The Effect of RRR Cut to the Money Market essay

The cut aimed to selectively loosen the lending control imposed to the banks earlier, targeting to provide credit aid to mall businesses, agriculture sector and exporters. China has experienced a decelerating growth in recent years as it started seeing a single digit GAP growth as opposed to the decades long double-digit GAP growth. Recently, China government has taken several steps to sustain the high growth rate and meet the forecasted GAP growth one of them is by cutting the ERR at bank. This paper will elaborate the effect of ERR cut to the money market and how it would help to rebalanced the economy in short term.

On long term economic growth, China faces several challenges to sustain its growth base n capital intensive, industry focused and export oriented strategy. The effects of controlled fertility rate, rapid arbitration of sub-cities and inland without sustainable population density as well as the “closed” market directly intervened by the government are also the growth inhibiting factors looked at. Required Reserve Ratio and Money Supply China has had unfavorable credit growth in the past few years that led to financial imbalances.

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The main driver of such was the excessive lending to high risk sectors when the previous stimulus packages were released, causing the country to have the highest corporate debt to GAP in Asia. Central bank thus made extensive efforts to restrict lending and credit product creation. As a result, the interbrain rates surged in 201 3 and early 2014 (Economic update – June 2014). Central bank had then injected liquidity by buying back bonds and communicated the policy intentions, which collectively, stabilized the interbrain rates.

In June 9, Central bank announced the extension of half basis point cut to Required Reserve Ratio at banks that serve the small and micro businesses, agriculture and exporters. This policy would release 12. 76 billion Yuan from Bank of Inning Co. , and 35 million Yuan from Industrial Bank, Enmeshing bank and Merchants Bank. (Shanghai Daily, 23 June 2014). The policy easing is expected to increase the money supply in the market by the means of credit availability for lending.

This will in turn, enable the money creation process and base on Money Multiplier = I/ERR, assuming the ERR was X% before the policy and the Money Multiplier was Z, the equation would be Z = I/X. So the new money multiplier after the 0. 5 percent cut will be Z = 1/ (X-0. 5), which will now give the Money Multiplier value offs+2, and when used in the equation Money Created = Money Multiplier x Initial Excess Reserve, he final amount of loan available in the market would become higher than the one with Z as money multiplier.

The effect of increase in money supply to the financial market can well be illustrated by Money Market Diagram, in Graph 1. The increase in money supply to the financial market will shift the Money Supply Curve MIS to the right as MS, bring the interest rate down from RI to RE, thus attracting small businesses to borrow loan for investment in capital goods, which will push up aggregate demand. When aggregate demand increases, the AD Curse shifts to the right hence the real GAP.

This change is illustrated in Goods Market Diagram, in graph 2. Fiscal Policy Besides the cut in ERR, Chinese government also introduced preferential tax policies in April to support Small Medium Enterprises by loosening the eligibility threshold qualified for corporate income tax cut. According to the Economic Update-June 2014 by World Bank, more than 6 million businesses would be at the receiving end of such fiscal policy.

This is deemed to be able to stimulate the growth because base on Aggregate Expenditure (AY) = Consumption (C) + Investment (l) + Government (G) + Net Export (x-m), the none loaned to the businesses will be utilized for investment In capital goods such as machines, equipments, buildings and additions to inventories thus increase in Investment (l). Besides, the consumption will also go up as reduction in tax will increase the disposable income that translates to an increase in Consumption, base on C a + b (Y-T), where aggregate consumption function is a function of disposable-after-tax income (Y-T).

However we could not rule out the possibility that some of the loans could be used to build redundant capacity or interest repayments and defeat the purpose of such policy. Agriculture sector China’s economic growth is forecasted to continue staying at single digit as the country moves forward. One of the problems that the country will face in few years time is the aging population. According to China 2030 by World Bank, the population will start to grow old before it grows rich. In fact, as soon as by 201 5, the labor force will start to shrink.

The employment-to-population ratio and working-age population growth are very much the consequences of one child policy implemented decades ago and will start to take its toll on the country aggregate hours. Part of the labor-based work can be replaced by new investment in capital goods, here technology advances such as automation’s take over and free up the labor force thus increase the overall productivity. This is advantageous to the agriculture sector of which the potential to improve the efficiency remains one of the highest in Asia.

From biotechnology, mechanization, irrigation system, high yield production to advance harvesting equipments, there remains a large room to push to reach the maximum output per land use. If the loans to agriculture sector can be fully exploited to address the gap, not only the total productivity of agricultural goods will peak and able to retain he self sufficiency in grain, but the surpluses in vegetables and fruits will enable a net export of 8. Million tons and 5. 0 million tons respectively in 2030, contributing directly to the economic grog. H/the.

In addition, the higher efficiency of agricultural sector will increase the income of the farmers hence reduce the income inequality between the inland and coastal cities. Subsequently, the higher disposable income at households will lead to surging demand on durable goods and services besides the basic non- durables. As a result, the higher personal consumption expenditures (C) by he rural area will bring up the country GAP growth. Factor market According to World Bank, the share of industry against service sector in GAP is about equal currently but the ratio will become 61 and 34 in 2030 as the migration of workforce to cities continues.

In 2013, there was 6. 3 million of migrant inflows to urban areas, though it has slowed down by half compared to 2010 due to the household registration system. The 2014 target of 10 million urban jobs is likely to achieve as the labor migrant inflows to city maintain. The dynamic labor market on one hand does help the country in ransoming its labor force from the manufacturing to service, which reduces the urban-rural income and consumption gaps, on the other hand, the rapid workforce migration has seen the local government spent heavily on cities expansion, in terms of building infrastructure using the fund raised through land sales.

In conjunction with the expansion, new properties development were growing at the expense of cheap finance (though lately it’s been tightened), and resulting in speculative investment rather than the real demand. These “ghost cities” exist in China today as a proof of over- expansion without proper planning in place. Although the GAP growth of that few cities posted a positive growth earlier, the problem faced now is the sustainability of such growth. The investments are neutralized due to low density of population which indirectly raised the cost of transport and infrastructure.

If the cities expansion was planned and managed properly, it could help prevent the loss of arable lands while allowing concentration of technological and social investments in the expanded cities, forming a larger economy scale and gathered brains – an essential combination to bring innovation and new ideas to the country development. Government intervention China government’s full control of the market through state owned enterprises (SEE) imposed detrimental effect to the country productivity growth. Ender most circumstances, the SEE would have preferential financial facility, cheaper land cost, closed-loop access to the business opportunities and shielded from open market competition. The privileged position raised an invisible entry barrier to the private firms and resulted in monopoly of key industries, which retarded the domestic growth. In fact, the input required by the SEE was usually bigger than that of private sector, but the total factor radioactivity growth generated was only a third that of the private sector. China government had gone through a major reform of SEE in asses that cost over GAP of then.

Recognized the importance of private sector contribution to the productivity growth, more financial aids were rolled out to small and medium enterprises in the recent stimulus package, whose access to the financial institutions were limited largely due to the dominance of state-owned banks. Besides, the intervention in financial sector such as the interest rates and currency exchange no doubt had contributed to a robust paving and outstanding economic performance, the same concept may not be as effective now as the country economy has evolved into a more sophisticated, complex and globalizes model which requires a market-based system.

This remains a topic to be studied as China has not changed its way of managing the financial sector as far as the open-market concept is concerned. Conclusion China has gained a strong economic growth in the past few decades with strong intervention from the government in financial sector, goods market, factor market and resources. While it brought prosperity to the country, the Tate-owned banks and enterprises would inhibit the growth moving forward.

The state-owned enterprises having access to preferential financial facilities, cheaper land and raw material cost are singling out the competitions from private sector comprises of micro, small and medium businesses who would not have the same level of privileges. As the growth contribution by state- owned enterprises is only one third that of the private sector, China government has effected fiscal policy such as relaxing the threshold for corporate tax, as well as exercise monetary policy by reducing the Required

Reserve Ratio at commercial banks and rural banks who serve the small businesses and agriculture sector. The increase of money supply in the market as a form of loan will create more money through the multiplier effect as the borrowers invest the loan in capital goods, thus boosting the GAP growth. Agriculture remains the sector having the highest room for efficiency improvement by the means of mechanization, would be benefited from the loan by investing in technology that yields higher productivity, which in turn prosper the vegetables and fruits export, thus increase the economic growth.

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