PRCs Central Bank - Essay Example

?Oscar B. Valencia Economic 02 Jun Macro & Micro Economics When PRC began its economic reforms in 1978, the “Sleeping Giant” as quoted by Havely(CNN.com) has now become the second largest economy worldwide according to International Monetary Fund data of 2010. Basically, PRC is still a communist country ruled by the Communist Party of China. Compared to its closed-door policies until the mid-1970s, the liberalization it initiated has generated more business opportunities for entrepreneurs especially in small-scale enterprises. When the government relaxed its price control and promoted foreign investment, the United States started to invest in PRC beginning 1979 after both countries establish diplomatic relations. With Japan as their fund provider since 1978 through soft loans, PRC is now the fastest growing major economy in the world. Its success has been attributed to a formula of cheap labor, ease government policy, overall infrastructure, high productivity, and some say, an underrated exchange rate. In spite of a growing trade surplus, PRC is consciously making effort to lower its inflation rate and/or manage inflation expectations by raising bank reserve ratio of deposits through a directive from PRC’s Central Bank. This brings as to the first question as to how will this affect the balance sheets of both the banks and the PRC’s Central Bank. As regard to the banks, their assets, particularly deposits will decrease and the same amount will increase the reserve in the “Liabilities” portion in their Balance Sheet. Expectedly, the assets of the Central Bank either in receivables or deposits will increase as well as their reserves. Normally, banks hold two bank reserves, one is use for cashing checks or satisfying client’s withdrawals while the other is called “legal reserves” or sometimes called “federal reserves” or central bank reserves. This is the specific reserves that the PRC’s Central Bank wanted to be raised by the banks, and for this year alone, the reserve requirement ratio (RRR) has been raised for the 5th time to a record high of 21 percent according to Xinhua. PRC’s Central Bank recent move which is a “contractionary monetary policy” according to Li-Gang Liu, could help manage excessive liquidity in the market but the economic growth of PRC will slow down, however steady during the next two years. Asian Development Bank (ADB) said in its 2011 Asian Development Outlook that “there is very little risk of hard landing because growth momentum remains robust for the medium term”. As compared to last year the Gross Domestic Product (GDP) growth will slow to 9.3% in 2011, a dip from 10.3% annual growth in 2010 (Global Times), mainly due to stubborn inflation this year. One determinant factor of inflation is the Consumer Price Index (CPI), as the CPI rise so is the inflation. Consumer consumption is one of the major components in arriving at the total GDP, the others are government expenditures, gross investment and the net of exports versus imports. Consumer consumption may not be a factor at this time because wages will not outpace production. Government expenditures were already programmed to pay maturing foreign loans, hence will be constant, while investment will decrease minimally due to expected increase in interest rates. The one that will affect most in computing the GDP is the net difference between exports and imports. As I analyze it, imports will continue to outpace exports due primarily to higher demands for fuel consumption, which are outsourced externally. The World Bank said “strong domestic demand and relative price changes has reduced the importance of external trade for China” (Reuters.com) There might be an oversupply of products which will considerably affect prices and therefore have an effect on equilibrium. As regard the aggregate expenses, again this will tend to be low as the net effect of imports versus exports is high. PRC’s Central Bank raising of RRR will certainly have an effect on the money multiplier since it will decrease the banks’ money intended for loans, thus less opportunity for prospective investors to come in. With this scenario, spending and investment multipliers will be low since there will be fewer investments. There may be a slight decrease or no effect at all regarding the Average Propensity to Consume (APC) percent in 2011. APC refers to the percentage of income that is spent on goods and services according to the definition of Investopedia. National Bureau of Statistics (NBS) of PRC reported that APC fell by 5.2 percentage points from 2005 to 70.5 percent in 2010 (GOV.cn). This is in spite of an annual growth rate of 9.7 percent as NBS added. Inversely, the Average Propensity to Save (APS) will increase due to high priority on education of dependent/s in every Chinese family.. Investopedia defines APS as to the percentage of income that is saved. The Marginal Propensity to Consume (MPC) will slightly increase because of the expected salary increase of the workers, they will probably replace old things for a new one. MPC refers to the percentage of “new” income that is spent on goods and services. The Marginal Propensity to Save (MPS) will also increase mainly because most Chinese are frugal. MPS refers to the percentage of “new” income that is saved. Lastly, PRC’s move will have no direct bearing effect on interest rates. The raising of interest rates is just one tool or option to bring down inflation or achieve price stability. High interest rates will have an impact on aggregate demand and supply because this will decrease consumer spending, which eventually will have an effect on supply to be over. Moreover, most companies and industries who wanted to expand their businesses are hesitant to borrow money from the bank because of high interest rates, and since prices are rising, these industries have no choice but also to increase their prices. Once prices rise, the demand is low and will have a counter-effect on the supply. Normally, when demand is high and the supply is low, the price is also high, on the contrary, when demand is high and supply is also high, the price is low. There is no truth that when supply is high the prices will go down, this is only true in department store, where they sell their “old stocks” at a discounted price, usually in a “sale event”. Prices of goods and services dictates the demand and supply, that is, when the price is low, demand and supply is high but when price is high, the demand and supply is low. In conclusion, PRC’s Central Bank directive to raise the RRR has been their strategy since 2007 to fight against inflation. So far it works for PRC, inflation has been kept at a minimum and the GDP is acceptable, however their global partners, the USA, the European Union, and Japan has been affected so much. Because PRC’s currency is moving a little bit slow, its global partners can’t benefit from their exports to PRC due to low currency rate. Works Cited China.org. “Central Bank raises reserve ratio for third time this year” 22 Mar 2011 Web. May 2011 Gov.cn Havely, Joe “Giant aspires to superpower status” CNN.com Web. 28 May 2011 Heytens, Paul J. ADB’s director for China Investopedia.com Liu, Li-Gang Reuters.com Wikipedia.org Xinhua Read More