Question

Assume the emergence of the coronavirus creates a permanent increase in the perceived risk of saving in China. Using the small open economy model, what is the impact on:

1. China' net capital outflows? Explain.

2. The real value of China's currency in the foreign exchange market? Explain.

3. Domestic investment in China? Explain.

4. Economic growth in China? Explain.

5. How will your answers differ if you use a large open economy model instead?

Answer 1

1) China has been very closely monitoring capital outflow transactions, which helps explain the low net outflows in 2019. Another is the weak dollar: This increase the USD holdings of other currencies and therefore raises the value of China's shifted to greater non-USD holdings in its FX reserve this year

2) The root of the conflict for the United States-and other countries-is complaints that China keeps the value of the RMB artificially low, boosting it's export and trade surplus at the expense of trading partners. Although the U.S. treasury has repeatedly stopped short of labelling China a "currency manipulator" in its twice-yearly report to Congress, it has consistently pressured China to allow the RMB to appreciate at a faster pace, and to let the currency fluctuate more freely in line with market forces.

3) Chinese firms, especially those involved in agriculture, daily necessities and high-end manufacturing, are stepping up investment at home to further bloster the country's economy growth. Sustained efforts being undertaken to minimise the Novel Corona virus impact on global supply chain and facilitate cross border flow of goods and services, as well as effort to boost consumption and build new infrastructure projects, have been the driving force for the investment.

4) China's economy has enjoyed 30 years of explosive growth, making it the world's largest. Its success was based on a mixed economy that incorporated limited capitalism within a command economy. The Chinese government's spending has been a significant driver of its growth. China's economy is measured by its gross domestic product. In 2019, growth totaled $22.5 trillion, the largest in the world. That's roughly 8% more than in 2018.

5) Large open economy is that can influence it's domestic intereste rates, has a substantial impact on world market, and in particular, on the world interest rate. Answer could differ as Large open economy can be consisent with those predicted by the IS-LM model. The reason is that a large open economy has the characteristics of both an autarky and a small open economy.