Macroeconomics Internal Analysis

Macroeconomics Internal Assessment

Keigo Tanaka

This article is about China implementing an expansionary fiscal policy, decreasing the tax but mainly increasing government spendings to improve livelihoods and attempt economic growth. Fiscal policy refers to increasing or decreasing tax and government spending according to it being expansionary or contractionary, affecting aggregate demand. In this case it is expansionary, as China is attempting to open up the economy. Unemployment refers to the situation where individuals are actively seeking but unable to find work. Lastly, although there are various aspects in the term, economic growth refers to an increase in real GDP over the previous year.

Graph 1 below refers to a Keynesian model

The multiplier effect refers to the fact that when the government increases its spendings, firms and households receive that spending and re-spend that income (government spending is received as income). This leads to multiple routes of spending, so overall the increase in net aggregate demand is greater than the initial increase in government spending. Therefore, a small increase in government spending can possibly be enough to stimulate the economy, because the net increase in AD will be greater. Secondly, another advantages is effects on the supply-side. In this case, the spending is mainly on improving infrastructure and livelihoods, meaning there are supply-side effects, which increases the short run aggregate supply. (SRAS) This is because it improves the quality or quantity of the factors of production. (Land, Labor, Capital, Entrepreneurship) This will also lead in long term economic growth as LRAS increases. However, the government spending can be also wasteful, depending on what the government spends it

In this case when the government borrows, it would lead to a higher demand for loanable funds, meaning it increases the interest rates. When interest rates increase, it lowers consumption and investment. Referring back to the graph, the government borrows money, which shifts DM0 (initial demand for money) to DM1. Simultaneously, the quantity demanded increases from Q0 to Q1 (as the government borrows), creating a temporary shortage of money. By borrowing so much money, the government “crowds out” private individuals and private commercial interests. Now, the way these shortages get rationed, is for the prices to be pushed up, which is represented by a shift from i0 to i1 (also meaning interest rates are pushed up)

Graph 2: The “Crowding Out” Effect Once interest rates are pushed up, it brings unintended and opposite effects on the AD. Consumer spendings will go down, businesses won’t be able to afford money to buy new capitals, leading to decreases in investment spendings and consumer spendings. These are parts of AD, therefore the AD is shifted partway back as shown in graph 3 below. In this case, overall unfortunately, the intended expansionary fiscal policy is diminished.

Graph 3: Expansionary Fiscal Policy diminished by the “Crowding Out Effect”

In conclusion, China’s expansionary fiscal policy will achieve its macroeconomic goals,