Policy Rules And Macro-dynamics Under Internal And External Imbalances

This paper addresses three issues under the economic environment of double imbalances (internal and external):(1) Whether the policy implications of the aggregate demand management drawn from the IS-LM-BP model, viewed as the standard workhorse of macroeconomics, can be extended to the AS-AD-BP model with endogenous aggregate price without any modification? When this static AS-AD-BP model becomes dynamic under nominal wage indexation and government budget constraint, what’s the long-run effect of traditional aggregate demand management, and what are the short-run and long-run effects of aggregate supply management characterized by deregulations? (2) Under a framework with capital imperfect mobility, if the government employs nominal anchor to stabilize the price expectation, what are the effects to the steady state and to the key endogenous variables, such as unemployment, inflation rate, balance of current account, foreign exchange reserve etc., especially when aggregate demand and aggregate supply intervention are applied. Are the effects the same under two different policy rules known as exchange rate rule, which means nominal exchange rate changes with a predetermined speed, and monetary rule, which means domestic credit grows with a predetermined speed? When the two different policy rules aimed at the same unemployment rate target, is there a significant difference in the transitional dynamics? (3) As exchange rate revaluation is a main adjustment tool for external disequilibrium, whether the traditional proposition, that the exchange rate devaluation improves current account, can be supported by China’s relevant data? With varying opening degrees when varying forms of ownership is introduced, dose exchange devaluation still have significant effect on employment of China’s manufacture sector?Chapter 2 reviews all the relevant literatures; Chapter 3 studies the reaction of exporting firms to exchange rate policy in a partial equilibrium framework with monopoly competition in the foreign market. It is found that currency appreciation or relative cost increase leads to a decrease in market share, a decrease in mark-up rate and profit. When the demand substitutability increases, firms with cost advantage earn larger market shares, while mark-up rate and profit of the firms with cost disadvantage decreases. These results are robust to different competitive environment. Considering firm heterogeneity, entry and exit, devaluation is still an effective tool for the expansion of exports, allowing inefficient firms to easily enter into the foreign market. With respect to international industrial chain division, the exchange rate adjustment not only affects domestic employment but also spillovers to other countries.A foreign market monopoly competition model from a partial equilibrium perspective is constructed to prove a traditional proposal that real exchange rate devaluation will stimulate export quantity, and also, its robustness under different competition pattern settings is examined. Through an aggregate supply curve established on a domestic monopoly competition setting, Chapter 4 develops a AS-AD-BP model framework based on the micro foundation drawn from Chapter 3 for simultaneous investigation of internal and external imbalances, and concludes that the policy implications of aggregate demand management drawn from standard IS-LM-BP model can be extended to a static AS-AD-BP model without only a few modifications when aggregate price level is endogenous, and in long run, positive aggregate demand expansion leads to the movement of the composition of inflation rate and unemployment rate in steady-state along a given Phillips curve, current account deteriorates. Thus, exchange rate devaluation should be used to offset this variation. Deregulation brings about current account deterioration and real exchange rate appreciation in short run, and in long run, current account surplus falls down and Phillips curve shifts, resulting in a lower steady-state inflation rate corresponding to a targeted unemployment rate.Chapter 6 inherits domestic monopoly competition setting in Chapter 5, and develops a single production sector framework under imperfect capital mobility. With dynamic programming method, The paper discusses steady-state effects and induced transitional dynamics effects of all kinds of aggregate demand and aggregate supply intervention under exchange rate rule monetary rule. The conclusions are:①under exchange rate rule, steady-state inflation rate is equal to the predetermined velocity of nominal exchange rate variation; With deregulation policy, steady-state unemployment rate decreases, consumption and individual wealth rise monotonously to a higher new steady-state level, current account and foreign exchange deteriorates with a constant steady-state capital account balance; reduction in tax has the same transitional dynamics with deregulation policy but steady-state output and employment remain unchanged; ②under monetary rule, steady-state foreign exchange reserve always keeps constant. All kinds of policy shocks have not transitional dynamics and jump on new steady state instantaneously except for the change of innovation rate. With deregulation policy, steady-state consumption and output increase with same amount, current account, capital account and inflation rate in steady state remain unchanged.The basic model is further developed into a two production sectors including tradable sector and nontradable sector. I reach the conclusion that under exchange rate rule, output of nontradable sector in steady state will rise when deregulation, innovation acceleration, or mitigation of labor market segmentation is utilized, while output of tradable sector at least does not decrease. Moreover, consumption and net foreign asset rise, and steady-state inflation rate remains unchanged.Chapter 6 concludes the hypothesis that exchange rate devaluation stimulates export is supported by China’s data. In addition, exchange rate variation leads to labor reallocation of Chinese manufacture sector through employment creation and destruction, while opening up enlarges this effect. Compared with private ownership, state ownership brings down this effect. Chapter 7 is the total conclusion.