Copyright by Xiaojun Yang 2003 The Dissertation Committee for Xiaojun Yang Certifies that this is the approved version of the following dissertation: Essays on Income Inequality, Exchange Rate, and Policy Coordination Committee: David A. Kendrick, Supervisor Li Gan Vince Geraci William Glade Hong Yan Essays on Income Inequality, Exchange Rate, and Policy Coordination by Xiaojun Yang, B.A., M.I.A., M.S. Dissertation Presented to the Faculty of the Graduate School of The University of Texas at Austin in Partial Fulfillment of the Requirements for the Degree of Doctor of Philosophy The University of Texas at Austin May 2003 UMI Number: 3116243 ________________________________________________________ UMI Microform 3116243 Copyright 2004 by ProQuest Information and Learning Company. All rights reserved. This microform edition is protected against unauthorized copying under Title 17, United States Code. ____________________________________________________________ ProQuest Information and Learning Company 300 North Zeeb Road PO Box 1346 Ann Arbor, MI 48106-1346 iv Acknowledgements I am deeply indebted to my supervisor Professor David A. Kendrick for his kind guidance, advice and encouragement. Under his consistent, conscientious and patient supervision, I have gained insight about macroeconomics and computational economics, importantly how to approach academic research. I will continue to value his friendship. I also owe thanks to the other member of the dissertation committee: Dr. Li Gan, Dr. Vince Geraci, Dr. William Glade, Dr. Hong Yan, for their valuable discussions and suggestions, and for their generosity and kindness. Also, I would like to express my appreciation to Seung-Rae Kim and Marco Tucci for their intellectual and technical advice. Finally, I express my special thanks to my parents for their lasting support and love. v Essays on Income inequality, Exchange Rate, and Policy Coordination Publication No._____________ Xiaojun Yang, Ph.D. The University of Texas at Austin, 2003 Supervisor: David A. Kendrick The goal of this dissertation is to develop and to use computational methods to study issues in policy coordination, exchange rates and income inequality. The topic of policy formulation among interdependent economies has received much attention in the literature. In the first essay a two-country model is used to illustrate the interdependence of China’s and Hong Kong’s economies. Not surprising, we find that the policy effect is asymmetric, due to difference in size. Shocks to the Chinese economy will affect Hong Kong’s stable economic growth. In order for Hong Kong to keep a stable growth, both governments must act in certain ways. Particularly, by importing more China can help Hong Kong’s economy, especially during the financial crisis years. We find that fiscal policy is vi more effective than monetary policy in affecting economic activities in this model. In the second essay, we develop a model to study the behavior of the Yuan/Dollar exchange rate. The parameter values estimated for the model are such that when China increases its relative money supply, the exchange rate appreciates, which is different than the conventional result. Also the parameter values indicate that in order for China to have a higher level of GDP, China has to increase its money supply; and for a stable exchange rate, China either decreases its money supply then increases it or increases its money supply during the entire period. The right policy hinges on the desired path for the exchange rate. Since the model is simple in essence, the results should be interpreted with caution. The third essay analyses the contribution of different factors to the determination of income inequality. The questions regarding whether greater income inequality is conducive to China's growth and the role of degree of reform for growth and inequality have been studied in the paper. We find a positive correlation between income inequality and growth, that reform plays a dominant role in determining growth and income inequality, and that steady growth can not be emphasized too much, otherwise the reform process will be reversed, which is not practical. Finally, the tradeoff between income inequality and growth is analyzed. vii Table of Contents Chapter One: Introduction 1 Chapter Two: Economic Interaction and Policy Coordination Between China and Hong Kong 3 2.1 Introduction 3 2.2 The Model 4 2.3 The Optimal Control Theory 10 2.4 The Model with Price Variables 32 2.4.1 The Model Equations… 32 2.4.2 Simulations 39 2.4.2.1 Historical Simulation 39 2.4.2.2 Policy Simulation 43 2.4.2.2.1 Fiscal Expansion 43 2.4.2.2.2 Monetary Expansion 49 2.5 The Model with Price Variables in the Control Theory Framework 50 Chapter Three: Yuan - Dollar Exchange Rate Model 62 3.1 Introduction 62 3.2 Developments of China's Foreign Exchange System 63 3.3 The Model 71 3.3.1 The Model Equations… 72 3.3.2 Data 74 3.3.3 Estimation 75 3.3.4 Policy Simulation 77 3.4 The Control 82 3.4.1 The Control Framework 82 3.4.2 Results and Experiments 86 viii 3.5 Conclusion 95 Chapter Four: Reform, Inequality, and Growth 96 4.1 Introduction 96 4.2 Factor Consideration 97 4.3 The Model 102 4.4 Control and Sensitivity Analyses 112 4.4.1 The Control Framework 112 4.4.2 Sensitivity Analysis 117 4.4.2.1 Sensitivity Analysis from 1991 to 1998 119 4.4.2.2 Sensitivity Analysis from 1998 to 2010 132 4.4.2.2.1 Caring More about Income Inequality 135 4.4.2.2.2 Caring More about Growth Rate 140 4.4.2.2.3 Greater Difficulty to Further Reform 144 4.4.2.2.4 Inequality verse Growth 149 4.5 Conclusion 152 Appendix A-1 Historical Simulation 154 Appendix A-2 Simulation Results for China's Fiscal Expansion 158 Appendix A-3 Duali Input File 1 162 Appendix A-4 Duali Input File 2 179 Appendix B-1 Comparison of Different Money Supply 198 Appendix B-2 Duali Input File 199 Appendix C-1 Constant Inequality, Growth and Inflation 204 Appendix C-2 Duali Input File 206 Appendix D-1 Data-China 212 Appendix D-2 Data-Hong Kong 220 ix Appendix D-3 Data-US 226 Bibliography 228 Vita 231 [...]... determining growth and income inequality, and that steady growth can not be emphasized too much, otherwise the reform process will be reversed, which is not practical Finally, the tradeoff between income inequality and growth is analyzed 2 Chapter 2: Economic Interaction and Policy Coordination Between China and Hong Kong 2.1 INTRODUCTION The economic reforms that took place in mainland China in the... China’s economic policies have a big effect on Hong Kong, but the reverse is not true However, China and Hong Kong’s economies are intertwined The shock of the Chinese economy will affect Hong Kong’s stable economic growth In order for Hong Kong to keep a stable growth, both governments must act in certain ways China can help Hong Kong government reduce expenditure without hurting Hong Kong’s economic... expectation The interaction of the two economies is represented by the export functions: China’s export is a function of Hong Kong’s GDP, and Hong Kong’s export is a function of China’s GDP 2.2.2 The Estimation Technique2 This section describes a consistent estimator of a simultaneous-equations model in which there is a lagged dependent variable and serial correlation Consider the following equations (in... households—rural and urban—is introduced to illustrate factors that should be considered in income distribution and growth Based on this framework, equations are developed for urban income inequality, rural income inequality, growth and inflation Contradicting a popular view regarding East Asian countries, a positive correlation between income inequality and growth was found The other findings are that... China in the late 1970s began a new process that fundamentally changed the economic relationship between mainland China and Hong Kong In the 1960s and 1970s, Hong Kong’s economic growth rate reached, on average, almost 10 percent per year However by the early 1980s high land rents and wages began to erode Hong Kong’s international competitiveness that had been the basis of its success Coincidentally,...Chapter 1: Introduction The topic of policy formulation among interdependent economies has received much attention in the literature China and Hong Kong are economically closely linked Policy initiatives in one economy may influence the evolution of economics variables in the other In the first essay a two-country model is used to illustrate the interdependence of these two economies Not surprisingly,... choices and more opportunities, and that income inequality has increased The final chapter analyses the contribution of different factors in the determination of income inequality The questions regarding whether income inequality is conducive to China's growth and the role of degree of reform for growth and inequality have been studied in the paper A two-period model with two-group households—rural and. .. that the size of an economy matters Since China’s economy size is bigger than Hong Kong’s, China’s economic policy has a large effect on Hong Kong, but the reverse is not true Experiment two: China has lower GDP growth In this experiment, we want to see what happens to Hong Kong’s economy if China’s GDP growth is slower In order to mitigate this adverse effect on Hong Kong’s economy, what should both... these two economies Not surprisingly, we found that the policy effects are asymmetric, due to differences in size China’s economic policies have a big effect on Hong Kong, but the reverse is not true However, China and Hong Kong’s economies are intertwined A shock to the Chinese economy will affect Hong Kong’s stable economic growth In order for Hong Kong to keep a stable growth, both governments must act... more China can help Hong Kong’s economy, especially during financial crisis years In doing so, China has to have higher government expenditure and Hong Kong has to have higher money growth At the same time, Hong Kong should steadily increase its government expenditure and China should keep a stable money growth Fiscal policy is more effective than monetary policy in affecting economic activities in . dissertation is to develop and to use computational methods to study issues in policy coordination, exchange rates and income inequality. The topic of policy formulation among interdependent economies. between income inequality and growth is analyzed. vii Table of Contents Chapter One: Introduction 1 Chapter Two: Economic Interaction and Policy Coordination Between China and Hong. Dissertation Committee for Xiaojun Yang Certifies that this is the approved version of the following dissertation: Essays on Income Inequality, Exchange Rate, and Policy Coordination Committee: