Economic Analysis Report

This report analyzes two articles: one on slowing US job growth and rising wages, and another on the paradox faced by China due to US interest rate hikes. The report defines key economic concepts like expansionary fiscal policy, budget deficit, labor market expansion, full employment, federal funds rate, interest rates, exchange rates, currency appreciation, and depreciation. It applies these concepts to analyze the implications of the issues discussed in the articles, providing economic insights and suggesting solutions. For the first article, the report discusses the potential increase in budget deficit due to expansionary fiscal policy and the implications of a labor market nearing full employment. For the second article, it examines the impact of US interest rate hikes on China's capital outflows, currency decline, and fragile financial sector. The report concludes by summarizing the findings and offering recommendations for addressing the identified economic challenges.

Contents
Introduction.................................................................................................................................................2
Article 1.......................................................................................................................................................2
Summary.............................................................................................................................................2
Definition of Economic concepts used.................................................................................................3
Economic analysis................................................................................................................................3
Conclusion...........................................................................................................................................6
Article 2.......................................................................................................................................................7
Summary.............................................................................................................................................7
Definition of Economic concepts used.................................................................................................7
Economic analysis................................................................................................................................8
Conclusion.........................................................................................................................................11
References:................................................................................................................................................12
1

Introduction
The aim of this report is to summarize the key issues identified in the articles published in
newspapers and to identify the key economic definitions used in those articles. After this, the
report applies those concepts of economics to the key issues for determining the implications of
the issue and to identify the possible solutions for the same. Finally, the issue has been evaluated
in terms of applicability, usability and giving recommendations for solving that issue.
Article 1
Summary
Article 1 ("Job growth in US slows in December but wages climb", 2017): The first article talks
about the slowing down of the job growth in US and the climbing of wages. In December, the
employment in the US increased at the level which was less than expected but, the wages got
rebounded for sustaining the momentum in labor market. Thus, the economy of US was all set
up for the stronger growth and for the hike in rate of interest from the Federal Reserve. There
was increase in the non-farm payrolls and the gains are above the sufficient level which helps in
absorbing new entrants in the labor market. The numbers of jobs created in the past months were
more than that of the previous month and hence the average hourly earnings increased in the US.
The rise in the rate of wages has been largest since June 2009. For further lifting up the
growth, the expansionary fiscal policy is likely to get adopted but it will increase the budget
deficit of the country. The labor market is already expanding and along with that the
economic growth will become faster, but that will lead to Fed falling behind the curve on
the hike in the rate of interests.
2

Definition of Economic concepts used
The following economic concepts have been used here:
Expansionary fiscal policy: It is a policy by government which is adopted so that the money
supply in the economy gets increased and the rate of inflation is raised. This is done by
decreasing the rate of taxes, and increasing the expenditure of the government (Hansen, 2013).
Thus, this helps in fighting the recessionary pressures of the economy. When the taxes are
reduced, the disposable income of the people gets increased thus they spend more and consume
more. When the goods and services are invested into and the people spend more, the GDP of the
country gets improved.
Budget deficit: The financial health of the country is indicated by the budget deficit. The budget
deficit is said to have occurred when the expenditures exceed the revenue of government
(Moran, 2014).
Expansion in the labor market: The supply and demand for the labor is called as the labor market
where the supply of labor is provided by the employees and the employers create the demand for
labor (David, 2013). The labor market is the major component of any economy and it is tied up
with the capital market, and the market for goods and services. The labor market gets expanded
when the demand and the supply expands. This means that more people want to enter the market
and more people are required by the employers to work.
Full employment: It is a condition where all the people who can work and they are willing to
work are employed in the economy at a particular time (Beveridge, 2014).
Economic analysis
Application of the concepts and theories to the key issue
3

According to the first article, “But the proposed expansionary fiscal policy stance could increase
the budget deficit (refer to the diagram1 below). That, together with faster economic growth and
a labor market that is expected to hit full employment (refer to the diagram2 below). This year
could spark concerns about the Fed falling behind the curve on interest rate hikes (refer to the
diagram3 below).” ("Job growth in US slows in December but wages climb", 2017).
Diagram 1
In the above diagram, when the expansionary fiscal policy is adopted, the government reduces
the rate of taxes and r1 falls to r2. Thus the government was borrowing LF1 which increased to
LF2 and the supply curve shifted right. With the rise in the loanable funds borrowed by the
government, the budget deficit o the government will rise.
4

Diagram 2
In the above diagram, the full employment is reached E. at this point, the aggregate demand
curve and the short run supply of the labor meets at point E which is the equilibrium price and
GDP level. At point E, the full employment is depicted by long run aggregate supply curve being
a vertically straight line which shows that all the people in the economy are employed.
Diagram 3
5

In the above diagram the rate of interest rises from i* to i** which lead to shift in the demand for
money curve to the right and demand curve shifts from D to D’. this leads to rise in the demand for
money from M* to M**.
Determination of price in the economy
In an economy, price of all the goods and services are determined by the intersection of
aggregate demand and aggregate supply.
In the above diagram, the prices of goods and services are determined at point ‘e’ when the
aggregate demand (AD) curve intersects aggregate demand (AS) curve. This is the level at which
the optimal level of price and output of the economy can be determined.
Factor affecting aggregate demand
6

Factor affecting aggregate demand are consumption, investment, government expenditure and
net export. Thus, increase in any one of above factor shift the aggregate demand curve right side
and vice-versa.
When the economy is not at equilibrium level and is operating below full employment, the above
situation arises. In long-run, aggregate increase from AD(1) to AD(2) and equilibrium shift from
E(1) to E(2). Thus, as a result economy attains its full employment level.
7

If the economy is at above full employment level and the aggregate supply curve shift leftward
from AS(1) to AS(2), the price will decrease from P(1) and P(2) and output increases from Y(1)
to Y(2). It will control the inflationary pressure in an economy.
8

In the above diagram, when the consumption and the investment falls, which are a part of AD,
the AD1 curve shifts left from AD1 to AD2 and hence the price falls from P1 to P2. This shows
that Consumption and investment has an impact on the demand of the economy and on the level
of prices.
9

In the above diagram, when the expansionary policy is adopted, the aggregate demand AD1
shifts to the right to AD2 and the aggregate supply in the economy rises too from AS1 to AS2.
As a result, the real GDP of the country rises from Y1 to Y2 and the level of prices in the
economy falls a bit. Similarly, when the spending by government rises, then also the money
supply curve shifts to the right, indicating an increase in the supply of money in economy.
When the expansionary fiscal policy is adopted by the government of a country, the government
reduces the amount of taxes and hence the government earns less as far as the revenue of the
government is concerned. Also, the government increases its spending so it puts an extra burden
on the pocket of government as it has to arrange for funds for spending extra. Now, the revenue
falls and the spending rises which cause a gap and hence the budget deficit increases.
10

With the expansionary policy, the economy of country grows in terms of GDP, increase in the
rate of employment etc. With the rise in people getting absorbed in the labor market, the
employment rate will rise and thus, the full employment will be reached after a certain point of
time. When all the people who are able to work and who want to work are earning in the
economy, then the money supply in the country will rise. They will spend more and invest more.
With the increase in investment, the rate of interest is likely to fall and thus, Fed will not be able
to increase these rates.
The situation depicted in this article is likely to increase the rate of inflation in the country and it
is likely to increase the budget deficit of the country.
Implications and the economic insights
The problems caused and the possible solutions:
According to the first article, the problems that can be suffered by the economy of US are that
the rate of inflation of this country will jump and thus the economy will get unstable. The people
in US, who have fixed incomes, will not be able to afford the goods and services sold in the
country. Also, with the continuous increase in the spending by government, the budget deficit is
like to increase too much which is not good for the GDP and the growth of the country. This
problem has occurred because the rate of employment in the country is increasing and hence
more people are getting paid which is contributing to rise in the money supply in the country.
To solve this problem, the government should control the level of inflation in the country. For
this, the government should decrease its spending and it should increase the level of taxes
(Weale, 2015). When this will happen, the country will be benefitted in two ways. One is that the
money supply in the economy will be controlled and the goods and services will become
11

affordable to all the people. Secondly, when the government will earn more money from the
taxes and it will decrease its spending, then the budget deficit will get improved. It is a good sign
that the employment in the country is getting improved, but at the same time, the economy needs
to think about those people who are unemployed and they will face difficulty in paying for the
increased cost of goods and services.
Conclusion
In the first article, author has stated that the rate of unemployment can be lowered with the
expansionary fiscal policy but it will lead to rise in the budget deficit. The labor, market of US is
near to full employment due to which the rate of employment has lowered down. The remaining
positions that are not filled yet are because the employers are not getting the qualified people
who can take up those positions. Therefore, according to me, the slow rate of employment
increase is justified and acceptable. This is because if the positions get filled by some person
who does not have the required qualification or experience, then the outcome will not come as
expected and it will be a loss to the economy of country. The argument that the author has made
sounds convincing. Since almost all the people in economy are employed and they have jobs so
the money supply in the economy is more and this is likely to increase the rate of inflation in the
country. Hence, the government requires controlling this rising rate so that the economy stays
balanced and it does not create problem in the future.
Article 2
Summary
12

Article 2 ("As Fed raises rates, China faces a paradox", 2017): The second article talks about the
paradox faced by China when Fed raised the rate of interest. The interest rates were increased by
the US Federal Reserve which causes a problem for China because there were large scale capital
outflows and the currency declined too. The currency of China is allowed to rise and fall within a
narrow band against the US dollar but the economies of both countries are diverging. The US is
raising the rates because the economy of the country is growing and the labor market is getting
tightened but the China is growing slowly as compared to US. With the fall in value of yuan, the
Chinese trade will get affected and the fragile financial sector will be hit in China.
Definition of Economic concepts used
The following economic concepts have been used here:
Federal funds rate: It is the rate at which the banks borrow money from Fed and then they
distribute this money further to the people (Afonso, 2015). When this rate increases, the banks
borrow less from the Fed and hence they are able to give lees loans to the people.
Rate of interest: It is the amount charged, expressed as a percentage of principal, by a lender to a
borrower for the use of assets (Holston, 2017). When this rate rises, the borrowers are able to
borrow less money because they need to pay more interest on the loans. When they reduce the
amount of loans taken, they are able to invest less and they consume less. Thus, the supply of
money in the economy gets reduced and the rate of inflation falls.
Exchange rate: The value of one currency to convert it to another is called as exchange rate
(Cavoli, 2014).
Currency appreciation and depreciation: The currency gets appreciated when the value of one
currency increases in terms of another currency. For example the Canadian dollar appreciates in
13

relation to euro i.e. CAD/EUR appreciates, then earlier, 1EUR=1.5 CAD and after appreciation,
1EUR=1.4CAD. For purchasing 1 EUR, the Canadians will have to pay fewer dollars.
On the other hand, the currency gets depreciated when the value of one currency decreases in
terms of another currency. For example the Canadian dollar depreciates in relation to euro i.e.
CAD/EUR depreciates, then earlier, 1EUR=1.5 CAD and after appreciation, 1EUR=1.6CAD.
For purchasing 1 EUR, the Canadians will have to pay more dollars.
Economic analysis
Application of the concepts and theories to the key issue
According to the second article, “Last week, when the US Federal Reserve raised interest rates, it
was a sign for many investors that things were getting back to normal. For China, facing large-
scale capital outflows and a declining currency, it was a sign of a serious problem. A significant
drop in the yuan matters not for how it will impact Chinese trade but for how it will affect an
increasingly fragile financial sector” ("As Fed raises rates, China faces a paradox", 2017).
Determination of exchange rate
Exchange rate is determine by the demand of foreign currency by an economy for purchase of
good and services of foreign country and supply of domestic currency to other country.
14

Factor affecting exchange rate
15

1) If the demand for domestic currency increase it will lead to shift of supply curve of
domestic currency as a result exchange rate fall.
2) If the demand for foreign currency increase in an economy, it will lead to increase in
exchange rate.
16

In the above diagram, when the exchange rate falls and thee economy of China is able to produce
less goods and services, then the demand for the US goods will rise and the aggregate demand
will shift from AD1 to AD2. Also the supply will move up along the supply curve and the prices
of the goods will rise from P1 to P2. The real GDP of the economy of US will rise from Y1 to
Y2.
The US and China are doing business with each other. But, the country US is planning to raise
its rate of interest. When the rate of interest will rise, the money supply in the country will reduce
and hence the people will have less disposable income. Thus, they will spend less and they will
buy less. This will reduce the demand for the goods and services of China in US. Thus, the
demand for the goods and services of China in US will reduce and the Chinese yuan will
depreciate in value. With the fall in value of Chinese currency, it will have to pay more while
importing the goods and services from US. For this, the government of China will have to
arrange for more funds so that it is able to pay for the goods and services that it imports from US.
Hence, the financial sector of China will suffer. It is already fragile and it will suffer from further
losses and extra burden.
Implications and the economic insights
The problems caused and the possible solutions:
According to the second article, China is facing the problem of decline in the value of its
currency and the increased outflows of the country. Also, the country’s trade is getting adversely
affected and hence the financial sector. This is happening due to the hike in the rate of interest
by Fed in USA. If the currency for China is depreciating, the imports will become expensive for
China. This can also lead to cost push inflation. This inflation is caused due to the increase in
17

prices of inputs of a country like the labor, the raw material etc. When the factor of production
becomes expensive, the supply of the goods and services falls.
To solve this problem, the country should sell its foreign exchange assets and they should buy
their own currency. Suppose China has $1 trillion of the US government bonds and if the
government of China sell this bill to US and it brings the proceeds back to China (Moschella,
2015), this will depreciate the currency of US and hence the currency of China will appreciate.
The Chinese government should increase the rate of interest. This will help the country in
attracting the hot money flows. The government of China has bound the yuan within the band of
dollar and it needs to unbind it so that it can float freely. With the free float, the demand and
supply will help in determining the rate of exchange and hence the value of yuan will not depend
on the rate of dollars in USA.
Conclusion
In the second article, author has stared that due to the Fed policy of increasing the rates, the
China is facing a decline in value of its currency. This has been done by Fed because it was
worried about the rising prices in the economy of US. The economy was growing at a steady
arte and there was tightening in the labor market. This created the possibility of inflation. So,
with the rise in rate of interest, the Fed tries to control the supply of money in the economy of
US. Because of the decline in value of currency of China, the country is facing problems in
doing trade. The author has also stated that China has maintained a soft peg of its currency and it
rises and falls within the narrow band against the US dollar. This causes the yuan to get affected
whenever any policy is taken in US. Thus, the author has suggested that China should let its
currency float freely and it should spare yuan from the grip of dollar. Some of the policy
measures have also been recommended by the author with which China can increase the value of
18

its currency. For example, the `reform needs to be done in the banking sector. I completely agree
with the author’s point as it is very convincing, and apt. This is because if the currency of China
is dependent on the currency of some other country then any changes in the policy of that
country will affect the currency of china. Also, if China lets its currency float freely, then the rate
of exchange will be established with the help of demand and supply conditions. Also, the
government of china needs to take the steps for increasing the value of its currency otherwise the
country will face trade deficit in the long run. According to me, China should take these steps as
soon as possible so that its trade balance does not get deteriorated further and it is able to recover
the fall in the value of yuan.
19

References:
Afonso, G., & Lagos, R. (2015). Trade dynamics in the market for federal
funds. Econometrica, 83(1), 263-313.
Beveridge, W. H. (2014). Full Employment in a Free Society (Works of William H. Beveridge):
A Report (Vol. 6). Routledge.
Cavoli, T., & Rajan, R. S. (2014). Intervention and Exchange Rate Regime Choice in Asia: Does
the US Dollar Still Matter? (Doctoral dissertation, World Scientific Publishing).
David, H., Dorn, D., & Hanson, G. H. (2013). The China syndrome: Local labor market effects
of import competition in the United States. The American Economic Review, 103(6), 2121-2168.
Hansen, A. H. (2013). Fiscal policy & business cycles. Routledge.
Holston, K., Laubach, T., & Williams, J. C. (2017). Measuring the natural rate of interest:
International trends and determinants. Journal of International Economics.
Moran, T. (2014). The United States Budget Deficit and Social Security Games.
Moschella, M. (2015). Currency wars in the advanced world: Resisting appreciation at a time of
change in central banking monetary consensus. Review of International Political
Economy, 22(1), 134-161.
Weale, M., Blake, A., Christodoulakis, N., Meade, J. E., & Vines, D. (2015). Macroeconomic
Policy: Inflation, Wealth and the Exchange Rate (Vol. 8). Routledge.
20

Articles:
Job growth in US slows in December but wages climb. (2017). The Straits Times. Retrieved 4
February 2017, from http://www.straitstimes.com/business/job-growth-in-us-slows-in-december-
but-wages-climb
As Fed raises rates, China faces a paradox. (2017). The Straits Times. Retrieved 4 February
2017, from http://www.straitstimes.com/opinion/as-fed-raises-rates-china-faces-a-paradox
21