Free Essay About Graph 1: Relation Between Investment Expenditure And Interest Rate With Optimistic View

Interest Rate Cuts and Stimulating Economy in China

Dear Mr. Zhou Xiaochuanh - The President of the Chinese Central Bank,
I am . , an economist who works on exploring the relationship between the economic growth and monetary policy. I am sending this letter to you to express my thoughts on your recent monetary policy strategy. I strongly disagree with your assumption on the negative relation between the interest rate and the economic growth. The occurrence of increasing expenditures of investment and consumption is not necessary as a result of decreasing interest rate in the economy. In fact, there is no certain relation between the interest rate, the economic growth, and the economic stimulation. I will give relatively more detailed explanations below in my letter.
Many economy managers force the central banks to drop the reference interest rate to influence the markets for creating stimulation in their economies. However, decreasing interest rates do not cause stimulation all the time. The Chinese Economy is carrying a risk to face a recession because the global demand for their products is decreasing. The economy management is worrying about a possible recession problem in the economy, and they are willing to stimulate the domestic demand for the products.
The optimistic view on this issue depends on some assumptions. In macroeconomics, the expectations of the agents play an essential role that might change the directions of the expected results of the economic policies. Let us assume that the Central Bank decreases the interest rate by 25 basis point. If the investors believe that their main issue is the cost of interest they pay when they get a loan to do their investment expenditures, and then we might expect that some investors increase the amount of their investments. Also, the investors should believe that the economy is economically and politically safe to invest. If these assumptions are verified in the economy, and then we might expect a positive influence on the economy. However, if the investors believe that the recession is inevitable and investing at this time is highly risky, and then the decrease in the interest rate might not cause the expected positive influence on the economy.
Similar to the investors, the consumers follow the moves in the interest rate. However, the consumers have a long run utility maximization problem. Depending on the macroeconomic conditions, the consumers might prefer spending relatively more in the current time, or they might prefer delaying their consumption to be able to consume relatively more in the future or vice versa.
The Chinese Economy is an economy dependent on the developed economies as the largest exporting country in the world. The Chinese Economy also can create the domestic demand for the products thanks to being the most populated country in the world. Considering that the developed economies are struggling and trying to cut their imports from China, the Chinese Economy management might need to stimulate the domestic demand. The decreasing interest rates might stimulate the domestic demand under the right conditions; however, the decrease in the Chinese exports to the developed countries might develop a catastrophic situation in the economy and the expected positive influences from decreasing the interest rate might not occur.
Graph 1 exhibits the situation where the assumption of negative relation between the investment expenditure and interest rate. In the second case, the agents in the economy are relatively more sensitive to the interest rate. The third graph is the case when the agents are less sensitive to the interest rate and changing the interest rate will not create a large influence on the investment expenditure. Consequently, the policy that the Chinese Economy Management is trying to implement may not give the desired results because the agents in the economy might not be sensitive to the interest rate. The economy management needs to analyze the sensitiveness of the agents to the interest rate. Based on this research, the economy management needs to develop proper economic policies.

Graph 2: Investment Expenditures relatively more sensitive to Interest Rate
Graph 3: Investment Expenditure relatively less sensitive to Interest Rate
Sincerely,

Works Cited

Gerlach, Stefan. 'Monetary Policy After The Crisis'. The Manchester School 81 (2013): 16-34. Web.
Szeto, Ricky W. F. 'Economic And Business Development In China After The Financial Tsunami'. Chinese Economy 44.3 (2011): 3-4. Web.