The Internal And External Balance In An Open Economy And The Research Of Monetary And Fiscal Policy

Since1990s, China’s pace of opening has been faster and faster, but as the speed of China’s marketization and internationalization of economy increases, many problems appear, and the sustainability of China’s economic growth is more and more further away from us. This phenomenon reflects the internal and external unbalance of Chinese economy.Allowing for these facts, this paper built a MM-CM-BP model to explain why this situation which Chinese economy is experiencing has been the reality and to give suggestions.The framework of this paper including four parts:building the model in a closed economy,the internal and external equilibrium in a open economy, empirical research and conclusion.First, we launch a hypothesis of long-term equilibrium while in a closed economy condition, and demonstrate the shape of the equilibrium line of monetary market and commodity market. After that,we discuss the influence of fiscal policy and monetary policy to economy, including the influences of fiscal and monetary policies to price and output, how economy move away from long-term equilibrium and the selection of policies when facing problems in economy.Then we extend the condition to open economy from closed economy, and add the exchange rate as a factor. Based on that, we start to analyse the internal and external equilibrium under open economy condition. It becomes rather complicated after add the exchange rate into the model when analyzing the internal equilibrium, but we in the end obtain the implications of the model after analyzing, including the effect of monetary and fiscal policies and there influence to economy; the analysis of the external equilibrium mainly focused on the balance of current account, and finally we obtain the implications of the equilibrium line of balance of payment and its shape.Thirdly we have done the empirical work according to the data of China using our model developed in this paper. We analyse the data intuitively first, and examine the covariance of the variable. After that, we use VAR model to analyse the effect of fiscal and monetary policies quantitively.At last, this paper obtain the conclusion after analyzing the model theoretically and empirically. After analyzing, we found that:1. In a closed economy, whether monetary policy or fiscal policy, they do have ’side effects’when policy makers want to achieve their goals:the expansionary monetary policy has a strong effect on the rising of price level while the output growing, especially when the slope of CM line is large, not only the effect of increasing output is moderate, but also the pressure of the rising of price level is great; when adopting expansionary fiscal policy in order to increase output, we must pay attention to the scale of the demand for commodities. If the demand for commodities is moderate, the expansion of the commodity supply will be surplus, this is reflected in the MM line while it is rather steep.2. In a closed economy, when facing inflation, we need to arrange the monetary and fiscal policies to control inflation, if the MM line is steep, expansionary fiscal policy will be better;if the CM line is steep, tight monetary policy will be better; when facing economic recession, the model imply that a expansionary monetary policy will have little use to make economy recover and rather, make price level rise greatly if CM line is steep, and we shoud avoid to adopt a expansionary fiscal policy when MM line is steep; when facing deflation, we should use both expansionary monetary policy and tight fiscal policy.3. In a open economy, the situation will be complicate. Because of the appearance of the demand of foreign resident for domestic commodity, the movement of monetary and fiscal policy will be different. In this situation, whether the MM line and CM line is upward or downward will be unknown, and also, we cannot know directly the effect of monetary and fiscal policy to output and price level. The measure of the slope will be determined, on one side, by the income effect and substitute effect of price to the demand for commodities and money, and on the other hand, whether the demand for money and commodities is force by the price or the output.After analyzing the data of China, we found that since1990s(1992-1995), the economic structure of China has changed, and the slope of the equilibrium line of monetary market has become positive, and its slope is greater than the equilibrium line of commodity market. Furthermore, although the data shows that the slope of commodity line is greater than the line of monetary market before1990s, we still cannot give a definite answer because of the lack of enough data.When analyzing from a perspective of external equilibrium, the equilibrium line of balance of payment is a line with positive slope, and its slope is right between the equilibrium line of monetary market and commodity market. This paper suggest that expansionary fiscal policy will make the economy far away from its equilibrium route, and even far away from the goal of policy makers. Opposite to people’s traditional perspective, the expansionary fiscal policies will lower output, and also lower price level; and tight fiscal policies will make output and price level grow.After empirical research, this paper suggest that tight fiscal policies and expansionary policies have a better effect to make output grow when to achieve internal equilibrium because fiscal policy has a strong effect at immediate, but monetary policy has a one-year time-lag to price level and output. In spite of the time-lag effect, monetary effect has a strong influence to the price level. Because of this, we should adopt tight monetary policies and expansionary fiscal policies to deal with inflation. In a perspective of external equilibrium, expansionary monetary and fiscal policies will both expand current account deficit.It follows that expansionary monetary policy have a better effect when facing both internal and external imbalance in Chinese economy, especially the internal imbalance. So, expansionary monetary policy and moderate fiscal policy is a nice arrangement to deal with the both internal and external imbalance in China.