This is the first of the three courses part of the Globalization, Economic Growth and Stability Specialization. This course will employ a non-technical approach to analyze how governments use policy to influence a country's economy. Upon completing the course you should be able to discuss national debts and deficits, examine fiscal and monetary policy and their appropriateness to the situation of an economy, and anticipate the results of fiscal and monetary policies and structural reform on a country. These concepts will give you the tools to develop your own position in many current economic debates, such as fiscal stimulus vs. austerity, the merits of quantitative easing, the need for higher interest rates or the future growth path of many modern economies.
Policy Mix in the Real World
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From the course by IE Business School
Understanding economic policymaking
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From the lesson
Combining Policies and Other Policy Tools
Welcome, Courserians, to our fifth module in the Understanding Economic Policy course! We have so many tools in hand now that we can spend our last sessions putting the pieces together and tackling real-world policy questions. There is little that could be more relevant, and I hope you will enjoy it. In the real world, fiscal and monetary authorities may move in the same policy directions or they may act in opposition to one another. We will explore what happens as fiscal and monetary policies interact in the real economy. Additionally, economic decision-makers have two other policies that they can use to influence the economy, which are exchange-rate policy and structural policy. We will discuss how these work, and what special complications and advantages they present. There is also a peer-evaluated assignment for this course, and it’s included in this module. You will use the Economic Policy Simulator, a free interactive exercise, to make policy for an unknown country. Use all of the tools that we have learned together, and enjoy getting a chance to run a country! Thanks for your enthusiastic participation, and enjoy these last two modules of the course!
Meet the Instructors
Gayle AllardProfessor
Economics
[MUSIC]
Now we've seen all four of the policies.
We've seen how they may interact with each other, contradict each other How one can
take the place of others in stimulating the economy how they lead
economic policy making authorities into conflict, into dilemmas.
What I'd like to do now for just a few minutes, and we'll continue with
some of this in the next session, is to see what countries have actually done.
In the wake of the greatest financial crisis, the greatest economic crisis
that we, we had had since the Great Depression of the 30s.
This table is, it doesn't look very intuitive
at first, so we're going to walk through it
slowly, and I'm going to translate to you all
those acronyms so we know what we're talking about.
But I think, in the end, it delivers a pretty powerful message.
About how authorities use the tools at their disposal to try and combat
the crisis, and how very, very differently they acted in different situations.
The only thing is that this chart doesn't include structural policy, and you can
imagine why, because you can't just measure
how much structure or form there is.
Maybe it happened in the financial market, the labor market, there's no.
Quantitative indicator to show where this is going.
So we're going to have to leave that one out of our discussion.
But we're going to reflect monetary policy.
We're going to reflect fiscal policy, and we're going to talk about
what happened to the exchange rate in four very important areas.
The United States The euro area, which is the
17 countries that are in the, that share the
single currency in Europe, the UK, which doesn't share
that currency, they have their separate currency, and Japan, OK.
So, the first thing I want, should just explain
to you, is what some of these acronyms mean.
Now, we, there are.
Two areas that are sort of framed in black here.
And they would be kind of our performance indicators if you will.
How well did the economy do?
This chart reflects the situation from the end of 2007 until 2012, okay?
So it's not the whole crisis, but you know a lot of recovery had
Has gotten under way, at least in, in, in the U.S. by this time.
So the areas that I've marked in black squares are these performance indicators.
How did this economy do from the onset of the crisis until 2012.
We can see at the top GDP, you understand that one very well
by now In GDP we can see how much GDP grew in these countries.
Now it's reflecting, not every year, it's from 2007 until the end.
So that means when you look at the US figure that
the US economy in that whole period only grew 1.4% alright?
The entire period, that's not very much.
For you know, four, five years of history, okay.
So the US grew only 1.4% but if you continue across
that top line, you see the Euro area over this entire period shrinking by 1.7%.
So that's a pretty bad result, again, for that
You know, more than four years of, of history.
The U.K. in that same period shrunk by 3.5%.
So, this is pretty dramatic that in all of these years
you don't not only not manage to grow, but you shrink by 3.5%.
And then we get Japan that shrunk by 2.3% In that period, okay?
So that's GDP that's the growth of the macro economy.
The next line is industrial production, IP
stands for industrial production and this shows
sort of what happened to your manufacturing
sector, or your manufacturing output in this period.
And again you can see In this case, all of them fell.
The whole period where we would normally see growth
every year, all of them fell over this entire period.
But you can see the United States fell only 6.4%.
Look at the following the Euro area, 9.3%.
And the UK, 11.6%.
This is just dramatic.
And Japan's even worse.
12.1%, okay.
So these are falls that are very, very severe
when compared with any other period in recent economic history.
The third line is the CPI.
And we didn't talk very much about inflation in this course,
but the CPI is what we usually use to measure inflation.
And so you can see how much inflation went up again
over the entire period this entire four years, four plus years.
So the CPI in the US rose by 8.5.
The, in the Eurozone exactly the same amount.
Okay.
So we divide that out a couple of percent, a couple of percent a year.
The UK rose by 15.5 now that's a number we want to explain.
Okay, keeping in mind some of our earlier discussions and Japan fell.
Japan experienced deflation, deflation over this period which means
your general price level is falling instead of rising.
Deflation of 1.1%, okay?
Then we have one other result there.
If you skip down a little bit, you can see equity prices.
And that means what happened to your stock market in this period.
You can see it would be a good thing not to own stocks in any
of these places in this period because in
the US, overall the stock market fell 6.3%.
The Euro area fell by 43.7 %.
This is mainly the Euro zone crisis, which caused a lot of.
Shareholders to dump their European shares and leave, go somewhere else.
That actually helped the US figure, right.
So 43.7% decline in the stock market.
Then you can see the UK with a 10.7%
decline, and Japan with a 42% decline, all right.
So really severe You can imagine how this hit wealth.
Remember our discussion of aggregate demand and the wealth effect?
All right, when people's wealth goes down, they're going to consume less.
So, these very large declines will make the crisis longer.
Okay, so those are the performance, that's the performance of the economy.
Let's look now and see what authorities did to try to combat the crisis.
All right?
We're going to start with these dark blue rectangles.
There's two of them there, which is basically monetary policy and
we've talked about all these things so just follow me through here.
The first one is the policy rate.
Now that's when we talked about money market
sets that rate that the central bank is targeting.
In the free financial system, okay?
So, they don't control it directly, but they use the movement of money,
the increase or decrease of the money supply to move that interest rate.
So here you can see that in the United
States, monetary authorities cut the interest rate by 4.1.
Percentage points alright its pretty dramatic.
You can see in the Euro area they didn't cut interest rates as much, its 3% points.
In the UK they cut them even more than in the US 5% points so we can see he
US and the UK leaning heavily on monetary policy, expansive monetary policy.
To try to pull out of the crisis.
In Japan, you can see they only cut interest rates by 0.4 percentage points.
But the fact is, that Japan already came out of a very long crisis.
All right?
And so there was no room to cut rates.
They were already very, very low.
So That explains Japan.
If they could have cut them, they would have, right?
The next line is a 10-year yield.
This also takes us back to an earlier discussion.
You remember in that secondary bond market where the bonds live?
Okay?
That's what happened to their interest rates in that market.
Again, it's not controlled by the Central Bank.
They move up and down as The different bold holders buy or
sell them okay and as the price moves the implicit interest rate moves.
So you can see that 10 year interest rate on bonds
h, fell by 2.2% point in the U.S., 2.5 in the
Euro zone that has to do with the crisis, again people
dumping European bonds because they were afraid they wouldn't get paid.
In the UK it fell by 2.4 percentage points and in
Japan, again, they were so low there wasn't far to go.
0.6 percentage points.
Now the third blue rectangle is also monetary
policy and it's something we haven't explained yet.
So this is sort of looking ahead to our next session.
This third one which is, which appears as a
CB bal sheet, this is Central Bank balance sheet and
this reflects something that we're going to talk about
in the next session which is called quantitative easing, alright?
Remember when we talked about monetary policy and we said sometimes
the transmission mechanism breaks down, authorities Create money and maybe it even
causes the interest rate to fall, but it doesn't get out
to GDP because people don't want to borrow, banks don't want to lend, okay?
Transmission mechanisms breaks down.
We'll talk about this in the next class but what
happens, and what did happen in, in three of these
Areas was the central banks said, okay, I can't get
over here to GDP because my transmission mechanism is broken down.
So what I'm going to do is I'm just going to
create a lot of money and keep buying from banks.
Lots and lots of bonds so that they feel comfortable
and some day, they start lending, and we get to GDP.
Again, we'll define that in the next session.
But this reflects to what extent central banks were doing quantitative using.
Printing extra money.
That's not exactly what it is, but anyway.
Increasing the money supply that reaches banks so that
maybe they will lend and the economy will pick up.
Look at these numbers.
They're quite dramatic in some cases.
In the United States The balance sheet of the Fed.
And we'll define this later, but this just
refers to how much the money supply increased.
The money supply that reached banks increased 222%, 222%
in a period of little more than 4 years.
So, this is a massive expansion of Money in the United States.
In the Euro-zone they say they don't believe in quantitative easing.
But they expanded the balance sheet of the
Central Bank by almost 100% in this period.
So something was going on.
And the UK did this even more than the United States.
233.6% increase in the balance sheet of Central Bank.
So you can see Quantitative easing, as we will define later, is being carried
out by, mainly by the UK, the US, little bit by the Euro area.
And this is sort of a supplement to monetary policy.
Trying hard on the monetary front to expand the economy.
You can see Japan didn't do this.
They let the money supply grow at normal rates 25% over that period.
There's a reason for that which is that Japan had already
done quantitative.easing but anyways we'll talk about that in the next session.
Then the next line the next area which is in green it says real TWI.
This means the real trade-weighted exchange rate, okay?
So, the real trade-weighted exchange rate refers to the value of the currency.
What happened to it in this period, all right?
Now, real trade-weighted, they, they do some adjustments to it.
But, we'll just think about it broadly as
what happened to the value of the currency.
Well, In the United States, the value of the dollar
actually rose against all of the countries that it trades them.
Averaging them by their weight in its trade.
Which is interesting.
With all of that quantitative easing going on, we'll refer back to that.
So, the US didn't get any help from the exchange rate for its recovery.
Remember, A falling value of your currency
will stimulate your economy through more net exports.
U.S. didn't get any help there.
The euro area, thanks to the euro zone crisis,
the euro fell my 10.3 per cent in this period.
So that would help the European economy; that would be expansive.
The pound fell by 14.2 per cent.
So one thing that helped the U.K. Was the falling pound.
That decline in GDP over this period, that 3.5%, would've
been a lot worse if the pound had not fallen.
And then we get the problem in Japan in the final, figure in this line.
the Yen rose by 27 and one half percent.
Okay, so imagine the restrictive effect that, that had on the Japanese economy.
Now, in this course we can't really talk about
why that happened, okay, and
unfortunately, because very interesting issue.
But Japan fights against this.
The rising yen.
In the next session when we talk about abenomics we
can see what they're trying to do to combat it.
Now, there's one other fiscal, there's one other policy to it
we want to refer to here, which is in a light blue.
This is fiscal policy.
And what we have here are just some figures saying when
I take into account changes in taxes, changes in government spending.
How much did fiscal policy add to or subtract from GDP in this period?
Alright.
When I put it all into affect.
How much did it add to or subtract from GDP?
If fiscal policy added to GDP, it would have been expansive.
If it's subtracted it's restrictive okay?
So we look at these four countries or group of countries, groups
of countries, we say that, we see the UK only expanded its
expansive fiscal policy was only equivalent to 1.1% of GDP it did
not use expansive fiscal policy very much just a little bit all right?
The Euro zone, their expansion was equivalent to 1.4% of
GDP, again, remember, this is over more than four years.
They didn't use expansive fiscal very much.
Look at the United States, 4.3% of GDP.
Sig, strong fiscal expansion over this period.
In Japan, 4.9% of GDP.
So you can see the US and Japan leaning Also on fiscal policy to try to pull
the economy out of this deep recessionary gap, the
UK and the Eurozone not using it very much.
So, if we put all of these together, just to sum this up.
What did countries do?
To try to combat this crisis well you can see in the UK they used
monetary policy fairly aggressively expansive monetary policy
not much fiscal afraid of deficit and debt.
The result wasn't great [UNKNOWN] they shrank over
the period You can see the U.S. they used
monetary policy almost as aggressively as the U.K.
between quantitative easing and the cutting of interest rates.
They also used fiscal policy aggressively.
Okay.
Here we are in that zone of the
quadrant where we use expansive fiscal, expansive monetary together.
It gives a big push to the economy and the
U.S. actually managed to grow and come out of the crisis.
Then you can see Japan, alright?
Japan didn't use monetary policy because it
really couldn't; interest rates were already too low.
Couldn't use the exchange rate because it was rising freely by itself.
What did they do?
Lots of expansive fiscal.
It helped, but still they shrank over the period.
And then we look at the Eurozone.
What did they do?
Well, not very much monetary policy, alright?
They were much more conservative than the U.S. and the UK.
Not much fiscal policy because they were worried about deficit and debt.
So, a very timid use Of fiscal and monetary and a pretty bad result in
terms of their growth over the period
and the different performance indicators of the economy.
So I think it's a nice picture to put these different policies
together and think about how governments have used them and what their
real results were and we can see that actually in a crisis
as big as this one Expansive fiscal and expansive monetary policy worked.
[MUSIC]
[BLANK_AUDIO]
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