Case Study: Chinese Economy
If the money supply is fixed, the effect of the aggregate real money and interest rate on the Chinese economy would be as follows: At first, the total demand for money will decline owing to the reduced demand for domestic products and the foreign goods. It will be a case of too many goods being chased by very few monies. The fall in demand for cash will infer that people are holding cash or liquid assets in excess which will result in savings. The residues in money will increase the savings and conversely, the interest rate will decrease (Dow 1555). The interest rate will fall to discourage further savings as the savings institutions will have had enough money supply. In the long-run, the forces of demand and supply will normalize the situation.
If the Chinese Central bank, in fear of recession, responds by increasing the money supply in the economy, then the purchasing power of the Chinese increase leaving them with enough to save. Increased savings will reduce the interest rates to discourage the Chinese from further saving. The reduction in the interest rates will lead to an outflow of foreign capital from the country (Dow 1550). The increased flow of foreign currency will increase its demand as its presence diminishes as the domestic currency surges. The Chinese Yuan will therefore depreciate, and thus the Dollar/Yuan rates will fall.
If the situation in Question 2 persists permanentl…
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