essays on income inequality exchange rate and policy coordination

Trang 6 v Essays on Income inequality, Exchange Rate, and Policy Coordination Publication No._____________ Xiaojun Yang, Ph.D.. Trang 7 such that when China increases its relative money

The Model

The model consists of the GDP identity and functions for each of its components Specifically, for the Chinese economy we have:

CY t+1 = CC t+1 + CI t+1 + CG t+1 + CX t+1 – CM t+1

The equation CX t+1 = d 0 + d 1 CXt + d 2 HY t+1 represents the relationship between various economic factors in China, where CX denotes exports, HY signifies imports, and other variables include GDP (CY), consumption (CC), investment (CI), and government expenditure (CG) This model highlights the interconnectedness of these components in understanding China's economic dynamics and the implications for policy coordination in addressing income inequality and exchange rate fluctuations.

For the Hong Kong economy we have:

HY t+1 = HC t+1 + HI t+1 + HG t+1 + HX t+1 – HM t+1

The equation HX t+1 = h 0 + h 1 CYt + h 2 CY t+1 represents the relationship between Hong Kong's GDP (HX) and its consumption (CY), highlighting the influence of current and future consumption on economic performance While economic theory provides limited insights into the lag structure, incorporating lag variables into the stochastic equations enhances the model's accuracy in fitting the data.

To estimate the interrelated endogenous variables between China and Hong Kong, we employ a two-stage least squares approach, utilizing all relevant variables as instrumental variables In cases where the Durbin-Watson statistic reveals first-order serial correlation, we apply the Cochrane-Orcutt technique for correction.

The following is the estimation result 1 : For the Chinese economy:

CY t+1 = CC t+1 + CI t+1 + CG t+1 + CX t+1 – CM t+1

The data utilized in this analysis is sourced from the "Statistical Yearbook of China," covering the period from 1987 to 2001, as published by the State Statistical Bureau (SSB) This dataset provides a comprehensive foundation for examining income inequality, exchange rates, and policy coordination in China during these years.

For the Hong Kong economy:

HY t+1 = HC t+1 + HI t+1 + HG t+1 + HX t+1 – HM t+1

This article explores the intricate relationship between income inequality, exchange rates, and policy coordination It highlights how fluctuations in exchange rates can exacerbate income disparities, emphasizing the need for effective policy measures By analyzing various economic models, the research demonstrates that coordinated policies can mitigate the adverse effects of exchange rate volatility on income inequality Ultimately, the findings suggest that a comprehensive approach to economic policy is essential for fostering equitable growth in the face of global financial challenges.

The standard errors are indicated in parentheses, and all signs align with our expectations The interaction between the two economies is illustrated through their export functions: China's exports depend on Hong Kong's GDP, while Hong Kong's exports are influenced by China's GDP.

This section presents a consistent estimator for a simultaneous-equations model that incorporates a lagged dependent variable and serial correlation The model is represented by the following equations in deviation form: equation (1) illustrates the relationship between variables with a lagged dependent variable, while equation (2) describes the serial correlation present in the model Additionally, equation (3) highlights the independent nature of the error terms, u_t and v_t, which are uncorrelated over time.

The first equation is identified and contains an autoregressive error term

Since ρ is not known, the estimate of the serial correlation coefficient, r, may not equal ρ Then (4) becomes

This section is primarily based on the work of Pindyck and Rubinfeld (1998), which explores the interconnections between income inequality, exchange rates, and policy coordination The analysis emphasizes how these factors influence economic stability and growth, highlighting the importance of effective policy measures to address income disparities and maintain balanced exchange rates Understanding these relationships is crucial for developing strategies that promote economic equity and sustainable development.

According to Fair, a consistent estimator can be obtained by the following procedure

Stage one: estimate the equation t 2 t 5 1 t 4 1 t 3 t 2 t y q p q w p = γ + γ − + γ − + γ − + (6) and get the predicted values p ˆ t

Stage two: estimate the equation

− (7) where w ˆ t = p t − p ˆ t , the residual from the first stage The estimate of ρ can be obtained via the Cochrane-Orcutt procedure

The figure presented illustrates out-of-sample predictions based on the previous estimations This analysis focuses on the interplay between income inequality, exchange rates, and policy coordination, highlighting their critical relationships and implications Understanding these dynamics is essential for developing effective economic policies that address income disparities while ensuring stable exchange rates.

Panel a: China's Consumption actual predicted

Panel b: China's Investm ent actual predicted

Panel c: China's Im port actual predicted

Hong Kong's consumption patterns are significantly influenced by income inequality, exchange rates, and policy coordination The interplay between these factors shapes economic behavior and impacts overall market dynamics Understanding the relationship between income distribution and consumption is crucial for effective policy formulation Additionally, fluctuations in exchange rates can alter purchasing power, further complicating the economic landscape Effective policy coordination is essential to address these challenges and promote sustainable economic growth in Hong Kong.

Dynamic models play a crucial role in economics, with control theory serving as a dynamic optimization method that guides economic systems from less desirable to more desirable states over time This approach focuses on optimizing an objective function while adhering to specific state or system equations, which are influenced by the decision maker's goals In this framework, variables are categorized into state variables, representing the current state of the economic system, and control variables, which are policy instruments that decision makers can adjust A common application of optimal control in economics is the quadratic linear tracking problem, where the objective is to align both state and control variables with their desired trajectories, a model that is utilized in this study.

The objective function in the quadratic linear tracking problem is

1 N t t t t t t t t t t t x W x x u u u u x and the system equations are in the structural form used by Pindyck (1973), i.e

For a comprehensive exploration of control theory methods, refer to Kendrick's works from 1981 and 2002 The discussion encompasses various essays that analyze the interplay between income inequality, exchange rates, and policy coordination The equation presented, A x + B u + C z = 0, illustrates the relationship between the state vector x at time t and other influencing factors, highlighting the complexity of economic dynamics.

~ = desired path for the state vector u t = control vector of period t u ~ = desired path for the control vector t z t = purely exogenous variable vector of period t

W t = penalty weight matrix for the state vector which is a diagonal matrix Λ t = penalty weight matrix for the control vector which is a diagonal matrix

A 0 , A 1 , B 1 , and C 1 are the coefficient matrices and vectors

To specify, in our model we have:

HM HX HI HC HY CM CX CI CC CY x , 

The article discusses the intricate relationship between income inequality, exchange rates, and policy coordination It highlights how fluctuations in exchange rates can exacerbate income disparities, necessitating effective policy measures By examining the interconnectedness of these factors, the article emphasizes the importance of coordinated economic strategies to mitigate inequality and promote sustainable growth Understanding these dynamics is crucial for policymakers aiming to create equitable economic environments.

In our representation of the model using Duali software, as outlined by Amman and Kendrick (1999), we address the limitation of the software, which does not permit variables in concurrent terms To navigate this constraint, we introduce the variables Lead CG t and Lead HG t.

The relationship between income inequality, exchange rates, and policy coordination is critical in understanding economic dynamics Income inequality affects consumer behavior and investment patterns, which in turn influence exchange rates Effective policy coordination among governments can mitigate the adverse effects of income disparity and stabilize currency fluctuations By addressing income inequality, countries can enhance economic resilience and promote sustainable growth, leading to more favorable exchange rate conditions Therefore, a comprehensive approach that integrates income distribution, currency management, and coordinated economic policies is essential for fostering equitable economic development.

The Model with Price Variables

The Model Equations…

China’s consumption (cc): cc = -6518 + 0.856cc(-1) + 0.48cy – 0.40cy(-1)

(11253) (0.2563) (0.04) (0.13) Adjusted R-squared = 98 Hong Kong’s consumption (hc): hc = -5577 + 0.036779hc(-1) + 0.62hy;

The analysis of income inequality, exchange rates, and policy coordination reveals a high Adjusted R-squared value of 0.99, indicating a strong correlation among these variables This suggests that effective policy coordination can significantly influence income distribution and exchange rate stability Understanding these relationships is crucial for developing strategies that address economic disparities and enhance financial governance.

National income has a positive correlation with consumption, while lagged consumption also serves as an explanatory variable Wages are excluded from the analysis due to multicollinearity with national income The equations developed illustrate consumption patterns in China and Hong Kong Although consumption theoretically depends on interest rates and price levels—where higher rates or prices typically reduce consumption—these factors are not included in the consumption equations due to insufficient data support.

China’s investment (ci): ci = 10611 + 0.65ci(-1) + 0.46cy – 0.35cy(-1)

Hong Kong’s investment (hi): hi = -8653 + 0.4237hi(-1) + 0.718hy – 0.4839hy(-1)

Investment is theoretically influenced by national income, negatively impacted by interest rates, and affected by previous investment levels However, in the case of China and Hong Kong, interest rates do not play a significant role in their investment functions, indicating that monetary policy has a limited effect on investment decisions in these regions.

China’s exports (cx): cx = -12910 + 0.86cx(-1) + 0.355hy

(19165) (0.22) (0.34) Adjusted R-squared = 927 Hong Kong’s exports (hx): hx !3572 + 0.22cy - 0.18cy(-1) – 78882er

Exports are significantly influenced by foreign income, particularly in the context of China and Hong Kong, where their economic growth relies on mutual demand for each other's exports An increase in foreign income typically leads to a rise in demand for domestic goods and services While exchange rates theoretically impact exports—where a depreciation of a country's currency can make its goods more attractive to foreign buyers—data does not support this relationship for China's export function, leading to its exclusion from the analysis.

China’s import (cm): cm = 60485 + 0.137cy - 34364er

The analysis of income inequality, exchange rates, and policy coordination reveals a significant relationship, with an adjusted R-squared value of 0.83 indicating a strong explanatory power of the model This study emphasizes the interconnectedness of economic factors and the importance of coordinated policies to address income disparities effectively.

Hong Kong’s import (hm): hm = -33299 + 2.54hy – 0.915hy(-1)

If a country has higher income, the country will have higher demand for imports

When a country experiences currency depreciation, the cost of imports rises, leading to a reduction in import demand Consequently, imports are influenced by both national income and the exchange rate In Hong Kong, the exchange rate has minimal impact on import functions, indicating that currency depreciation has a limited effect on export growth in China.

China’s price level (cp): cp = 0.12 + 0.68387cp(-1) + 0.1347cmg(-1);

Hong Kong’s price level (hp): hp = 5.1533 + 0.882358hp(-1) -0.0000545hy + 0.0836hmg(-1) (3.4) (0.16) (0.000025) (0.067) Adjusted R-squared = 82

The inflation rate is influenced by factors such as the unemployment rate, national income, and money supply; however, data indicates no significant tradeoff between inflation and unemployment Additionally, due to institutional limitations, comprehensive data on China's unemployment rate is unavailable An excessive money supply can lead to a rise in overall price levels, demonstrating a positive correlation between money supply growth and inflation Conversely, if the money supply remains constant while the supply of goods increases, price levels tend to decrease This perspective on national income focuses on supply rather than demand, as evidenced by observations in Hong Kong's economy, yet the data does not support national income as a key variable in China's price equation.

China’s rural income (crw): crw = -4.66 + 0.27crw(-1) + 0.000256cy (9.7) (0.11) (0.000037) Adjusted R-squared = 973402 China’s urban wage (cuw): cuw = 2193 + 0.150806cy + 95.537cp(-1)

(5159) (0.0077) (144) Adjusted R-squared = 97 Hong Kong’s wage (hw): hw = 236 + 0.95hw(-1) + 0.003hy(-1)

The analysis of income inequality, exchange rates, and policy coordination reveals a strong correlation, as indicated by an adjusted R-squared value of 0.99 This suggests that the model effectively explains the relationship between these economic factors Understanding how exchange rate fluctuations impact income distribution is crucial for developing coordinated policies that address inequality By focusing on these interconnected themes, policymakers can create strategies that promote economic stability and equity.

Wage equations are influenced by key explanatory variables such as the unemployment rate, prices, and national income Wages tend to rise with increasing prices and national income, while they decline as unemployment rises Specifically, higher prices prompt workers to demand increased wages to compensate for the cost of living, and lower unemployment coupled with higher national income boosts labor demand, further elevating wages In the context of China and Hong Kong, unemployment is not a significant factor in wage equations, leading to its exclusion, along with price variables in Hong Kong’s equation China has distinct wage equations for urban and rural areas, where urban wages are based on staff and worker salaries, while rural wages are derived from annual individual net income.

China’s urban unemployment rate (cun): cun = 1.535 + 0.000013355cuw – 0.00184cp (0.32) (0.000003) (0.010) Adjusted R-squared = 77 Hong Kong’s unemployment rate (hun): hun = 0.26 -0.22hun(-1) + 0.0021hw -0.000057hy (0.99) (0.31) (0.00064) (0.000025) Adjusted R-squared = 79

The unemployment rate exhibits an inverse relationship with national income and a direct correlation with wage levels Higher wages can lead to reduced employment opportunities as they increase input costs for employers Understanding the dynamics of income inequality, exchange rates, and policy coordination is crucial for economic simulations However, due to insufficient data, an unemployment equation for China's rural areas is unavailable Additionally, GDP is not a significant factor in the urban unemployment equation in China and has therefore been excluded from analysis.

China’s interest rate (cr): cr = -12.7 + 0.53cr(-1) + 0.000094ci(-1) -0.7cmg(-1) (9.6) (0.4) (0.000058) (0.4) Adjusted R-squared = 13

Hong Kong’s interest rate (hr): hr = 4.223 + 0.237hr(-1) -0.127hmg (1.4) (0.28) (0.06) Adjusted R-squared = 25

Interest rates are inversely related to money growth and are influenced by investment demand When investment spending rises, the demand for credit increases, leading to higher interest rates However, data indicates that investment does not significantly explain interest rate fluctuations in Hong Kong, resulting in its exclusion from the interest rate equation.

Exchange rate er = 0.044 + 0.86er(-1) +0.0000036(cx(-1)-cm(-1));

The analysis of income inequality in relation to exchange rates and policy coordination reveals a strong correlation, as indicated by an adjusted R-squared value of 0.87 This suggests that the studied variables significantly influence each other, highlighting the importance of coordinated policies in addressing income disparities Understanding the interplay between these factors is crucial for developing effective economic strategies.

The exchange rate between China's RMB Yuan and Hong Kong's currency is influenced by the interest rate differential and China's trade balance When China's interest rates rise relative to Hong Kong's, the RMB Yuan appreciates Additionally, an increase in China's trade surplus results in a higher accumulation of US dollars, further strengthening the RMB Yuan against the Hong Kong dollar.

Simulations

This section presents our simulations, encompassing both historical and policy analyses The historical simulation assesses the accuracy of our estimated model, while the policy simulations examine how state variables react to alterations in policy variables, considering both temporary and permanent changes We will conduct four distinct policy simulations, addressing both fiscal and monetary policies for each economy.

Figures 2.13 and 2.14 present the results of historical simulation from

From 1988 to 2000, the economies of China and Hong Kong experienced significant developments, which serve as a baseline for comparing policy simulation results Each analysis includes four key metrics: GDP, price level, unemployment, and wage trends For a comprehensive overview of the historical simulations, please refer to Appendix A-1.

Figure 2.13: Simulation Result for the Chinese Economy

From Figures 2.13 and 2.14 we can see all the trends for each variable are well captured, especially the two wage variables and the two GDP variables are quite

Panel c: China's Urban Unemployment Rate

Panel d: China's Urban Wage Incom e

The historical analysis of simulated essays on income inequality, exchange rates, and policy coordination reveals that predicted unemployment rates show slight deviations from actual historical values in both economies This underscores the complex interplay between these economic factors and highlights the importance of effective policy coordination to address income inequality and stabilize exchange rates.

Figure 2.14: Simulation Result for Hong Kong’s Economy

Panel c: Hong Kong's Unemployment Rate

This article explores the intricate relationship between income inequality, exchange rates, and policy coordination It emphasizes the historical context of these factors and their impact on economic stability The analysis highlights how fluctuations in exchange rates can exacerbate income disparities, necessitating coordinated policy responses By examining past trends, the article underscores the importance of addressing income inequality through strategic economic policies that consider exchange rate dynamics Ultimately, it advocates for a holistic approach to policy-making that integrates these critical economic variables to foster equitable growth.

Figure 2.15 illustrates the simulation results for the exchange rate and current account across different economies, demonstrating accurate predictions for the exchange rate and effectively capturing the trends in the simulated current accounts.

Figure 2.15: Simulation Result for Current Accounts and the Exchange Rate

The historical analysis of income inequality highlights the significant impact of exchange rates and policy coordination on economic disparities This relationship underscores the necessity for effective policy measures that address both currency fluctuations and income distribution By examining past trends, we can better understand how coordinated economic strategies can mitigate inequality and promote balanced growth Ultimately, addressing these interconnected issues is crucial for fostering equitable economic development in today's globalized world.

This article explores the effects of varying government expenditure and money growth rates on economies, focusing solely on expansionary policies It distinguishes between temporary increases, which occur in the initial year, and permanent increases, which are sustained throughout the entire period.

In 1988, China's government increased its expenditure by 10%, amounting to $5,127 million, which resulted in a significant GDP increase of $26,025 million—approximately five times the expenditure increase This fiscal expansion impacted various economic variables, as illustrated in Figures 2.16 and 2.17, which compare the effects on China's and Hong Kong's economies The figures display GDP and unemployment rates under both temporary and permanent fiscal expansion scenarios However, the temporary fiscal expansion had minimal long-term effects on these variables, primarily due to its negligible impact on price variables, which remained largely unchanged in subsequent years For a comprehensive analysis of the simulation results, refer to Appendix B and the price variables detailed in Appendix A-2.

The other reason is that the effects due to the expansion are canceled out For example, in China’s investment function:

We can see, initially when China’s government expenditure increases, both CI and CY increase in the first year, and the increase in CY is bigger than the

Figure 2.16: China’s Fiscal Expansion Results for the Chinese Economy

Panel c: China's Urban Unemployment Rate base tempg

Panel a: China's GDP base tempg

Panel b: China's GDP base permg

China's urban unemployment rate has been significantly influenced by factors such as income inequality, exchange rates, and policy coordination An increase in the Consumer Index (CI) in the second year reflects a complex interaction between these elements When calculating the CI, the rise in the Consumer Yield (CY) offsets the increase in CI due to the negative coefficient of CY, leading to a nuanced understanding of economic dynamics This interplay highlights the importance of effective policy measures to address unemployment and economic stability in urban areas.

Figure 17: China’s Fiscal Expansion Results for the Hong Kong’s Economy

Panel c: Hong Kong's Unemployment Rate base tempg

Panel a: Hong Kong's GDP base tempg

Panel b: Hong Kong's GDP base permg

Hong Kong's unemployment rate is influenced by various factors, including income inequality, exchange rates, and policy coordination Despite a significant increase in the CY variable, its impact on investment is limited due to a smaller coefficient compared to CI's This suggests that while CY shows growth, it plays a lesser role in shaping the overall investment landscape in Hong Kong.

So, the effects are cancelled out when we calculate subsequent year’s investment

From 1988 to 2000, China's government expenditure increased by 10% annually, significantly impacting both China's and Hong Kong's GDP and unemployment rates This permanent fiscal expansion, illustrated in Figures 2.16 and 2.17, demonstrates that increased government spending leads to higher GDP, which in turn boosts consumption, investment, and wage rates However, the rise in wage rates also contributes to an increase in unemployment.

China's increasing GDP enables higher imports, benefiting Hong Kong's exports and consequently raising its GDP This growth results in increased consumption, investment, and wage rates in Hong Kong, although higher wages can lead to higher unemployment China's fiscal expansion has minimal impact on price variables, as detailed in Appendix B, and while it positively influences interest rates due to increased investment, the effect remains small The price level in China is primarily determined by its own lag and money supply, with government expenditure playing a negligible role Similarly, Hong Kong's interest rates are influenced by its own lag and money supply, rendering China's fiscal expansion insignificant for Hong Kong's interest rates Hong Kong's price level is affected by its lag, money supply, and GDP, where a higher GDP leads to increased supply, ultimately lowering prices Although China's fiscal expansion impacts Hong Kong's GDP and, in turn, its price levels, the overall effect is minimal, as illustrated in Table 2.3.

Table 2.3: The Effect of China’s Fiscal Expansion on Hong Kong’s Price

Above we have seen what happens in the two economies if China increases its government expenditure Figure 2.18 presents what happens to the Hong Kong

The impact of Hong Kong's fiscal expansion on its economy mirrors that of China's fiscal expansion; however, the effects on China's economy are minimal due to Hong Kong's relatively small economic size.

Figure 2.18: Hong Kong’s Fiscal Expansion Results for the Hong Kong’s

Panel d: Hong Kong's Import base permhg

Panel b: Hong Kong's Price Level base permhg

Panel c: Hong Kong's Unemployment Rate base permhg

Hong Kong's GDP is significantly influenced by factors such as income inequality, exchange rates, and policy coordination Understanding the interplay between these elements is essential for analyzing the region's economic performance Income inequality affects consumer spending and social stability, while exchange rate fluctuations can impact trade and investment Effective policy coordination is crucial for addressing these challenges and promoting sustainable economic growth in Hong Kong.

Monetary expansion in both China and Hong Kong has minimal impact on each other's economies, with the primary effects observed in price variables rather than investment The analysis, illustrated in Figures 2.19 and 2.20, indicates that China’s permanent monetary expansion ("permm") significantly influences its price levels, while Hong Kong’s permanent monetary expansion ("permhm") affects its own price variables In both regions, increased money supply results in higher price levels and lower interest rates.

Figure 2.19: China’s Monetary Expansion Results on China’s Price Variables

Panel b: China's Interest Rate base permm

The Model with Price Variables in the Control Theory Framework

Incorporating the model into the control theory framework, we present the desired paths for the new state and control variables, including the added price variables, as shown in Table 4 Together with Table 2.1, Table 2.4 outlines the desired paths for all variables, with the new variables' desired paths reflecting their historical averages Additionally, Table 2.5 details the penalty weights for these new state and control variables, derived using the same methodology applied to the previous variables in Table 2.2.

Panel a: Hong Kong's Inflation base permhm

Hong Kong's interest rate dynamics significantly impact income inequality, exchange rates, and policy coordination The interplay between these factors shapes the economic landscape, influencing both local and global markets Understanding the relationship between interest rates and income distribution is crucial for effective policy formulation Additionally, the coordination of monetary and fiscal policies is essential to address the challenges posed by exchange rate fluctuations and their effects on economic stability.

Table 4.4: Desired Paths for the new State and Control Variables

Year CP CRW CUW CUN CR HP HW HUN HR ER CMG HMG

Table 4.5: Penalty Weights on the New State and Control Variables

CP CRW CUW CUN CR HP HW HUN HR ER CMG HMG

Experiment: China Has a Higher Growth Rate of Imports

Following the implementation of economic reform policies, China consistently experienced a trade surplus, while Hong Kong's economic growth slowed after 1997 due to the Asian financial crisis This study aims to explore how increasing China's imports can enhance Hong Kong's economic growth during these challenging years We approach this investigation by selecting a specific trajectory for one state variable to derive a more effective solution for another state variable Subsequently, we analyze the necessary controls to achieve this solution, diverging from the conventional method of altering controls to observe their impact on state variables.

In this experiment you will also see optimal control model require some

The initial "base-solution" case yields positive outcomes for certain variables while presenting unrealistic results for others Subsequent adjustments detailed in this chapter lead to the development of the "base-new" case, which demonstrates improved results.

China's import trajectory is projected to grow at an impressive rate of 11.5%, matching the export growth rate observed from 1987 to 2000 The penalty weights on imports have been significantly increased, now standing at ten times their base case values As illustrated in Figure 2.21, this adjustment leads to a notable rise in China's import levels compared to the base case scenario.

Figure 2.21 illustrates China's import base, highlighting the intricate relationship between income inequality, exchange rates, and policy coordination The analysis emphasizes how these factors interact to shape economic outcomes in China, underscoring the importance of strategic policy measures to address disparities and enhance economic stability This comprehensive examination sheds light on the challenges and opportunities within China's trade dynamics, making it crucial for policymakers to consider these elements in their economic strategies.

The change positively impacts Hong Kong's economy, as illustrated in Figure 2.22 Prior to 1994, Hong Kong's GDP remained stable at baseline levels; however, post-1994, it began to exceed these levels, particularly from 1997 onward This growth is crucial for bolstering Hong Kong's economy during times of crisis.

In order to achieve this, how must the policy variables change? Figures 2.23 and 2.24 reflect the responses of Hong Kong’s policy variables

Figure 2.22 illustrates Hong Kong's GDP in relation to income inequality, exchange rates, and policy coordination The analysis highlights the interconnectedness of these factors and their impact on economic stability Understanding the dynamics between income distribution and exchange rate fluctuations is crucial for effective policy formulation This examination underscores the importance of coordinated efforts in addressing economic disparities while fostering sustainable growth in Hong Kong.

Hong Kong's monetary growth rate is expected to surpass the base case, while government expenditure should be reduced This decrease in government spending is attributed to the rise in imports from China, positively impacting Hong Kong's economy.

Hong Kong's government faces the challenge of balancing its expenditure as exports rise significantly To mitigate the impact of increasing exports, it is essential for Hong Kong to reduce its government spending The higher money growth rate in Hong Kong can be attributed to its price level equation, which indicates that with a higher income, the price level tends to be lower Consequently, to maintain the price level near its target, a higher money growth rate is necessary.

Figures 2.25 and 2.26 shows China’s policy variables

China's government expenditure plays a crucial role in addressing income inequality and managing exchange rate policies Effective policy coordination is essential for balancing economic growth and social equity By analyzing government spending patterns, we can better understand their impact on income distribution and overall economic stability.

China's government expenditure must exceed the base case to stimulate increased imports Additionally, the money growth rate should remain below the base case, with the exception of the final period, due to a lower price level.

The proposed solutions are not feasible due to two main reasons: China's money growth experiences significant fluctuations and is often negative, while Hong Kong's government expenditure has shown a U-shaped trend, with negative spending from 1993 to 1996, which is unrealistic These fluctuations in money growth lead to corresponding volatility in China's interest rates and price levels, as illustrated in Figures 2.27 and 2.28.

China's monetary growth has significant implications for income inequality, exchange rates, and policy coordination Understanding these dynamics is crucial for effective economic management and addressing disparities The interplay between monetary policy and exchange rate fluctuations can influence income distribution, necessitating coordinated efforts to achieve equitable growth.

Figure 2.27: China's Interest Rate base solution

China's price level is significantly influenced by income inequality and exchange rate policies The coordination of these factors plays a crucial role in shaping economic stability and growth Understanding the interplay between income distribution and currency valuation is essential for effective policy formulation Addressing income inequality can lead to more balanced economic development, while strategic exchange rate management can enhance competitiveness in the global market Overall, a comprehensive approach to these issues is vital for fostering sustainable economic progress in China.

Introduction

This study presents a model analyzing the Yuan/Dollar exchange rate, linking it to the income, money supply, interest rate, and current account of both China and the U.S Building on Fonseca's (1999) extension of Gibson's (1996) framework, the model incorporates principles from Kendrick (1981) Interestingly, the findings reveal that an increase in China's relative money supply leads to an appreciation of the exchange rate, defying common intuition but aligning with the model's predictions Additionally, the results indicate that for China to achieve higher GDP levels, it must increase its money supply, while maintaining a stable exchange rate requires either a temporary decrease followed by an increase in money supply or a consistent increase throughout the period.

This paper is structured into five sections Section 2 outlines the foreign exchange system in China In Section 3, we detail the model equations and present the results of policy simulations Section 4 integrates our model within an optimal control theory framework and conducts a sensitivity analysis Finally, Section 5 offers concluding remarks on the findings related to income inequality, exchange rates, and policy coordination.

Developments of China's Foreign Exchange System

Before 1978, China operated as a closed and highly planned economy with strict foreign exchange controls due to limited foreign exchange resources However, following the economic reform and open-door policy initiated in 1978, China gradually incorporated market elements into its foreign exchange administration This shift included the use of price incentives and exchange-rate adjustments to boost exports and manage the macroeconomy, alongside the introduction of market mechanisms to influence exchange rates A significant milestone was achieved in late 1996 when China allowed the official convertibility of the renminbi (RMB) under current accounts China's foreign exchange system has evolved through three distinct phases: the planned economy period, the economic transition period, and the exchange rate unification period.

3.2.1 China’s Foreign Exchange System Under Planned Economy (1953-78)

During this period, China operated as a highly planned economy, with the Ministry of Foreign Trade managing all import and export activities and overseeing foreign exchange under a unified system All foreign exchange receipts were required to be submitted to the state, which allocated them according to a predetermined plan Prior to 1973, the Chinese yuan (RMB) was pegged to the US dollar under a fixed rate regime Following the general floating of major currencies in 1972, China transitioned to a composite peg system.

The Renminbi (RMB) is the official currency of China, with the Yuan serving as its primary unit Initially, the RMB was pegged to a basket of 13 Western currencies, reflecting China's approach to exchange rate management and policy coordination This system aimed to stabilize the currency and promote economic growth while addressing issues related to income inequality.

1975 pegged to US dollar and Deutsche Mark

Under this system, the exchange rate served merely as a means of account, as the state monopoly on foreign trade allowed all import and export transactions to be settled at any exchange rate Consequently, losses in exports due to an overvalued exchange rate were balanced by gains from imports, and vice versa.

3.2.2 China’s Foreign Exchange System in the Transition Period (1979-1993)

In 1979, a retention scheme was introduced to address the incompatibility of the old foreign exchange system with market-oriented economic reforms, encouraging exporters to enhance their foreign exchange earnings This scheme allowed exporters to retain a specific percentage of their foreign exchange earnings, with the retention rate set by the state, which progressively increased over time.

In the early days, different regions and sectors had different retention rates In

In 1991, retention rates for export receipts were standardized at 80%, significantly encouraging exporters by allowing them to retain a portion of their foreign exchange earnings This retention scheme provided exporters with the flexibility to import goods from global markets according to their needs Additionally, exporters had the opportunity to sell any excess foreign exchange they retained to other companies, facilitating access to foreign currency for those looking to import.

From 1981 to 1984, China operated with dual exchange rates: an official rate and an internal settlement rate The internal settlement rate, set at Y2.8 per US dollar, was provided by the Bank of China to companies involved in foreign trade, while the official rate, approximately Y1.5 per US dollar in 1981, applied to other foreign currency transactions To correct the overvaluation from the previous system, the official rate underwent frequent devaluations, ultimately aligning with the internal settlement rate by the end of 1984.

China implemented dual exchange rates, introducing the internal settlement rate to encourage exports by providing a lower exchange rate that would benefit exporters who faced losses under the official rate This change was necessary due to economic decentralization, allowing local authorities and enterprises to engage in foreign trade independently, necessitating a uniform exchange rate lower than the official one to support less developed regions However, concerns arose regarding the potential negative impacts of a sharp devaluation, including decreased foreign currency from remittances and tourism, diminished foreign confidence in China's economic stability, and significant discrepancies in living costs between China and the U.S.

The State Council has opted to implement a reduced internal exchange rate for Chinese enterprises engaged in import and export trade, while maintaining the previous official rate for all other foreign exchange transactions involving both Chinese and foreign companies with the Bank of China.

However, this dual exchange rates was viewed by the International Monetary Fund (IMF) as a multiple exchange rate practice which was prohibited

The International Monetary Fund (IMF) urged the Chinese government to abandon its internal settlement rate policy In response, China accepted the IMF's recommendation and abolished this internal settlement rate By the end of 1984, the official exchange rate was aligned with the internal settlement rate, leading to the complete disappearance of the internal settlement rate.

Under the retention scheme, some exporters might have excess retained foreign exchange, and some might have insufficient retained foreign exchange

The foreign exchange swap business began in October 1980, initially restricted to state-owned and collective enterprises, with transactions required to go through the Bank of China Due to limited fluctuations in swap rates, the market remained inactive until the margins were extended in 1986 and 1988 By late 1985, foreign exchange adjustment centers (FEACs) emerged, first in Shenzhen, followed by Shanghai and Beijing, allowing swap transactions to occur outside the Bank of China This development opened the market to both domestic and foreign enterprises and individuals, with swap rates primarily influenced by supply and demand, despite potential central bank interventions.

The official exchange rate in China has experienced significant depreciation since the abolition of the internal settlement rate It fell from Y2.8 to Y3.2 per US dollar in October 1985, further declining to Y3.7 in July 1986, Y4.7 in December 1989, and Y5.2 in November 1990 In April 1991, China introduced a floating exchange rate regime, leading to multiple devaluations until late 1993, when the rate reached Y5.8 per US dollar This downward trend was primarily driven by high inflation in China and increasing costs associated with acquiring foreign exchange, necessitating the devaluation of the official rate to promote exports.

3.2.2.4 Major Problems with Multiple Exchange Rate

The establishment of an official parallel market for swap transactions led to a multiple exchange rate system, characterized by varying retention rates This created disparities among exporters, with some gaining more from the swap market than others Initially, the retention scheme favored coastal regions, resulting in higher retention rates that attracted resources from inland areas Consequently, this shift diminished foreign exchange proceeds in inland regions, negatively impacting local imports and production.

The foreign exchange retention scheme primarily aimed to incentivize exporters, particularly in labor-intensive and low-tech industries However, this approach inadvertently disadvantaged high-tech and heavy industrial sectors, which are crucial for sustainable long-term growth in China.

The presence of numerous Foreign Exchange Adjustment Companies (FEACs) contributed to a thin swap market that was highly sensitive to changes in macroeconomic conditions, resulting in more volatility in swap rates compared to official rates The entry or exit of large holders of retained foreign exchange significantly impacted swap rate fluctuations Notably, the sharp increases in swap rates observed in early 1992 and 1993 were likely driven by an artificial shortage of foreign exchange, as potential sellers withheld their reserves in anticipation of further depreciation.

The Model

The Model Equations…

A model has been created to analyze the relationship between the Yuan/dollar exchange rate and key economic factors in China and the United States, including income, money supply, interest rates, and the current account The model identifies income, the exchange rate, and interest rates as endogenous variables, while the money supply and current account balance are treated as exogenous variables The primary focus is to examine the impact of money supply variations in both countries on the exchange rate To facilitate this analysis, three equations have been formulated: one for the exchange rate, one for the interest rate, and one for income, which will be discussed in detail.

The exchange rate is influenced by disparities in income, interest rates, and money supply between the two economies, along with China's current account status Additionally, a dummy variable is incorporated to account for the varying exchange rate regimes in China It is important to note that the inflation rate is excluded from the analysis due to multicollinearity concerns.

ER t = a 0 + a 1 DM t + a 2 DY t + a 3 DR t + a 4 CCA t + a 5 DUM t (1) where

The exchange rate between the Yuan and the Dollar is influenced by the differences in money supply (CM-UM), income levels (CY-UY), and interest rates (CR-UR) between the two economies Additionally, China's current account (CCA) plays a crucial role in shaping these financial dynamics.

DUM: dummy variable for China’s exchange rate regimes

As China's money supply increases relative to that of the United States, the exchange rate of the Yuan against the Dollar rises A growing trade surplus in China results in a higher accumulation of US dollars, leading to an appreciation of the RMB Yuan Therefore, we anticipate that the indicators related to domestic monetary supply (DM) will show positive trends, while those concerning capital account adjustments (CCA) will reflect negative trends.

An increase in China's income compared to American income leads to a higher demand for money, resulting in a surplus in China's balance of payments and an appreciation of the Yuan against the Dollar Conversely, a rise in domestic interest rates relative to foreign rates decreases money demand, causing a balance of payments deficit and a depreciation of the currency Consequently, we anticipate positive signs for changes in relative income (DR) and negative signs for changes in relative interest rates (DY) This analysis is grounded in the equilibrium of the money market, represented by the equation M s /P = L(R,Y), where P denotes the price level.

M s is the money supply, R is the interest rate, and Y is real income and L(R,Y) is aggregate money demand The value of L(R,Y) falls when R rises, and rises when

According to the interest parity condition, an increase in China's interest rates relative to U.S rates will lead to an appreciation of the Yuan However, when China's income (Y) rises, consumers tend to spend more on foreign goods, resulting in a decrease in China's trade balance as imports increase Consequently, this scenario causes the Yuan to depreciate Therefore, the relationship indicates a negative sign in front of the depreciation rate (DR) and a positive sign in front of the income change (DY), contrasting with the outcomes derived from money market equilibrium.

The signs in front of DR and DY are unclear, leading to confusion in understanding their implications This ambiguity affects discussions surrounding income inequality, exchange rates, and policy coordination Addressing these issues is essential for creating effective economic policies that promote equity and stability in financial systems.

The interest rate is explained by income, money supply

An increase in output typically leads to a rise in interest rates, whereas a decrease in output results in lower interest rates Additionally, an increase in the money supply tends to decrease interest rates Consequently, we anticipate a positive correlation with output changes and a negative correlation with money supply changes.

The income difference between the two countries is explained by the exchange rate, money supply and interest rate

An increase in the money supply theoretically boosts aggregate demand, leading to higher income levels Similarly, a depreciation of the exchange rate enhances the current account balance, also resulting in increased income Additionally, a decline in interest rates stimulates both consumption and investment spending, further contributing to income growth Consequently, we anticipate positive signs for exchange rate (ER) and money supply (DM) changes, while expecting negative signs for interest rate (DR) changes.

Data

This study utilizes data from the Statistical Yearbook of China (1980-2001) and the International Financial Statistics (1980-2001) from the International Monetary Fund, focusing on the exchange rate evolution following China's open door policy initiated in 1978 Due to a lack of quarterly data, annual figures from 1980 to 2000 were analyzed Key variables examined include the Yuan/dollar exchange rate, income, consumption, investment, government expenditure, current account balance, money supply, interest rates, and price levels, all of which are crucial for understanding the relationship between income inequality, exchange rates, and policy coordination.

Estimation

To address simultaneity issues arising from interrelated endogenous variables, we employed two-stage least squares for model estimation Instrumental variables included consumption, investment, price levels, government expenditure, relevant lag variables, and the American current account balance To correct for first-order serial correlation indicated by the Durbin-Watson statistic, we applied the Cochrane-Orcutt technique Below are the estimation results for each equation, with standard errors provided in parentheses.

ERL = -1.1 + 0.88ERL(-1) + 0.0004DM + 0.094DR - 0.0005DY – 0.035CCA (4) (0.54) (0.2) (0.0003) (0.02) (0.00029) (0.0082)

Adjusted R 2 = 62, Durbin-Watson = 2.03, Rho = -.45 Where ERL is the first difference of exchange rate

The stability of the exchange rate estimates in equation (1) prompted the use of the first difference of the exchange rate for analysis The results indicate that the signs of DM and CCA align with expectations, while DR and DY conform to predictions derived from money market equilibrium Most coefficients are statistically significant, particularly highlighting the importance of the real interest rate difference and China's current account Consequently, the DUM variable, lacking significance, was excluded from equation (4).

Adjusted R-squared = 22 From equation (5), we can see interest rate is a function of income and money supply Both are statistically significant

In our analysis, income is influenced by the money supply, while the exchange rate and interest rate do not provide significant explanatory power, leading us to exclude them from our model However, the data indicates that lagged income is a significant explanatory variable, prompting us to incorporate it into our equation.

Policy Simulation

This section explores monetary policy simulations, focusing on the response of state variables in our model to changes in policy variables We analyze both temporary and permanent changes, with a temporary increase reflecting a rise in China's money supply in the initial year and a permanent increase representing a sustained rise throughout the model's time horizon In both scenarios, the magnitude of the increase is set at 10 percent.

Figure 3.1 illustrates the outcomes of China's monetary expansion, with base cases depicted in panels a, c, and e, while permanent monetary expansion scenarios are shown in panels b, d, and f In the temporary cases, the initial monetary expansion has minimal impact on key state variables such as the exchange rate, interest rate, and income, with only slight changes observed in the initial periods that are too subtle to be represented in the figures Consequently, the temporary cases are omitted from the visual representation, but a summary table is provided to highlight the changes in state variables during the first period following the temporary monetary expansion.

Table 3.1: The Effect of Temporary Monetary Expansion

According to equations (5) and (6), an increase in China's money supply results in a decrease in the relative interest rate (DR) and an increase in income (DY) This relationship is accurately represented by the signs of the interest rate and income differences shown in Table 3.1 Although the negative sign of the exchange rate may seem counterintuitive, it is clarified in the section discussing permanent monetary expansion.

Permanent monetary expansion significantly impacts exchange rates and interest rates, as demonstrated in panels b and d of Figure 1 However, the effect on income is not observable, as the two lines in panel f overlap.

The impact of exchange rates and policy coordination on income inequality is significant, as illustrated in Table 3.2 Understanding this relationship is crucial for developing effective economic policies that address income disparities.

Figure 3.1: The Effects of Monetary Expansion

Panel b: Exchange Rate Difference base perm

Panel c: Interest Rate Difference base

Panel d: Interest Difference base perm

Panel f: Income Difference base perm

The exchange rate significantly impacts income inequality and policy coordination Fluctuations in exchange rates can exacerbate economic disparities, influencing the distribution of wealth across different social groups Effective policy coordination is essential to mitigate these effects and promote equitable growth By understanding the relationship between exchange rates and income inequality, policymakers can implement strategies that foster economic stability and inclusivity Addressing these issues is crucial for achieving sustainable development and reducing poverty on a global scale.

Table 3.2: The Effect of Permanent Monetary Expansion on Income

The article discusses the intricate relationship between income inequality, exchange rates, and policy coordination It highlights how fluctuations in exchange rates can exacerbate income disparities within and between countries Furthermore, the need for effective policy coordination is emphasized to mitigate the adverse effects of economic imbalances and ensure equitable growth By analyzing various essays on these interconnected topics, the article aims to provide insights into potential solutions for reducing income inequality through informed economic policies.

China's expansion of its money supply leads to a surprising outcome: the exchange rate (Yuan/$) decreases, resulting in an appreciation of the RMB Yuan This counterintuitive finding is supported by a review of the model's equations and estimated parameter values, which align with this unexpected result.

ERL = -1.1 + 0.88ERL(-1) + 0.0004DM + 0.094DR - 0.0005DY – 0.035CCA (4)

The exchange rate is influenced by various factors, including money supply, interest rates, income, and the current account balance While the current account can be considered exogenous and thus ignored, an increase in China's money supply results in a higher exchange rate (Yuan/$), indicating a depreciation of the Yuan However, a larger relative money supply in China also correlates with a decrease in the relative interest rate in the country.

The combination of a lower Debt Ratio (DR) and a higher Dividend Yield (DY) leads to a depreciation of the exchange rate (Yuan/$), resulting in an appreciation of the Yuan This trend helps explain the stability of the Yuan's exchange rate since 1994, despite an annual increase of approximately 17% in China's money supply from 1994 to 2000.

The Control

The Control Framework

Now we put the model into the control theory framework As in Chapter

2, the objective function is to minimize:

1 N k k k k k k k k k k k x W x x u u u u x (18) subject to the system equations: k k k k k k A x B u c x +1 = + + (19) Where x k = state vector of period k x k

~ = desired path for the state vector u k = control vector of period k u ~ = desired path for the control vector k

W k = penalty weight matrix for the state vector which is a diagonal matrix Λ k = penalty weight matrix for the control vector which is a diagonal matrix

A k , B k and c k = coefficient matrices and vectors

To specify this framework, we have a state vector of

The relationship between income inequality, exchange rates, and policy coordination is crucial for understanding economic dynamics This article explores how these factors interact and influence each other, emphasizing the need for effective policy measures By analyzing various essays on this topic, we can identify key trends and implications for economic stability and growth Coordinated policies can mitigate the adverse effects of exchange rate fluctuations on income distribution, highlighting the importance of comprehensive economic strategies.

To enhance clarity, we have transitioned the measurement units of the money supply and income from billion dollars to trillion dollars This adjustment leads to updated relative estimated equations.

ERL = -1.1 + 0.88ERL(-1) + 0.4DM + 0.094DR - 0.5DY – 0.035CCA (7)

The following matrixes are based on equation (7), (8), and (9)

The initial conditions for the state variables are

0 , where ER difference is the exchange rate difference between 1980 and 1981 DR and DY are the data in 1981

Also the parameter matrices are

Income inequality is a pressing global issue that significantly impacts economic stability and social cohesion The relationship between exchange rates and income inequality is complex, as fluctuations in currency values can disproportionately affect lower-income populations Effective policy coordination is essential to address these disparities, ensuring that economic policies promote equitable growth By aligning monetary and fiscal policies, governments can mitigate the adverse effects of exchange rate volatility on vulnerable groups Ultimately, fostering inclusive economic policies is crucial for reducing income inequality and enhancing overall societal well-being.

The desired paths of interest rate differences (DR) and China’s current account (CCA) represent their average values during the analyzed period Additionally, the desired paths for income and money supply differences (DY and DM) are calculated based on their average growth rates The exchange rate difference is expected to follow a declining trajectory until it stabilizes at zero For a comprehensive overview, Table 3.3 presents the desired paths for both state and control variables, while Table 3.4 outlines the associated penalty weights.

Table 3.3 Desired Paths for the State and Control Variables

Year ERL DR DY DM CCA

Table 4: Penalty Weights on State and Control Variables

ERL DR DY DM CCA

Income inequality is a significant issue that intersects with exchange rates and policy coordination Addressing these challenges requires a comprehensive understanding of how economic policies can influence income distribution Effective coordination among policymakers is essential to mitigate the adverse effects of exchange rate fluctuations on vulnerable populations By analyzing the relationship between income inequality and exchange rates, we can develop strategies that promote equitable economic growth and stability.

Results and Experiments

By utilizing the desired paths and penalty weights through the Duali software developed by Amman and Kendrick (1999), we obtain the optimal values for each variable, establishing these as the baseline case values for subsequent experiments.

3.4.2.1 Experiment one: more stable exchange rate

To analyze the impact of allowing the exchange rate to adhere more closely to its desired trajectory, we have increased the penalty weights on the exchange rate difference to ten times their original values As illustrated in Figure 3.2, this adjustment leads to a more stable exchange rate Notably, China's relative money supply decreases prior to 1990, remains stable from 1990 to 1991, and begins to rise again from 1993 onward, as shown in Table 3.5 Although these changes are also depicted in Figure 3.2 Panel d, they may be less discernible due to the scale.

Panel a: Exchange Rate Difference base er

Panel b: Interest Rate Difference base er

Panel c: Income Difference base er

Panel d: Money Supply Difference base er

China's current account is significantly influenced by income inequality, exchange rates, and policy coordination The interplay between these factors shapes the country's economic landscape, impacting trade balances and capital flows Effective policy coordination is essential to address income disparities while maintaining stable exchange rates Understanding these dynamics is crucial for formulating strategies that promote sustainable economic growth and equitable wealth distribution in China.

Table 3.5: China’s Money Supply Change unit: trillion US dollar

The volatility of interest rate differences has increased due to recent changes, as illustrated in Figure 3.2 Panel b, with income differences mirroring the fluctuations in money supply Initially, the current account is lower but rises over time Notably, the exchange rate and interest rate move in opposite directions during the first and second periods; this is because a stable exchange rate requires an initial spike in interest rates, followed by a gradual decrease The key conclusion is that to achieve a stable exchange rate, it is essential to reduce China's relative money supply in the first half of the period and subsequently increase it, albeit at the cost of heightened interest rate volatility.

3.4.2.2 Experiment 2: more growth in China’s GDP

In this experiment, we aim to boost China's GDP by increasing its money supply This involves reducing the money supply gap between the United States and China, adjusting it to 90% of its previous level annually.

The "higher-cm" case illustrated in Figure 3.3 demonstrates the impact of China's decision to increase its money supply, leading to optimal solutions for all variables As depicted in Panel d, China's money supply rises, resulting in a relatively higher GDP, as shown in Panel c However, this increase also causes a decline in China's current account, illustrated in Panel e Consequently, the exchange rate experiences a decrease, resulting in the appreciation of the Yuan, as evidenced in Panel a, mirroring the outcomes from the policy simulation.

Despite the negative values of DM and DY in the model, their signs accurately indicate their influence on the exchange rate This highlights the complex relationship between income inequality, exchange rates, and policy coordination, underscoring the need for a nuanced understanding of these economic factors.

Figure 3.3: Higher Level of China’s GDP

Panel a: Exchange Rate Difference base higher-cm

Panel b: Interest Rate Difference base higher-cm

Panel c: Incom e Difference base higher-cm

Panal d: Money Supply base higher-cm

China's current account is significantly influenced by income inequality, exchange rates, and policy coordination The interplay between these factors plays a crucial role in shaping the country's economic landscape Addressing income inequality is essential for sustainable growth, while effective exchange rate management can enhance competitiveness Furthermore, coordinated policy efforts are necessary to navigate the complexities of China's economic environment, ensuring stability and fostering development.

We aim to examine whether the patterns observed will shift with a further increase in China's relative money supply, which is currently at 80% of its previous annual level The "highest-cm" scenario depicted in Figure 3.4 illustrates optimal solutions for all variables under the assumption of a greater money supply increase in China As shown in Figure 3.4, while the overall pattern of changes remains consistent with that of Figure 3.3, the primary distinction lies in the magnitudes of these changes.

The distinction between "higher-cm" and "highest-cm" runs is illustrated in Appendix B-1 This analysis highlights the varying impacts of income inequality, exchange rates, and policy coordination, providing insights into their interrelationships and implications for economic strategies Understanding these differences is crucial for formulating effective policies that address income inequality and enhance economic stability.

Figure 3.4: Further Increase in China’s Money Supply

Panel a: Exchange Rate Difference base highest-cm

1981 1984 1987 1990 1993 1996 1999 panel b: Interest Rate Difference base highest-cm

Panel c: Income Difference base highest-cm

Panel d: Money Supply Difference base highest-cm

China's current account reflects significant dynamics influenced by income inequality, exchange rates, and policy coordination The interplay of these factors shapes the economic landscape, highlighting the importance of understanding how exchange rate policies can impact income distribution and overall economic stability Effective policy coordination is crucial for addressing the challenges posed by income inequality, ensuring sustainable growth, and maintaining a balanced current account.

3.4.2.3 Experiment 3: Future Exchange Rate Stabilization

This experiment focuses on predicting the future Yuan/$ exchange rate by establishing a new desired path for key economic variables According to Table 3.6, our forecast indicates that the future exchange rate will remain stable, the current account will achieve balance, the interest rate differential will decrease, and the growth rates of the differences in money supply and income will also decline.

Table 3.6: Desired Paths for the State and Control Variables

Year erl dr dy dm cca

The "base" case illustrated in Figure 5 reveals the optimal values achieved through the desired path implemented in the Duali software In contrast, the "erf" scenario shows the effects of increasing penalty weights on exchange rate differences, which are raised to 100 times their original values This significant adjustment leads to a complete transformation in the exchange rate dynamics, emphasizing the critical impact of policy coordination on income inequality and exchange rate management.

Figure 3.5: Future Exchange Rate Stabilization

Panel a: Exchange Rate Difference base erf

Panel b: Interest Rate Difference base erf

Panel c: Income Difference base erf

Panel d: Money Supply Difference base erf

China's current account has remained stable, particularly in the last period, as illustrated in Figure 3.5, panel a To maintain this stability, it is essential for China to increase its relative money supply and sustain a higher current account level, as shown in panels d and e This increase in money supply allows China's GDP to remain elevated while keeping interest rates relatively low, as depicted in panels b and c Unlike the first experiment, where a decrease in relative money supply was followed by an increase to stabilize the exchange rate, this scenario requires a consistent increase in China's relative money supply throughout the entire period The contrasting results stem from the differing desired exchange rate trajectories: in the first experiment, the exchange rate gradually decreased, whereas in this case, it remains constant across all periods.

This paper presents a model to analyze the Yuan/$ exchange rate behavior, revealing that an increase in China's relative money supply leads to currency appreciation Additionally, the findings suggest that for China to achieve a higher GDP, it must also expand its money supply To maintain a stable exchange rate, China may need to either reduce its money supply before increasing it or consistently increase it throughout the period The appropriate policy choice depends on the desired exchange rate trajectory However, given the model's simplicity, caution is advised in interpreting the results.

Chapter 4: Reform, Inequality, and Growth

Control and Sensitivity Analyses

The Control Framework

As before, the goal is to minimize:

The article discusses the intricate relationship between income inequality, exchange rates, and policy coordination It emphasizes the importance of understanding how these factors interact within economic systems The analysis highlights that effective policy coordination is essential for addressing income disparities, especially in the context of fluctuating exchange rates By examining the state vector over different periods, the article aims to provide insights into the dynamics of economic policies and their impact on income inequality.

~ = desired path for the state vector u k = control vector of period k u ~ = desired path for the control vector k

W k = penalty weight matrix for the state vector which is a diagonal matrix Λ k = penalty weight matrix for the control vector which is a diagonal matrix

A k , B k and c k = coefficient matrices and vectors

The relationship between GDP growth, rural inequality, and urban disparity is a critical area of study Understanding income inequality is essential for effective policy coordination, particularly in the context of fluctuating exchange rates Addressing these inequalities requires comprehensive analysis and strategic interventions to promote equitable economic development across both rural and urban areas By focusing on income distribution and the impacts of economic policies, we can better align growth objectives with social equity goals.

Mogr Tedu Fixa Trad Agrt Drf Fgdi Drf u

Fixed trade Foreign tax Agr reform of ree deg Rural investment direct

Foreign reform of ree deg Urban

GDP of Growth rural Inequality urban Inequality

Notice that the initial value of the per capita GDP growth rate is 7.7%, which is going to be important in our sensitivity analysis

The article explores the intricate relationship between income inequality, exchange rates, and policy coordination It emphasizes how fluctuations in exchange rates can exacerbate income disparities, impacting economic stability Additionally, effective policy coordination is essential for mitigating these inequalities, as it allows for a more balanced economic approach The discussion highlights the need for comprehensive strategies that address both income distribution and currency valuation to foster sustainable economic growth Ultimately, understanding these dynamics is crucial for policymakers aiming to create equitable economic environments.

The ideal trajectories for control variables align with their historical mean values, with the exception of the degree of reform While reforms may lead to an increase in income inequality, this rise is intended to follow a historical trend line Our goal is to maintain a stable real growth rate alongside a consistent inflation rate, with both GDP growth and inflation reflecting their historical averages The desired paths for these economic indicators are detailed in Tables 4.2 and 4.3.

Table 4.2: Desired paths of State Variables

Year Inur Inru Pgdp Infl

Table 4.3: Desired Paths of the Control Variables

Drf1 Fgdp Drf2 Agrt Trad Fixa Tedu Mogr

The penalty weights for the base case are chosen according to: i *

W (mean of i) = 75.39 (20) i: state variables or control variables We use 75.39, since we want to normalize on Drf2, and 75.39 is the mean of Drf2

Normalizing variables in our model ensures that each variable is given equal importance, despite having different units This approach is crucial for accurately analyzing the relationship between income inequality, exchange rates, and policy coordination By standardizing the data, we can effectively compare and interpret the effects of these factors on economic outcomes.

The following table lists the penalty weights

Table 4.4: Penalty Weights on State and Control Variables

Inur Inru Pgdp Infl Drf1 Fgdp Drf2 Agrt Trad Fixa Tedu Mogr

Sensitivity Analysis

Since the implementation of reform and open-door policies, China's economy has undergone significant transformation, creating a mechanism that aligns individual effort with personal interest, thereby enhancing work motivation and enthusiasm This shift has resulted in greater job choices and opportunities, enabling some individuals to achieve rapid wealth accumulation However, this economic growth has also led to increased income inequality, which, paradoxically, can stimulate further growth Additionally, the new policies have spurred investment, international trade, and human capital development, including the revival of the college system As aggregate demand rises, inflation rates have also increased, further exacerbating income inequality.

The evolution of the economic system is influenced by the desired trajectories of key state variables and the importance assigned to them When a greater emphasis is placed on a specific state variable, it tends to align more closely with its intended path Our model highlights the dynamics of the economic system based on the desired paths of four critical state variables: urban income inequality, rural income inequality, per capita GDP growth, and inflation Once these desired paths are established, control variables will adapt to facilitate the movement of state variables towards their targeted trajectories.

The simulation results presented in Table 1 highlight the varying impact of control variables on economic indicators, emphasizing the significance of lag variables While both urban degree of reform and fixed assets investment positively influence per capita GDP growth, their trajectories diverge In scenarios prioritizing stable growth amidst rising income inequality, the urban degree of reform shows a consistent upward trend, whereas fixed assets investment exhibits a gradual decline This distinction underscores the complexity of economic dynamics and the need for nuanced analysis in policy-making.

The differing movement paths of two control variables with the same sign effect on a state variable can be attributed to the necessity of a steady increase in income inequality within our model To achieve this, the urban degree of reform, a crucial determinant of urban income inequality, must also rise However, this increase in urban reform, while promoting growth, may cause the growth trajectory to diverge from the desired path To counteract this deviation and ensure stable growth, adjustments to other control variables, such as fixed asset investment, which are less significant for income inequality but more critical for growth, will need to be made.

Lag variables play a crucial role in economic analysis, particularly in understanding GDP growth For instance, a one-period lag in GDP growth positively influences current growth rates, which in turn impacts the reduction in fixed asset investments The significance of lag variables correlates with a greater decrease in fixed asset investments, essential for maintaining stable growth The subsequent sensitivity analysis will provide a clearer understanding of these dynamics, covering two distinct periods: from 1991 to 1998 and from 1998 onward.

The experiment conducted for the period from 1991 to 1998 reveals that an ideal economic situation is characterized by stable growth, controlled income inequality, and a stable inflation rate, as indicated by the desired trajectories of state variables in Table 4.2 The system's stability is influenced by the degree of reforms and various control variables, with an expectation for a steady increase in reform levels Additionally, the desired paths of other control variables align with the historical averages presented in Table 4.3.

This article examines the relationship between stable economic growth and control variables, particularly focusing on the impact of reform degrees on income inequality By analyzing these dynamics, we aim to understand how various controls influence income distribution and overall economic stability.

Table 4.1 reveals that the urban and rural degrees of reform, fixed assets investment, international trade, human capital, and the money supply positively influence economic growth, while the agriculture tax negatively impacts it Due to the consistent patterns observed in fixed assets investment, international trade, and human capital across our experiments, we focus solely on the changing patterns of fixed assets investment in our figures, excluding the others Additionally, as the money supply plays a minimal role in fostering stable economic growth, we do not present its changing pattern in this analysis.

To mitigate the fluctuations in growth, we will prioritize a higher weight on growth metrics The low weight aligns with the base run, while the high weight is set at 100 times the base weight The changes in weight are illustrated in Figure 4.2.

Figure 4.2: More Weight on Growth

Between 1991 and 1997, various essays explored the intricate relationships between income inequality, exchange rates, and policy coordination These analyses highlighted the impact of economic policies on income distribution and the importance of coordinated efforts among nations to address these disparities The discussions emphasized that understanding exchange rate fluctuations is crucial for formulating effective policies aimed at reducing income inequality Overall, the body of work from this period underscores the need for comprehensive approaches to economic challenges that consider both exchange rates and income distribution.

The initial value of the growth of per capita GDP at 7.7% is substantially below the desired level at 9.525% This is important in our analysis.

Figure 4.3, which is the same as Figure 2 Pane a, shows the growth pattern after the change of weight

We can see, after the change of the weight, the optimal growth pattern almost overlaps with the desired path

Figure 4.3: Per Capita GDP Growth

Between 1991 and 1998, the discourse surrounding income inequality, exchange rates, and policy coordination gained significant attention Various essays explored the intricate relationship between these economic factors, highlighting how changes in exchange rates can impact income distribution and necessitate coordinated policy responses The ongoing analysis during this period emphasized the need for a comprehensive understanding of how economic policies can address income disparities while maintaining stable exchange rates This focus on policy coordination remains crucial for fostering equitable economic growth and minimizing inequality in the global economy.

To achieve the desired growth in per capita GDP, a significant initial reform effort is required in both urban and rural areas Notably, there is a sharp decline in the degree of reform from the first to the second period, resulting in levels that remain lower than the baseline scenario However, a gradual increase in reform efforts is observed over time Additionally, fixed assets investment experiences a sharp drop between the first and second periods, followed by a steady decline thereafter.

This is also true for international trade and human capital, since international trade and human capital have the same pattern as fixed assets investment The

Between 1991 and 1997, the relationship between income inequality, exchange rates, and policy coordination was a focal point of economic analysis Notably, agricultural tax policies exhibited a contrasting trend, starting low and then experiencing a significant increase, particularly after 1992, where the rate of increase began to slow down This dynamic reflects broader economic shifts and highlights the importance of understanding how tax policies can influence income distribution and economic stability.

The initial positions of control variables significantly differ from their second-period positions to ensure the growth rate, a key state variable, aligns with the desired trajectory Initially, the growth rate is 7.7, which is notably lower than the target rate of 9.925 To facilitate this increase, control variables positively influencing growth must remain elevated, while those negatively affecting growth should be kept low Additionally, lagged values of state variables, particularly the growth rate's lag variable, exert a strong positive influence on growth Consequently, as control variables contribute to elevating the growth rate from 7.7 to 9.925, other state variables like urban and rural income inequality, along with inflation, also maintain higher levels in the second period This relationship is illustrated in Figure 4.5, which depicts the trend of urban income inequality.

Urban income inequality has significantly increased from the first to the second period Notably, urban income inequality, rural income inequality, and inflation exhibit similar trends; therefore, we have excluded the graphs for rural income inequality and inflation from the figure.

Conclusion

Our analysis reveals that reform is the primary driver of growth and income inequality, with other control variables having a minimal impact Contrary to trends in many developing countries, we find a positive relationship between growth and income inequality Sensitivity analysis from 1991 to 1998 indicates that while growth stability is essential, excessive focus on it can hinder the reform process To promote moderate growth, initial high degrees of reform, fixed assets investment, international trade, and human capital are necessary, with fixed assets and trade gradually decreasing while reform levels rise From 1998 to 2010, achieving stable income inequality requires maintaining high reform degrees, significant foreign direct investment, and low agricultural taxes throughout the period A stable monetary policy is also crucial, alongside initially lower levels of international trade and human capital that should be allowed to grow For consistent growth, lower initial levels of reform, trade, foreign investment, and human capital are needed, while agricultural tax should be higher Finally, we illustrate the tradeoff between income inequality and growth.

Historical essays on income inequality explore the intricate relationship between exchange rates and policy coordination These essays highlight how fluctuations in exchange rates can exacerbate or mitigate income disparities within economies Furthermore, effective policy coordination is essential for addressing the challenges posed by income inequality, as it influences both domestic and international economic stability By analyzing historical contexts, these essays provide valuable insights into the dynamics of income inequality, emphasizing the need for cohesive strategies to promote equitable growth.

Figure 7: China's Urban Wage Income

Figure 8: China's Urban Unem ploym ent Rate

Figure 11: Hong kong's consum ption

Figure 12: Hong Kong's Investm ent

Historical essays on income inequality, exchange rates, and policy coordination explore the intricate relationships between these economic factors Understanding how income inequality affects exchange rates is crucial for effective policy-making Additionally, coordinated policies can help mitigate the adverse effects of income disparities on economic stability The interplay between these elements highlights the importance of comprehensive economic strategies to address inequality while promoting sustainable growth Analyzing past trends provides valuable insights for contemporary economic challenges, emphasizing the need for informed and coordinated policy responses.

Figure 15: Hong Kong's Price Level

Figure 17: Hong Kong's Unemployment Rate

Figure 18: Hong Kong's Interest Rate

Historical essays on income inequality, exchange rates, and policy coordination explore the intricate relationships between economic disparities and monetary policies These essays emphasize how fluctuations in exchange rates can exacerbate or mitigate income inequality across different regions Furthermore, they highlight the importance of coordinated policy efforts among nations to address the challenges posed by income inequality and ensure stable economic growth Understanding these dynamics is crucial for policymakers aiming to create equitable economic systems and foster sustainable development.

Figure 22: Hong Kong's Current Account

Historical essays on income inequality, exchange rates, and policy coordination highlight the complex interplay between economic factors and social disparities These essays explore how fluctuations in exchange rates can exacerbate income inequality, particularly in developing nations They emphasize the need for coordinated policy responses to address these challenges effectively By analyzing historical data, the essays provide insights into the impact of economic policies on income distribution and the importance of international cooperation in mitigating inequality Understanding these dynamics is crucial for formulating strategies that promote equitable economic growth.

Appendix A-2: Simulation Results for China’s Fiscal Expansion

Figure 1: China's Consum ption base permg tempg

Figure 2: China's Investm ent base permg tempg

Figure 3: China's Export base permg tempg

Figure 4: China's Import base permg tempg

This article explores the intricate relationship between income inequality, exchange rates, and policy coordination It highlights how fluctuations in exchange rates can exacerbate income disparities within and between nations Furthermore, effective policy coordination is essential for mitigating these inequalities, as it allows countries to respond collectively to economic challenges The discussion emphasizes the need for a cohesive approach to economic policy that considers the interplay between exchange rates and income distribution, ultimately advocating for strategies that promote equity and sustainable growth.

Figure 7: China's Urban Wage Income base permg tempg

Figure 8: China's Urban Unem ploym ent Rate base permg tempg

Figure 9: China's Interest Rate base permg tempg

Figure 10: Exchange Rate base permg tempg

Figure 11: Hong Kong's Consum ption base permg tempg

Hong Kong's investment landscape is significantly influenced by factors such as income inequality, exchange rates, and policy coordination These elements interact to shape economic conditions and investment strategies within the region Understanding the relationship between these factors is crucial for investors looking to navigate Hong Kong's dynamic market effectively By analyzing the impact of exchange rate fluctuations and income distribution, stakeholders can make informed decisions that align with regional economic policies.

Figure 13: Hong Kong's Export base permg tempg

Figure 14: Hong Kong's Import base permg tempg

Figure 15: Hong Kong's Price Level base permg tempg

Figure 16: Hong Kong's Wage base permg tempg

Figure 17: Hong Kong's Unem ploym ent Rate base permg tempg

Hong Kong's interest rate plays a crucial role in understanding the dynamics of income inequality, exchange rates, and policy coordination Analyzing these elements is essential for developing effective economic strategies that address disparities in wealth distribution The interplay between interest rates and exchange rates significantly impacts economic stability and growth in Hong Kong Effective policy coordination is vital for mitigating the effects of income inequality and ensuring a balanced economic environment.

Figure 19: China's GDP base permg tempg

Hong Kong's GDP is significantly influenced by factors such as income inequality, exchange rates, and policy coordination Understanding these elements is crucial for analyzing the region's economic performance and its implications for social equity Effective policy measures are essential to address the challenges posed by income disparities and fluctuating exchange rates, ensuring sustainable economic growth and stability in Hong Kong.

The article discusses the intricate relationship between income inequality, exchange rates, and policy coordination It highlights how fluctuations in exchange rates can exacerbate income disparities, necessitating effective policy measures to address these challenges Additionally, the importance of coordinated economic policies among nations is emphasized to mitigate the adverse effects of income inequality Understanding these dynamics is crucial for developing strategies that promote equitable economic growth and stability.

This article explores the intricate relationship between income inequality, exchange rates, and policy coordination It emphasizes how fluctuations in exchange rates can exacerbate income disparities within economies Additionally, the piece discusses the necessity for coordinated policies among nations to mitigate the adverse effects of income inequality By examining various case studies, the article highlights the importance of understanding these dynamics to foster equitable economic growth and stability Ultimately, it advocates for collaborative international efforts to address the challenges posed by income inequality in the context of global financial systems.

The article discusses the intricate relationship between income inequality, exchange rates, and policy coordination It emphasizes the need for comprehensive essays that explore how these factors interact and influence each other in the global economy The repeated mention of income inequality highlights its significance as a persistent issue that requires careful analysis and coordinated policy responses to address effectively.

The data reflects significant financial figures, including repeated values such as -55990.07, -36861.90, and -9202.10, indicating a pattern in income inequality and its correlation with exchange rates The essay emphasizes the importance of policy coordination in addressing these economic disparities Notably, the consistent figures, such as 1254.41 and 4916.32, suggest potential areas for analysis within the broader context of economic policy and its impact on income distribution Understanding these dynamics is crucial for developing effective strategies to mitigate income inequality and enhance economic stability.

The debug file for QLP reveals significant financial metrics, including a total of 359,236.00 and various other amounts such as 184,088.00 and 133,468.00 Notably, the document contains repeated references to essays on income inequality, exchange rates, and policy coordination, emphasizing the importance of these topics in economic discussions The data also highlights fluctuations in values, with figures ranging from 2.70 to 24.00, indicating potential trends or patterns worth analyzing further.

The data presented reflects a series of numerical values associated with various categories, showcasing a range of scores from 1.00 to 80.50 Notably, the values exhibit consistent repetition, particularly in the lower ranges, indicating a potential standardization or commonality in the measured parameters The article also emphasizes themes related to income inequality, exchange rates, and policy coordination, highlighting the interconnectedness of these economic factors This repetition suggests a focus on the importance of analyzing these themes in depth to understand their implications on economic stability and growth.