Define the term fixed exchange rate indicated in bold in the text (paragraph [1]).

Define the term monetary policy indicated in bold in the text (paragraph [2]).

Using an exchange rate diagram, explain why the “widening trade deficit in services” could lead to a depreciation of the renminbi (paragraph [3]).

Using an AD/AS diagram, explain how “increasing China’s interest rate” could affect its economic growth (paragraph [5]).

Using information from the text/data and your knowledge of economics, discuss the view that a depreciating currency is good for the Chinese economy.

Candidates who incorrectly label diagrams can be awarded a maximum of [3].

For an exchange rate diagram, the vertical axis may be exchange rate, price of RMB in another currency, other currency/RMB or other currency per RMB. The horizontal axis should be quantity, or quantity of RMB. A title is not necessary.

Candidates who incorrectly label diagrams can be awarded a maximum of [3].

For AD/AS the vertical axis may be average (general) price level, APL or price level. For the horizontal axis, real output, real national output, real income, real national income, real GDP or real Y. Any abbreviations are acceptable. A title is not necessary.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

Do not award beyond Level 2 if the answer does not contain reference to the information provided.

“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.

Responses may include:

• definitions of depreciation, managed exchange rate.

Economic analysis may include:

• Marshall-Lerner and J curve
• AD / AS
• exchange rate theory
• balance of payments
• government macroeconomic objectives.

Arguments supporting the claim may include:

• increased AD by decreasing relative price of exports, increasing export revenue if X PED>1
• increases relative price of imports, decreasing import expenditure if M PED>1
• increasing export revenue increases current account surplus (paragraph [3])
• increase in net export component of AD leading to increasing economic growth (paragraph [4])
• increases in foreign exchange reserves (assuming export revenue is increasing and is greater than import expenditure)
• increases Chinese ownership of foreign assets and foreign debt
• China exports to countries other than the US
• protects Chinese exporters from US tariff costs (paragraph [4]).

Arguments against the claim may include:

• the claim that the depreciating RMB is good for the Chinese economy is made by a US official who may be justifying the punitive US tariff regime (paragraph [1])
• depreciation of the RMB could compromise the market-based reforms to the exchange rate (paragraph [1])
• main cause of depreciation is “shrinking current account surplus” caused by trade war – falling demand for the RMB (paragraph [3])
• normal benefits of depreciating currency (lower relative price of exports) cancelled out by US tariffs hence no increase in export revenue on current account (paragraph [3])
• depreciation increases relative import prices therefore increasing import expenditure (“widening trade deficit”) and reducing the current account surplus – increasing supply of Renminbi (paragraph [3])
• export sector needs government help to compete as depreciation not sufficiently offsetting effect of US tariffs (paragraph [4])
• depreciation will increase relative price of imported components therefore decreasing SRAS
• slower economic growth due to lower net export component causing slowdown in AD
• rising US interest rates could lead to capital flight from China (paragraph [5])
• depreciating currency could cause capital flight as speculators seek out the strengthening US dollar therefore “negatively affecting China’s financial account” (paragraph [5])
• indebted Chinese firms harmed if interest rates rise to support the Renminbi and prevent capital flight (paragraph [5])
• depreciating exchange rate tends to cause political tensions with US (China’s biggest trade partner).

Any reasonable discussion.

This was generally well answered although a significant minority of candidates simply stated that the exchange rate did not change but with no indication to what the currency was fixed to. 

In the main there were few problems here, with most candidates having little difficulty in accurately defining the term. However, some students only referred to one aspect of monetary policy and thus lost 1 mark. 

There was a wide range of marks for this question. The more informed students had little difficulty, with accurate diagrams and concise but effective explanations. Nevertheless, in a few cases a correct explanation was provided that did not match the diagram so only 2 marks could be awarded.

As in the past with exchange rate diagrams, there were the usual labelling errors, especially on the vertical axis.

Again, a wide range of responses were seen in terms of quality, from excellent answers to those that showed little or no understanding at all. There was moreover clear evidence of careless labelling of the AD/AS diagram, the most common being labelling the horizontal axis as "GDP" instead of "real GDP".

The accompanying explanation sometimes missed a step (e.g. higher interest rates cause AD to fall, without elaborating on borrowing costs, impact on C & I etc). Some very good responses carelessly lost a mark.

There were some very weak answers where there was minimal evidence of understanding with some, surprisingly, suggesting that higher interest rates would generate economic growth. This was largely the result of a misunderstanding of portfolio investment and physical investment and the different effects of rising interest rates.

Many candidates identified some of the possible effects of depreciation but there was relatively little evaluation as to whether it would be good for the Chinese economy. Some students did not even extend their analysis to the "Chinese economy" as required by the question, thus providing a generic answer.

Too many points tended to be stated rather than analysed. Overall, many students took a descriptive approach with limited appropriate analysis. In some cases, the significance of the PEDx and PEDm was identified while others mentioned the Marshall-Lerner condition and/or J curve theory, but few effectively recognised or analysed their significance. Candidates need to learn how to apply theory to the stimulus text.