Free «Economic Policy Objectives and Exchange Rate Policy in China» Essay Sample

The economy of China has rapidly enlarged over the previous three decades due to the fact that it has implemented numerous economic reforms. A large number these reforms are concentrated on the supply aspect of the economy, as authorities have implemented a wide variety of policies in order to manage the conglomerated demand and progression of inflationary pressures and fiscal hazards. The current performance of various Chinese economic policies differs from the typically utilized policies in the developed economies and the country’s previous experience, repulsing China’s specific institutional and economic setting. Economic policies are implemented in a coordinated manner with authorities utilizing various monetary, fiscal and exchange rate policy, which would help to achieve economic goals. The current paper will analyze China’s economic policy objectives, its exchange rate policy and regime and recommend possible changes that would help the country to compete more efficiently in the modern global market.

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China’s Economic Policy Objectives in the Past and Present

The economy of China has augmented intensely over the previous three decades, with annual increase averaging approximately 10 percent per year (Brada 31). The country was able to achieve such result by utilizing numerous economic reforms, which helped to make the economy more market-oriented and stimulated the increase of the economy’s productive capability (Li and Wang 103). The initial objective of country’s economic policy was related to the possibility of enhancing agricultural production. The consequent objectives and reforms were expanded to rationalization of the state-owned industrial sphere, estate ownership and the progressive opening of the economy to multinational commerce and investment, incorporating admission to the World Trade Organization in 2001 (Brada 48). Despite the fact that these objectives and reforms demonstrated a supply-side concentration, policymakers were required to implement a wide variety of policies in order to control the agglomerated demand. The major objective of economic policy demand management was related to the economic development support in order to be capable of reacting to oscillations in global and domestic business settings so as to endure domestic employment and impede an imprudent increase of inflationary pressures and fiscal hazards (Toohey, Picker, and Greenacre 25). Thus, the major economic policy objectives dealt with the possibility of employing new monetary, fiscal and exchange rate policies, which would allow managing conjoined demand (Brada 49). Nevertheless, the current objectives and functioning of Chinese economic policy differs in a number of essential ways from those previously utilized, due to changes in institutional features and the state of the Chinese economic evolvement (Brada 53). Despite the previous arrangements, current Chinese monetary and fiscal policies are strictly conformed by Chinese central government. In addition, the current monetary policy objectives demonstrate that the operated exchange rate regime depends on crucial restrictions of capital currents, while the comparative dominance of banks in the fiscal sphere depicts that monetary policy can be largely executed via a range of regulatory policies. Thus, due to the fact that the Chinese economy has evolved, the country demonstrates a progressive improvement towards the utilization of market-oriented policies, similar to those implemented in more developed economies (Toohey, Picker, and Greenacre 27). The Chinese government claims that the main intention of this improvement is to continue operating in line with the previous economic evolvement particularly in fiscal markets (Brada 54).

Generally speaking, since 1994, China’s economic policy objective has been dealing with the performance of the profit-investment nexus, the interaction of pro-increase monetary circumstances with forcible export elevation and a highly stable domestic demand evolvement (Brada 77). Highly favorable monetary settings stimulated capital agglomeration. Investment, powered by rapidly increasing non-equilibrium profits, was regarded as the major stimulus of development, while good export performance and high growth ratios of real income as well as the demands of households were the principal stabilizers of overall development. China’s indisputable success in sparkling and corroborative development from 1994 onwards was the result of a policy package, which consolidated market-based, but reasonable microeconomic reforms with importunate and growth-based macroeconomic policies (Toohey, Picker, and Greenacre 34). The experience of the 1990s demonstrate that no country around the globe obtained the possibility to unite a sustainable and emulative exchange rate, a decreased interest ratio level and an anti-recurrent financial demand management within a low inflation setting (Brada 78). Nevertheless, the aftermath of China’s inflation and exchange-rate disturbance in 1994 depicts that the country managed to implement an active pro-increase monetary policy with a high level of price firmness (Li and Wang 69). The main objective of the Chinese authorities was to tae the inflation ratio under control by using dissenting implements, including salary and price controls. This policy objective was supplemented by funds controls, unusual investment policies and an aggressive fiscal policy. Foreign Direct Investment performed a crucial sustaining function as it helped China to integrate into an aerial production network, thus, stimulating the country’s technological integration into the global economy (Li and Wang 71).

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The current situation demonstrates that Chinese national economic policy is defined by the State Council, which appoints the five-year projects. It illustrates the government’s broad long-range economic objectives and agenda, incorporating targets for urbanization, industrialization and gradual market liberalization. At the same time when the State Council defines the general objectives of policy, their execution is the liability of both local and central government agencies (Li and Wang 56). The State Council is also responsible for setting annual objectives of macroeconomic outcomes. On the other hand, targets for inflation and increase of the money supply and GDP are proclaimed at the annual sessions of the National People’s Congress (Li and Wang 56). It is proved that the current targets for the above-mentioned agents account for “3.5 percent, 13 percent and 7.5 percent per year, respectively” (Toohey, Picker, and Greenacre 48). Central budget is another economic policy objective announced during these sessions. Therefore, the overall state of macroeconomic policy, as summarized by the budgetary state and the targets for the increase in money supply, is created in an interconnected manner according to the State Council’s longer-range economic policy objectives. The targets for inflation are frequently modified on a yearly basis repulsing the State Council’s analysis of the levels, which are acceptable in the context of compromise between development and inflation compared to the experience of the previous year (Toohey, Picker, and Greenacre 50). Chinese target contrasts with inflation targets of the majority of inflation-targeting monetary policy systems due to the fact that it is not a stated objective and should be adjusted according to the evolving conditions. The State Council is also liable for assigning the variety of other policy objectives, especially those that impact macroeconomic management, including the management of exchange rate regime. The previous objective of exchange rate policy accounted the stimulation of industrialization and evolvement of the export sphere by preventing the exchange rate instability of the economy. The Chinese currency has been riveted against the US dollar before 2005 (Li and Wang 58). Starting from 2005, the currency is managed in a manner that allows progressive adjustments due to the fact that the authorities have an objective of gradually shifting towards a more market-defined exchange rate regime (Li and Wang 58). A wide variety of institutions are accountable for the execution of macroeconomic policy objectives. For instance, exchange rate policy is executed by “the People’s Bank of China (PBC) and the State Administration of Foreign Exchange (SAFE)” (Brada 81). In addition, the controlled float exchange rate regime requires regulative administration over external capital current so as to equip leverage over domestic capital supply. The destitution of capital controls would prevent the management from attaining both the exchange rate and domestic capital supply. This is the main reason why the PBC uses the above-mentioned framework to implement domestic monetary policy objectives utilizing standard interest ratios of credits and deposits, deliriums in stock demand ratios for banks, unclosed market procedures and direct impact over bank loaning. On the other hand, financial and other regulative policy objectives are currently executed by a great number of central and local government agencies. It is evident that the major part of public revenue is gathered by the central government, while the majority of governmental spendings is tackled at the local levels. The comparatively huge dimension of infrastructure and numerous public investments spending as a part of the Chinese economy demonstrate that financial policy is a significant constituent of macroeconomic management objectives, besides its magnitude in enlarging the supply facet of the economy (Li and Wang 62-63). A crucial characteristic of the current economy policy objectives implementation in China deals with the fact that financial and monetary policies are executed in an extremely unified manner, as the general trend of policy is fixed by the State Council. This tendency highly differs from the previous Chinese trends, which suggested higher level of self-sufficiency of central banks from financial authorities. The main example of unified policy objective implementation is related to the fact that the government executes fiscal policy via its impact on the investment operations of state-belonging ventures and local governments (Brada 83). The latter are sustained by the loan policy operations of the PBC, which guarantees that the Chinese banking system provides the required funding. The current trend allows Chinese policy authorities to react when necessary, change conditions in a well-timed way regardless the institutional structures, which are dependent on the five-year projects and annual economic policy objectives (Brada 83).

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China’s Exchange Rate Policy

The facts and the previous research demonstrate that China’s exchange rate is controlled by governmental powers, including the People’s Bank of China, which is accountable for managing the value of the renminbi (Toohey, Picker, and Greenacre 205). This is performed by setting the USD/CNY-ratios every trading day. This exchange rate merely appertains to trade currents, which enter and leave the country (Toohey, Picker, and Greenacre 205). Thus, China utilizes a stable exchange rate. The initial reason for China to sustain the cost of its currency low unlike its trading partners is related to the fact that this tendency makes China’s exportation less expensive, and therefore more appealing. The country assumes that such exchange rate policy is necessary for sustaining a high development ratio. Due to the fact that the controlled exchange rate sustains the renminbi at a comparatively low level, the country’s development relies largely on exports. In addition, a fixed exchange rate helps to liquidate some part of the exchange rate unpredictability for Chinese importers and exporters and their commerce associates (Toohey, Picker, and Greenacre 207). Nevertheless, the current exchange rate policy has a number of by-products and unfavorable impacts. Firstly, a required by-product of the exchange rates fixation refers to the cost controls. This is the reason for the fiscal markets of China to be comparatively closed. For instance, depositions into China can be performed only according to tight norms and standards. Secondly, a stated exchange rate is merely accessible when the People’s Bank of China appears to be set and organized to exchange renminbi for US dollars and at the proclaimed USD/CNY-ratio accordingly (Toohey, Picker, and Greenacre 207). When a Chinese exporter obtains US dollars for the exported items, US dollars are supposed to be converted into renminbi, which the Chinese exporter will actually receive. Therefore, the requirement for renminbi and the purveyance of US dollars demonstrates that theoretically the US dollar is supposed to undervalue in the cost unlike the renminbi (Sadeghian, White, and D’Arcy 13). Moreover, the renminbi is faced with upward pressure, thus, in order to offset it, China’s Central Bank is supposed to sell renminbi in exchange for US dollars or US dollar-denominated capitals (especially US Treasuries) (Sadeghian, White, and D’Arcy 13). This is the main reason why the People’s Bank of China has to accumulate foreign stockpiles. The negative side demonstrates that these stockpiles usually have comparatively decreased debit, particularly contrasted to the debits obtained from Chinese investments (Sadeghian, White, and D’Arcy 13). This by-product is known to be one of the most negative by-products of a fixed exchange rate. In addition, when the fixed exchange rate requires marketing renminbi to counteract any arising pressures on the currency, it actually elevates the quantity of renminbi in the domestic economy, resulting in the build-up of the domestic capital purveyance. Due to the fact that more currency is accessible, inflationary coercion increases. This by-product is highly objectionable, especially taking into account the past experience demonstrating that high inflation has frequently resulted in social unrests. Chinese current exchange rate policy allows neutralizing the effects of the above-mentioned bank intervention. It provides the People’s Bank of China with the possibility to avoid inflationary pressures (Sadeghian, White, and D’Arcy 14). Neutralized intervention refers to the fact that that the additional renminbi obtained as a result of fixed exchange rate, are consumed by the central bank via marketing central bank and/or government connections, for which it reciprocally obtains renminbi (Toohey, Picker, and Greenacre 207). Thus, when the People’s Bank of China utilized neutralized intervention, it inverted the proliferation of the domestic supply of renminbi. Nevertheless, when the central bank emits the connections, it is supposed to make the necessary interest defrayments to the bond owners (Toohey, Picker, and Greenacre 207). The final negative effect of the current exchange rate policy refers to the fact that it creates hazards connected with the value of the above-mentioned foreign reserves build-up. Due to the fact that the foreign exchange reserves of China are close to the level of 50 percent of the country’s GDP and the fact that the majority of the reserves are denominated in US dollar, a decrease in the cost of the dollar or dollar assets indicates huge derivations for China (Toohey, Picker, and Greenacre 207).

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China’s Exchange Rate Regime

The current exchange rate regime of China is known to be a cross-breed of fixed and floating. It used to be a truly fixed regime from 1994 to 2005 (Toohey, Picker, and Greenacre 197). Afterwards, Beijing proclaimed that it would re-evaluate the state’s currency to a number of other currencies, including dollar, Euro, the Japanese yen, and the Korean won (Goldstein and Lardy 164). The values of each have never been reported. The reform of the China’s exchange rate regime has created a so-called “managed float” (Toohey, Picker, and Greenacre 196). This kind of regime is known to be a merger of a fixed and floating currency with fixed type being dominating. This regime has several characteristics of a floating regime due to the fact that market authorities define the course of the currency’s tendencies. The current China’s regime demonstrates that the yuan is considered of high value (Goldstein and Lardy 164). Nevertheless, the regime resembles fixed, as Beijing is still trying to lower the speed of the currency value increase. The current regime demonstrates that China is actively devaluating its currency by posing indebted market coercion on the dollar, including trading-off dollars for yuan in the Chinese economy (Goldstein and Lardy 164). Such actions lower the demand for the yuan, simultaneously decreasing its cost in comparison with the dollar. Moreover, the regime stimulates the county to ensure that it consumes almost all foreign currencies within its economy through tight cost control. Cost control is related to the governmentally imposed limitations regarding inward and outward flow of foreign capital. The most outstanding cost control refers to the necessity of practically all Chinese entities to refuse foreign currencies in their property to the state-possessed banks and reciprocally adopt yuan (Toohey, Picker, and Greenacre 197). Moreover, the regime heavily regulates all foreign currency purchases.

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Possible Changes of China’s Economic Policies

The argument of Impossible Trinity, capital and financial account convertibility demonstrates that self-sufficient monetary policy and exchange rate fixity cannot be simultaneously obtained (Brada 142). It is possible for a small and open economy to adhere to exchange rate policy and regime objectives by means of monetary policy self-sufficiency (Brada 142). China cannot be regarded as a country with a small economy. China’s population accounts for 1.3 billion, which practically means that China cannot allow itself to forfeit self-determination of the monetary policy and expose itself to economic regulations or regimes of other countries (Li and Wang 201). Adaptation of a more flexible exchange rate regime can easily serve China’s long-range economic policy interests and objectives, suggesting the advantages of long-range cost firmness and economic reorganization, which can exceed the costs of reconstructing specific industries and eliminating outmoded and obsolete capacities. The analysis of the current economic situation in China demonstrates that a more flexible exchange rate regime may help to curb inflation and asset gaps. When domestic inflationary coercions are increased, a stronger domestic currency might help to bring down the cost of imports. The function performed by exchange rate in eliminating imported inflationary coercions is especially crucial for a country like China, which presently demonstrates a strong requirement to import primary products due to the adverse resource funding. Economic reconstruction and development pattern change (both being pressing objectives of strategic importance) cannot be attained without persistent endeavors. That is why China should look for a more balanced trade evolvement. Price implements, including exchange rate policy and regime, can be intercepted in order to modify trade and Balance of Payments (BOP) discrepancies (Brada 144). The change of exchange rate regime and policy will help to ease the coercions of influxes of foreign exchange and swift build-up of reserves. This change can also stimulate sound and stable development, and actualize solid and ordered money supply increase. The international experience demonstrates that a flexible exchange rate regime assists in mitigating the effects of external disturbances and enhancing macroeconomic flexibility. In fact, financial depressions in the 1990s vividly depicted that a purely fixed exchange rate regime was pregnable to speculations and could even trigger self-sufficient currency detriment (Brada 147). Finally, stronger exchange rate flexibility also assists in enhancing the transmission mechanism of monetary policies. Therefore, the adaptation of a more flexible exchange rate allows strengthening the risk management, improving financial services and stimulating higher level of product innovation.

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