FT.com / Asia-Pacific / China – China to focus on curbing inflation

Growth – the ultimate macroeconomic policy goal. Growth leads to improvements in material well-being; by definition it means more output per person. Growth also enriches society in other ways: more tax revenue for governments means more to spend on public goods like education, health care, and infrastructure, which all contribute to development of human capital, standard of living, and productivity. But is there such a thing as too much of a good thing? When it comes to growth in China, that may be the case.

According to Chinese premier Wen Jiabao:

“The primary task for macro­economic regulation this year is to prevent fast economic growth from becoming overheated growth…”

So, fast growth is good, but overheated growth is bad?

I once had a Jeep Wrangler that when I drove it across the country, anytime it hit 70 mph it started to overheat… is that the kind of overheating China’s economy is experiencing? Well, kind of, yes.

The reason my Jeep would overheat was that the pistons in the engine had to move so rapidly to keep the engine going at enough RPMs that the friction created overwhelmed the engine’s ability to properly cool itself. In China, the pistons can be compared to the manufacturing industry and agricultural sectors, which last year were stretched to their limits to meet not only rising demand from foreigners for China’s output, but record levels of domestic demand as well.

For the first time last year, China’s domestic consumption made up a larger component of the country’s GDP than investment. Returning to our metaphor, the engine was forced to work harder than usual, but I hadn’t spent enough to maintain the engine, so it was not properly lubed and tuned for the stress of long-distance travel. Maintenance on an engine is important, otherwise it will wear out and overheat while driving at high speeds over long distances. Likewise, investment in new capital is vital for an economy to keep from overheating as it grows at high rates over long periods of time.

Rising consumption and exports, without a corresponding increase in investment, means capital depreciates too quickly to meet Chinese and the world’s demand for output. In terms of our macroeconomic model, AD shifts out more rapidly than AS, causing inflation:

“the premier said the political priority was to tame consumer price inflation, which hit an 11-year high of 7.1 per cent in January.”

Rising consumption and net exports puts upward pressure on prices in China. To worsen matters, food prices have experienced record increases in the last year, making the matter especially hard for China’s urban poor, separated from the farmland and its produce as they are.

Investment, while an expenditure itself, tends not to contribute to inflation (as might be thought, since it shifts AD outward), but mitigate it, due to the supply-side effect attributable to the increase in capital and productivity that it creates. To combat rising food prices in China, Mr. Wen plans to encourage investment in the agricultural sector through targeted government intervention:

The government would expand agricultural commodity production, strictly control industrial grain use, establish an early-warning system to monitor supply and demand, and strengthen “market oversight” and “price inspections”, he said.

Subsidies for the poor would be increased and provincial governors and mayors held directly responsible for ensuring basic food supplies, said Mr Wen.

Overall China’s picture is looking rather rosy, it would appear. While 7.1% inflation is certainly something to fear, it seems to be manageable in the context of a global slowdown in income growth, and the corresponding decrease in demand for Chinese exports that implies. Combined with a strengthening RMB, China can look forward to a slower rate of growth in 2008, (“a now routine annual ‘target’ of 8 percent expansion in [GDP]“). The trick for the government is to foster investment and productivity growth in the agricultural sector to keep food prices down in the face of growing demand for meat products among China’s middle class.

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Economics focus | From Mao to the mall | Economist.com

China, long acknowledged as the world’s factory, could suffer if falling demand for its exports in the US results in a decline in aggregate demand and GDP here as some economists believe it will. But not all economists agree on the importance of exports to China’s domestic economy:

The increase in net exports (exports minus imports) has never been the main source of China’s growth. It contributed two to three percentage points to annual GDP growth between 2005 and 2007, whereas domestic demand (consumption and investment) added eight to nine percentage points.

But the latest figures show that exports have become even less important as a driver of growth. The World Bank’s latest China Quarterly Update suggests that net exports contributed only 0.4 percentage points to GDP growth in the year to the fourth quarter of 2007 (see left-hand chart). Overall GDP growth slowed only modestly (to 11.2%) because of faster growth in domestic demand, which contributed an impressive 10.8 percentage points.

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Defining the macroeconomic problem – Paul Krugman – Op-Ed Columnist – New York Times Blog

Paul Krugman, economics columnist for the NYT, shares his views the true problem with the US macroeconomy. Krugman thinks that the source of instability today is too much consumer spending and too few exports in the last decade.

Basically, I’d say, the problem is twofold. First, in the mid-00s the U.S. economy got badly unbalanced — too much dependence on housing and housing-inflated consumer spending, too big a trade deficit.

The table here (from Krugman’s piece) shows the net change in consumer spending, investment (non-residential or business investment, and residential investment) and net exports between 2007 and the average for the last 20 years of the last century. Continue Reading »

Can the stimulus save us? – from CNNMoney

Today the US Congress approved a $170 billion stimulus package that will consist of rebate checks to be mailed to 117 million low and middle-income households. The details of the package are as follows:

Tax rebates to 137 million people. A rebate of up to $600 would go to single filers making less than $75,000. Couples making less than $150,000 would receive rebates of up to $1,200. In addition, parents would receive $300 rebates per child.

Tax filers who do not owe income taxes but have at least $3,000 in income would get a $300 rebate.

The IRS will start sending out checks in early May, said Treasury Secretary Henry Paulson.

“Payments will be largely completed this summer, putting cash in the hands of millions of Americans at a time when our economy is experiencing slower growth,” Paulson said in a statement.

Business tax breaks. The bill would temporarily provide more generous expensing provisions for small businesses in 2008 and let large businesses deduct 50% more of their assets if purchased and put into use this year.

Housing provisions. The bill calls for the caps on the size of loans that may be purchased by Fannie Mae (FNM) and Freddie Mac (FRE, Fortune 500) to be temporarily raised from the current level of $417,000 to nearly $730,000 in the highest cost housing markets.

It also calls for an increase in the size of loans that would be eligible to be insured by the Federal Housing Administration.

Politicians from both parties joined forces on this act of expansionary fiscal policy. The hope, of course, is that with more money in their pockets, Americans will start spending again, firms will start investing, and these increases in expenditures will shift the US economy towards a path of expansion, increasing employment and output.

But what will the impact of this “stimulus package” be? Will Americans spend their rebate checks in the way Congress hopes they do? Some fear that low and middle-income households will take their newfound income right to Wal-Mart and buy Chinese imports, or put a large proportion of it into savings, or pay off existing credit card debt, three actions which would represent “leakages” from the circular flow, leading to no new income or output. Savings and spending on imports would do nothing to stimulate the US economy, therefore, before concluding that the tax rebates will help fend off a US recession, economists must consider the American peoples’ marginal propensities to save and to import. Only new spending on American goods and services will contribute to aggregate demand.

The provision of the stimulus package more likely to result in increased spending in the US is the business tax deduction for spending on new capital. Capital goods such as heavy machinery tend to be made in America by American workers, so encouraging firms to invest in new capital is likely to have a positive demand-side effect on US income and employment. Furthermore, more capital for US businesses is likely to increase productivity of workers in those firms which have invested, leading to greater income and output: this is the desired “supply-side” effect of stimulating business investment. When aggregate demand and aggregate supply increase simultaneously, economic growth is the result.

Unfortunately, the provisions aimed at encouraging business investment represent only around one third of the total stimulus package. Most of the $170 billion will end up in the hands of households, which I suppose should come as no surprise in this election year, when both the Democratic and Republican parties want to appear as the benevolent parties that helped make the average American household a little bit richer in 2008!

For some informative insight from Harvard economist Martin Feldstein, who is president of the National Bureau of Economic Research, click here.

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Alice Su, an AP Econ student, asked a very good question in class today during our discussion of the business cycle, which illustrates the tendency of national economies to fluctuate between periods of expansion and recession. Karen wanted to know what a government could possibly do to try and avoid the dismal prospect of repeated recessions on and on into the future that the business cycle seems to suggest is the fate of any economy.

To answer Alice’s question, we can look at the United States right now, where the Bush administration and the Democratic led Congress have teamed up to approve a fiscal stimulus package aimed at boosting consumer spending and business investment, thus putting the economy back on the path of expansion and economic growth.

A government can only try to stimulate aggregate demand and/or aggregate supply in times of recession. The tools at the government’s disposal include changing tax policies and increasing or decreasing government spending. In times of recession, tax cuts should encourage businesses and households to spend more, increasing GDP. Likewise, new government spending increases GDP directly. The current stimulus package approved by the White House and Congress focuses on the tax side. Listen to the excerpt from a recent episode of WBUR Boston’s OnPoint radio show.

OnPoint - Fiscal Policy Discussion [ 6:22 ] Play Now | Play in Popup | Download (5)

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Economy in focus in Bush address – Jan. 28, 2008

A week into our unit on macroeconomics, we’ve already introduced why the study of macroeconomics is so important. The health of a nation’s economy is dependent on the achievement through macroeconomic policy of three major goals:

1. full-employment
2. price level stability, and
3. economic growth

The word most heard on the lips of economists and political pundits in the US today is recession, a macroeconomic condition in which all three of the above goals are jeopardized. Defined as “a decline in real output over time”, a recession usually leads to unemployment, negative economic growth, and sometimes inflation (a rise in the overall price level), or in some cases deflation (a fall in the price level).

Recessions are usually a result of a decline in consumer spending, which in the US makes up around 70% of GDP. In other words, out of the four types of expenditures (C, I, G and nX), households’ spending on goods and services produced within the US is the largest component of our nation’s national income. When consumers stop spending for some reason, recession is a likely outcome.

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