Capital Inflows and Outflows in Thailand and China - Assignment Example

Name: Course: Instructor: Date: International Economics: Assessment 2 Question 1 The concern of China is because QE has positive impacts to the economy of U.S. and negative impacts to other impacts. Given that China is related to the U.S. significantly, it is concerned with the issue since, there is a high probability the exchange rates of the country will decrease, increase inflation rate and increasing interest rates. The diagram below present the impact of capital inflows to China through QE on inflation, exchange rates and interest rates. Interest Rates 8% 4% QE money supply Inflation Rates Unemployment The QE increases inflation rates in other countries including China. Therefore, as the inflation level increases the employment levels increase. The Undervalued Chinese Currency Equilibrium Value of Yuan A Syuan B C China exports increase Fixed value of Yuan Dyuan 200 700 1000 Imports decrease from China The QE leads to a decline in U.S. exports and increase in the imports. The Americans will be acquiring yields from China at lower prices and significantly low interest rates than those set by the Fed. Thus, this is a clear identification that the QE is beneficial for the U.S. and it disadvantages China. The quantitative easing policy main motive is to simplify the acclaim conditions in global market. The U.S dollar is perceived as the international coinage, where its policies influence other factors such as the interest rates and world production of other markets. In China, the QE started in 2008, which increased the CPI inflation rates to a peak of 7% (Ruan, 10). Thus, the dismay expressed by the Chinese was due to the concern on the impact the U.S. QE policy would trigger to its country. It had already occurred in 2008 causing a high inflation rate, which was a negative shock for the economy. Thus, given it had already appeared to increase the inflation rate of the country, it was a key cause for concern. The QE model is a financial tool used to enhance markets such as the US economy. However, the boost it provides the US is not experienced in other countries. That is; to other currencies, it conveys spill overs in their economies. The Chinese dismay is related to the probable upsurge in the prices of supplies, which would also lead to an upsurge in the production costs in China leading to a development in the inflation proportion of imports (China Daily). As the undervalued curve of the Chinese currency demonstrates, the imports from China decrease while exports from the U.S increase. The QE decreases the value of Yuan, which benefits the U.S. as they acquire products at low prices. The QE influences the total monetary rate and inflation, where the price fluctuations steer to the high inflation rates in China. This has a positive correlation since with the increase in inflation, employment increases. The QE is assumed to decrease the power of China economies though trading, while lowering the exchange rate of the country. That is; QE in US leads to the growth of the RMB, which consequently sinks the exchange rate of China. Thus, the exports will decline leading to growth in trade growth rate that declines the trade stability of China (Ruan). The dismay by China can therefore, be also linked to the fact that when US implements the QE, the interest rates fall, the USD depreciates leading to a decline in money supply and price level. Additionally, the Chinese Market is sheltered by the foreign exchange control that limits short-term money flows, thus, the QE in US tips to external shocks on price of stocks. That is; when the FED needs to lower interest rates, it opens the market procurements, leading to an increase in money supply (Ocampo and Ros, 78). The excess of money supply leads to excess demand of bonds in the market. Consequently, the bond’s/ stocks price go up leading to consequent reaction of lowered interest rates. The QE is also an extension of the open market operations where the central bank either contracts or expands the money supply through an open market of selling and buying government securities. The open market operations increase money supply and lower the interest. On the other hand, to increase the interest rates, the market opens a market sales leading to a decrease in the money supplied. As a result, there is excess demand of money and bonds supply leading to a price decrease of the bonds, which consequently leads to an increase in the supply rate. The Chinese sees the QE as a process of reducing the interest rates since where the dollar depreciation leads to the decrease of its foreign exchange leading to negative shocks to its economy. The dismay that the Chinese expressed was based on the theoretical implication on the QE, which stipulated that the economy would experience significant negative shocks. 2. Let us assume the following information for an economy. C=10000+0.6Y I=2000 G=5000 X=600 M=400 a. Find the size of the multiplier in this economy. (3 points) SOLUTION 1/1 – MPC MPC = 0.6 MPS = 1-0.6 = 0.4 Therefore, when consumers spend 0.6 and save 0.4 in every dollar of extra income, the multiplier in the economy is: 1/0.4 Multiplier = 2.5 Therefore, every dollar of extra income generates 2.5 extra income. b. Find the short run equilibrium output. (7 points) Short Run Equilibrium Output (OPEN ECONOMY) SOLUTION Y = C + 1 + G + (X - M) Y = 10000 + 0.6 Y + 2000 + 5000 + (600 – 400) Y = 1000 + 0.6Y + 2000 + 5000 + 200 Y = 10000 + 2000 + 5000 + 200 + 0.6Y Y = 17200 + 0.6 Y Y – 0.6Y = 17200 0.4Y =17200 Y = 43,000 Question 3 a. Why do you think that there is going to be capital outflow? (3 points) Capital outflow occurs in an open economy, where by the current account involve the transfer of assets to other countries. The capital outflow is triggered by the economic and political instability that compels investors to withdraw their holdings from a country due to the perceived weakness and probability of better opportunities in other countries. Thailand will have capital outflow due to the political unrest that has been occurring in the country. The political instability occurs as a weakness to the investors that may harm their reserves, which compels them to withdraw their investments to other countries that show the probability of better investments. More importantly, the weakening of its currency also stipulates the economic instability of the country. Therefore, the capital outflows in Thailand will occur due to the economic and political instability transpiring (Ho). b. If indeed there is going to be huge capital flight, what should be the policy taken up by Bank of Thailand to avoid a free fall of their exchange rate and how they can achieve it (explain at least one instrument)? (5+2=7 points) The capital outflows in Thailand, the currency supply of the country will increase as investors sell its currencies to acquire other currencies that provide better opportunities. Capital outflows demonstrate a reaction of the investors on the lack of confidence of its economy, which leads to the depreciation to the exchange rates (Grenville). To avoid a free fall of the exchange rate, the Central Bank of Thailand should tap into the foreign reserves. The market anticipates a devaluation with the capital outflow, when they tap on the foreign reserves, the downward pressure on the currency can be offset since there will be an upsurge in the interest rates. Consequently, to ensure the interest rate is up, the bank has to shrink the supply of money, which also increases the demand of its currency. The bank can also sell its foreign reserves by creating capital outflow, where it receives a domestic currency payment, which is circulated as an asset. The process will ensure that the price of domestic good is cheaper to foreign products, which creates an output for the country. Reducing the imports will create current account leading to reduced funding from foreign investments. Works Cited China Daily. "US Urged t Consider Effects of Policies." International Business Times (2012): 1-1. http://www.ibtimes.com/exnet/chinese-reaction-fed-qe3-not-happy-797141. Grenville, Stephen. "Central Banks and Capital Outflows." Working Papers in International Economics (2008): 1-40. https://www.ciaonet.org/attachments/385/uploads. Ho, Yudith. "Baht Falls a Second Week as Thai Stocks Drop on Political Unrest." Bloomberg: The Year Ahead (2013): 1-1. http://www.bloomberg.com/news/articles/2013-12-27/baht-falls-a-second-week-on-concern-protests-to-spur-outflows. Ocampo, Antonio, Jose and Jaime Ros. The Oxford Handbook of Latin American Economics. New York: OUP Oxford, 2011. Ruan, Hadong. "Impact of U.S. Quantitative Easing Policy on Chinese Inflation - a vector autoregression analysis based on QE1 AND QE2." Social Sciences (2013): 1-31. https://www.uvic.ca/socialsciences/economics/assets/docs/honours/Ruan_Ryan.pdf. Read More