Macroeconomic Implications of China's Fiscal Essay

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However, aggregate supply always responds, eventually, to demand so aggregate supply will fall as well, until there is a state of equilibrium again.

3.

Increasing the amount of deposits that commercial banks must hold with the central bank will diminish the money multiplier, which is the amount of money a bank can create with each dollar of reserves. The money multiplier is determined by the reserve ratio. The higher the reserve ratio, the less money the bank will have to lend out, diminishing the money multiplier. Requiring the commercial banks to increase deposits will increase the reserve ratio by.5%, thereby diminishing the money multiplier by .5.

The spending multiplier, which is the measure of additional spending in the economy generated as a result of the initial spending, will be reduced because of the reduction in consumption caused by less wages, rent, and profits paid by firms. The investment multiplier, the measure of additional investment in the economy generated as a result of the initial investment, will be reduced because of the reduction in investment caused by less lending to firms for business ventures.

The Marginal Propensity to Save, the increase in the desire to save as a result of increased income, will decrease as a result of China's policy because it will slow inflation, making money more valuable in consumption than in saving. A lower MPS increases the money multiplier effect by putting a larger portion of each created dollar back into the economy instead of sitting in a bank account. The Marginal Propensity to Consume, the increase in the desire to consume as a result of increased income, will increase as a result of China's policy for the same reasons that MPS decreased.

The Average Propensity to Consume, the actual proportion of income which is spent on consumption, would typically increase as money becomes more valuable in consumption but may not increase here because the base for the money multiplier has been reduced by the government policy.

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The Average Propensity to Save, the actual proportion of income which is saved, would typically decrease as money becomes more valuable but may increase her as a result of higher interest rates.

4.

Generally, when the amount of money in supply is lower than the amount of money that people want to hold, there is a money shortage. When there is a money shortage, interest rates tend to rise because of the higher opportunity cost of holding money that could be collecting interest somewhere. Specifically, commercial banks will have less money to lend out and will collect less interest as a result. However, banks usually compensate for their diminished lending base by raising interest rates, which will help build up their lending base by increasing the amount of interest they collect on each dollar.

Higher interest rates will decrease aggregate supply because firms will find it more difficult to obtain the loans they need for business ventures. This will reduce the amount of goods and services they can produce for the market, leading to a reduction in aggregate supply.

Higher interest rates will have less of an effect on aggregate demand. Demand from firms will be affected because firms will want to buy (invest) less because of the higher total cost of investment caused by higher interest rates. Demand from households, however, will be less affected by higher interest rates because households do not typically borrow for consumption at the rate firms borrow for investment. Household consumption might be indirectly affected by higher interest rates because they increase the profits that can….....

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