, as the resources are more concentrated and

accessible.

The government should try to transform second tier cities into cities with different areas

of specialization. This will improve labour mobility, and will have a positive effect on labour

productivity as well as supply side performance. Also, cities will form a more efficient and

functional industry chain so that the problems like congestion, poor air quality, or insufficient

public services will eventually be solved.

Overall, to have more effective policies in regulating the unemployment rate, the

government should focus on urban development and delocalizing the concentrated industries

in megacities. By doing so, second tier cities will be able to attract labors with specific skills

and have their job vacancies filled up, hence solving the problem of unemployment

eventually.

PART III: EXCHANGE RATE

Another expansionary policy used by China’s government is the adjustment of

exchange rate . On 11 August, 2015, the People's Bank of China (PBOC) changed the 14

calculation method of yuan's daily trading band, and executed a one-time devaluation of

yuan by 1.9% against the U.S. dollar, which was the biggest one-day move since the yuan

officially de-pegged from the U.S. dollar in 2005. A daily midpoint for yuan was set, around

which the currency is allowed to trade within 2% change.

The exchange rate is the price of one country’s currency in terms of another country’s currency; the ratio at which two 14

currencies are traded for each other.

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Devaluation is a demand management policy used to promote growth and fulfil various

macroeconomic objectives. Described by the marshell-lenar condition, currency depreciation

leads to increase of the net exports, thus increasing AD. Devaluation of yuan is an

expansionary monetary policy which aims to alleviate the economic stagnation in China by

affecting balance of payments . Exports contribute to an increase in autonomous 15

expenditures and cause the planned aggregate expenditure function to shift upward. Imports

affect the value of the multiplier. After imports are included, the aggregate expenditure

function rotates and equilibrium income decreases. 16

After the Central Bank of China began the program of expansionary monetary policy

in response to the stock market plumge, the intrest rate decresed significantly. China’s

financial and capital assets became less attractive as a result of their lower real rates of return.

Foreign companies reduced their positions in domestic bonds, real estate, stocks and other

assets. The financial account (or balance on capital account) will deteriorate as a result of

foreigners holding fewer domestic assets. Domestic investors will be more likely to invest

overseas in the pursuit of higher rates of return. According to official data released on

Monday, China's currency hoard declined by $93.9 billion in August. The reduction in

domestic investment by foreigners and the country's citizens decrease the demand for yuan

and increase the demand for the currency of foreign countries. The exchange rate of the

The balance of payments is the record of a country’s transactions in goods, services, and assets with the rest of the world; 15

also the record of a country’s sources (supply) and uses (demand) of foreign exchange.

Assuming Import (M) is a function of Income (Y).16

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AEhigher import

AElower import

Aggregate Expenditure

National Income45º

Aggregate Expenditure

National Income

45º

AEhigher export

AElower export

yuan thus tend to decline. As a consequence of yuan’s depreciation, onshore yuan trading

volume almost doubled in the 15 trading days following 11 August, compared to the previous

20 trading sessions and the year to date average.

With no government intervention, the financial account and the current account must

sum to zero. As the financial account declines, the current account will be expected to

improve by an equal amount. In other words, the balance of trade should improve. The

country's export will have become relatively cheaper and imports will be more expensive.

　　

Other consequences include the deepening of factory-gate deflation, which is likely to

spillover to export prices across the world.

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A weaker yuan also means it's more expensive now for Chinese consumers to buy

overseas products. As a main luxury purchasing power, China would affect some countries’

economy greatly if Chinese tourists cut back on their overseas spending.

Due to significant drop of currencies of many other countries against the US dollar, the

international market trend propels China to adjust the middle rate quotation mechanism of

the yuan exchange rate. The modification on exchange rate system not only makes the

exchange rate between yuan and dollar closer to the real value, but also narrows the gap

between yuan and other world’s major currencies. Hence China is not stirring up a ‘currency

war’, but promoting the global monetary market to a more rational stage.

However, the dramatic depreciation of yuan contradicts with Chinese government’s will

of having a stronger yuan. A decreased exchange rate of yuan would enlarge the amount of

capital outflow as yuan becomes more ‘valueless’. More people would trade yuan for USD to

hold value, which would cause a large amount of capitals flowing out of China, hence

reducing China’s foreign exchange reserves and further worsening its economy.

Given the fact that the U.S. dollar was already strong, this move caused an added

disadvantage to U.S. exports headed for China. This could potentially bring up a ‘currency

war’, considering many countries have already accused China of malicious currency

manipulation.

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China desires to internalize yuan to become a more common medium of exchange. For

this to happen, the yuan should move more in line with Asian currencies than be tied to the

U.S. dollar. The tie to the dollar has meant the yuan is overvalued in relation to its regional

trading partners. (This has been mentioned in the previous paragraph.) Some depreciation is

thus logical but this should have been done in a gradual and more flexible exchange rate

adjustment process over the past year rather than bundled into an unexpected adjustment

over a few days.

Alternatively, Chinese policymakers can try to stabilize their exchange rate through

actions other than direct intervention so that China’s economy would be more market-

oriented, and the government wouldn’t be blamed for ‘playing unfair’ so harshly. Imposing

more capital controls could potentially prevent more funds from leaving the country.

On the other hand, the government could open up financial markets to more regional

and international participants so that it can attract more investment and capital inflows into

the country. However, resilience of the China’s economy would also be tested in how it

conducts itself within an increasingly dense network of trade obligations.

CONCLUSION From the above analysis, it is evident that China is encountering macroeconomic

problems due to its unstable economic growth in the past decades. Stock market,

unemployment, and exchange rates are all essential elements in an economy. The collapse of

any of the three would severely affect the others, and have a significant effect on the whole

economy. Hence, we need to analyze them from a macroeconomic perspective, link all

problems together to find out the best solutions. China has already carried out various policies

to reduce the negative impacts brought by the problems to maintain a more stable economic

growth, which are shown to have sizable effects. However, the current measures are not

perfect and there exist areas which can be further improved. Thus, we proposed our measures

that are more focused and detailed. We hope that these suggested measures could enhance

the effectivenesss of the existing government policies, or potentially overcome more

challenges so as to secure a sustainable economy in the future.

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REFERENCES Burdekin, R. (2008). China's monetary challenges past experiences and future prospects. New York: Cambridge University Press.

Ba, Shusong, Qun Wang, 2009, “The impact of the real effective exchange rate of RMB on China’s economy,” Financial Issues Research, No.6, 2009.

Bordo, Michael D., 2003, “Exchange Rate Regime Choice in Historic Perspective,” NBER Working Paper, NO.9654.

Chen, Langnan, Yun Chen, 2009, “RMB exchange rate, asset prices and short term international capital flows,” Economic Management,No.1, 2009

Chinn, Menzie D. and Shang-jin Wei. 2009. “A Faith-Based Initiative: Does a Flexible Exchange Rate Regime Really Facilitate Current Account Adjustment”. HKIMR Working Paper N0. 12, Hong Kong Monetary Authority, Hong Kong.

Currency peace. (2015, February 21). Retrieved July 6, 2015.

China weakens yuan amid economic and reform boost. (n.d.). Retrieved August 9, 2015.

Kiyotaki, Nobuhiro, and John Moore, 2001, “Liquidity, Business Cycles and Monetary Policy,” Mimeo. London School of Economics.

Pissarides, Christopher A. 1992. Loss of Skill During Unemployment and the Persistence of Employment Shocks. Quarterly Journal of Economics 107:1371–1391.

Wang, Ashley W., 2003, “Institutional Equity Flows, Liquidity Risk and Asset Pricing,” Mimeo. University of California, Los Angeles.

INDIVIDUAL REFLECTION

Anyu In the course of doing this project I have benefitted a lot. I have received tremendous

intellectual stimulus during the research phase of this project, not only from books and online

sources, but also from comments and discussions with the group. 

In the course of doing this project we collaborated quite well as a group. This project

has made us more familiar with each other and more bonded in our personal lives. I have also

come to value the discipline needed for teamwork: planning things ahead of time, making

effort to convey and explain ideas, and being committed to the project. 

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Apart from the experience of teamwork, I have also developed skills in searching for

information, understanding research done by others, synthesizing my own opinions, and

arranging various ideas into succinct sentences. These skills would be helpful in aiding my

future study.

When we first run into our project, we recognized that there are things the group knows

and much more things that we need to know, even if they are not yet apparent. As much as

we can plan the entire project, exactly where are we on the learning curve only comes into

focus when we reach that phase or encounter the problem. Hence we did not hesitate to

research broadly to find out more possibilities and to put ideas into words by writing short

paragraphs about different macroeconomic phenomenons and its mechanism. After

considering various possibilities, the ultimate outcome is about knowing what we stand for,

being prudent about what to take on. As a result, the features of the essay would be more

succinct and logical. Keeping signal from the noise is really important, and that why we chose

the three areas - unemployment, decreased exchange rate, and stock market plunge - as our

areas of focus, even if it means there may be less space for applying simple concepts directly

from the notes. We believe the the kernel of this project is to gain knowledge, knowledge

regarding China’s economic development in particular for our group, followed by applying

the new concepts and formulating our thinking. Hence we tried our best to make the essay

well-structured, covering multiple policies that we could possibly explore, and to illustrate in

our own words why it works this way. The team is motivated, passionate to learn further. As a

consequence we had to reduce the amount of words from 7000+ to around 2000 (in a

struggle).

Overall, this project provided a great opportunity for me to learn, and the experience is

truly valuable.

Yiyun In this project, we started with a very ambitious goal that is to cover as much aspects in

China’s economy as possible. We decided to focus on three main areas: China’s stock market,

unemployment rate, and exchange rate. I was in charge of research on China’s exchange rate,

especially the case of depreciation of the yuan in August 2015. Yueze was in charge of

unemployment rate, while Anyu and Qiyao studied China’s stock market together. We spent a

whole day writing our first draft, covering problems and challenges, existing solutions, possible

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improvements, etc. We read a lot of papers and it wasn’t hard to get the information we

wanted.

However, it became so hard when we tried to integrate all the findings and organize

them into one complete report. Each of us only focused on our own part originally. The total

word account was way more than the word limit, and many economic concepts were

repeated. Moreover, it was very hard to link all three areas together to explain China’s

economy on the whole. Therefore, we met again to read through the others’ parts so that we

understand the other two issues as well. We equally assigned economic concepts and theories

that need to be explained to different members according to the content being mentioned, to

make sure that there was no repeating. We finally managed to link everything and reach a

conclusion after many discussions.

During presentation, we used a skit to interpret the concept of exchange rate. Our

intention to do the skit was to explain how exchange rate works in a much simpler and

creative way.

One learning point from this project was that I understand China’s economy much

more now than before. As a Chinese, even though I am staying in Singapore, the up and

down of China’s economy is still going to affect my family and me hugely. Meanwhile, I

developed strong interest in studying economics as a major in university. Another learning

point was how our group managed to work with each other. All of us were willing to put in

efforts, and were responsible for our own parts. However, teamwork was more than individual

contributions. It was a struggle to let go some parts and to revamp again and again so that we

were able to present an integrated piece in the end. The skills learnt from teamwork were

truly valuable.

Qiyao Focusing on China, we have been able to get a deeper understanding in this fast

developing economy and gain insights about the reasons for the success as well as limitations

of this economic structure.

I am very excited to realize that I can use the theories that we have learnt in class to

explain the macroeconomic phenomena and decisions which previously seemed very

unfathomable to me. I began to understand both the rationales and limitations of the relevant

demand or supply side policies. However I have also realized from this research project that

real life situations are often much more complicated than those in theories, where Ceteris

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Paribus is assumed. Thus, macroeconomic policies are never implemented individually. They

are always coupled with each other to compensate potential disadvantages. At the end of the

day, the effectiveness of certain measures will still not be very predictable simply because the

tremendous amount of uncertainty in the real world.

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