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Area 10 Macroeconomic Problems and Policies Exploring Economics in Daily Life

10 Macroeconomic Problems and Policies

Exploring Economics in the News The f inancial tsunami affects China’s

export Measures launched to expand internal

demand

New Horizon Economics (Compulsory Part)

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New Horizon Economics Extended Reading Materials (Compulsory Part) Sample

The financial tsunami affects China’s exportMeasures launched to expand internal demand

ThemeExamines the measures the Chinese government launches in the global financial tsunami to expand its internal demand

ObjectiveTo enable students to understand more about the relationship between macroeconomic policies and economic growth

Related topic(s)Book 5B Chapter 10 Section 10.1 ‘Aggregate demand’ (pp.90–99) Section 10.2 ‘Aggregate supply, long-run and short-run equilibrium’ (pp.100–129) Chapter 11 Section 11.3 ‘Macroeconomic policy and economic fluctuations’ (pp.151–170)

A07 China news DAILY NEWS 10 November 2008

The Chinese government announced yesterday its plan to invest RMB 4 trillion by 2010 to expand internal demand. The plan includes 10 measures that aim to facilitate economic growth. The government official said that the poor economic prospects and the weak consumer spending in the US have slowed down the growth of China’s exports. This, together with the rise in production cost, has affected firms’ willingness and ability to invest. The growth in consumption has also lowered.

Stabilizing its exports and expanding its internal demand will be the major economic objectives of China. Among the 10 measures, the Chinese government has decided to increase its investment in projects related to people’s livelihood, infrastructure and post-disaster re-construction works. To reduce the tax burden of firms and encourage technological advancement, the Chinese government has also decided that, starting from next year, the reformed value added tax system will apply to all industries in the country.

China will use RMB 4 trillion to expand internal demand

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Area 10 Macroeconomic Problems and Policies Exploring Economics in the News

In 2006, China’s

final consumption

expenditure, gross capital

formation and the net exports

of goods and services are

39.2%, 41.3% and 19.5% of its

GDP respectively.

A07 China news DAILY NEWS 12 December 2008

To reduce the impact of the financial tsunami on the Chinese economy, China will continue to adopt an ‘active’ fiscal policy next year. This includes a sharp increase in public expenditure and a cut in taxes. Details can be found in the table on the right.

Main content of tax cut1. Reformation of value added tax2. Temporary waiving of the income tax on the

interest received from savings and deposits3. Lowering of stamp duty on stock transactions4. Lowering of stamp duty on residential

property transactions

China adopts ‘active’ fiscal policy and cuts taxes drastically

The financial tsunami that affects the US has also spread to the mainland of China. As the US is one of the major trading partners of China, recession in the US will certainly hit China’s export trade. The total value of China’s exports dropped by 2.2% in November 2008 as compared to the same period in 2007. This is its first negative growth in 7 years.

As export demand is a part of aggregate demand, its reduction will reduce aggregate demand. As shown in Fig 5.1, the aggregate demand curve will shift to the left, and the real GDP and the price level will fall, ceteris paribus. The economy of China has been growing rapidly in recent years, at an annual rate of around 10%. Hence, despite the impact of the financial tsunami, the real GDP in China is expected to keep increasing, though at a lower rate.

Fig 5.1 A fall in exports leads to a leftward shift of the aggregate demand curve.

The effect of

US recession on

Hong Kong exports

In a report published by the

Hong Kong Trade Development

Counci l (TDC) in December

2008, Hong Kong expor ts

are expected to experience

negat i ve growth in 2009.

The value of the exports is

estimated to fall by 6%.

Moreover, according to the

statist ics the TDC revealed

about exports in the 4th quarter

of 2008, firms in Hong Kong

are generally pessimistic about

the prospects of exports in

Hong Kong.

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New Horizon Economics Extended Reading Materials (Compulsory Part) Sample

To offset the negative effects of the falling external demand on economic growth, Premier Wen Jiabao announced measures to boost internal demand and keep the economy growing at the target rate of 8%. These measures include encouraging household consumption and firms’ investment, and increasing government expenditure.

The following shows the impact of the financial tsunami on China’s external demand and how China facilitates economic growth through boosting internal demand.

Measures Expansionary fiscal policyPublic expenditure ↑

Tax rate ↓

Internal demandHousehold consumption (C),Firms’ investment (I),Government expenditure (G) ↑

Aggregate demand(AD) ↑

Global financial tsunami

External demandChina’s export demand (X) ↓

Aggregate demand(AD) ↓

Fig 5.2 China launches measures to boost internal demand in order to facilitate economic growth.

To ensure economic growth, the Chinese government uses expansionary monetary and fiscal policies to boost internal demand. Monetary policies include the lowering of the interest rate and the required reserve ratio of banks; fiscal policies include cutting taxes and raising public expenditure. In the AD-AS model, these policies help raise aggregate demand. The aggregate demand curve will shift to the right, thereby offsetting the adverse effects of the fall in export demand.

1. Aggregate demand (AD):

The quantity of domestic

output (i.e., all goods and

serv ices) demanded at

different price levels.

AD = C + I + G + NX

2. F i s c a l p o l i c y : T h e

g o v e r n m e n t u s e s i t s

expenditure and taxation to

achieve certain economic

objectives.

3. M o n e t a r y p o l i c y : T h e

government’s control of

the money supply or the

interest rate to achieve

certain economic objectives.

4. Recession: A sustained

d e c l i n e i n e c o n o m i c

activities from the peak.

The real GDP falls and the

unemployment rate rises.

The financial tsunami affects the

economy of Hong Kong, too. What policy / policies would you suggest the Hong Kong government adopt

to boost economic growth?