Global Economy Mechanisms PDF

Global economy mechanisms Fiscal policy, deficits and government debt Structure of the lecture q Budgets and fiscal policy qMeaning and history of government debt q Causes of debts q Sources of external finance q Global debt trends q Deb...

Global economy mechanisms Fiscal policy, deficits and government debt Structure of the lecture q Budgets and fiscal policy qMeaning and history of government debt q Causes of debts q Sources of external finance q Global debt trends q Debt crisis: Lessons and prospects  Fiscal policy, debt and deficits Monetary policy Output Aggregate demand Fiscal policy and Debt Interaction of AS and Employment AD Aggregate Capital supply Price and stock Inflation Source: Samuelson, P., Nordhaus, W., 2010 , ECONOMICS Nineteenth Edition, pp. 384.  Meaning and history of government debt v Public or government debt – v The total debt vs. the net debt accumulated borrowed amounts to v Net debt - is owned by households, banks, finance budget deficits. businesses, foreigners, and other nonfederal v External vs. Internal debt entities; v Internal debt – its own by a nation v The gross debt - equals the net debt plus to its own citizens. bonds owned by the government v External debt – owned by a nation to foreigners, involve a net subtraction from the goods and services available to people in the debtor nation. Source: Samuelson, P., Nordhaus, W., 2010 , ECONOMICS Nineteenth Edition, pp. 401.  Budgets and fiscal policy Debt vs. deficit You can remember the difference as follows: Debt is water in the tub, while a deficit is water flowing into the tub. The government debt is the stock of liabilities of the government. The deficit is a flow of new debt incurred when the government spends more than it raises in taxes. For example, when the government ran a deficit of $640 billion in 2008, it added that amount to the stock of government debt. By contrast, when the government enjoyed a surplus of $200 billion in 2000, this reduced the government debt by that amount. Source: Samuelson, P., Nordhaus, W., 2010 , ECONOMICS Nineteenth Edition, pp. 384.  Automatic vs. Discretionary policy Discretionary policy – occur when policymakers carefully watch trends, forecast future developments and change policies when the economy is not performing in a satisfying manner. Public works Public employment projects Variation of tax rates Automatic stabilizers – Unemployment insurance, welfare and other transfers Automatic changes in tax receipts. Source: Samuelson, P., Nordhaus, W., 2010 , ECONOMICS Nineteenth Edition, pp. 385.  Activity Think about automatic and discretionary stabilizers. What would be your preferred discretionary stabilizers for fighting inflation? For fighting recession? Which discretionary stabilizers seem least useful? Why?  Actual, Structural, and Cyclical Budgets The cyclical budget is the difference between the actual The structural budget budget and the structural The actual budget records the calculates what government budget. It measures the impact actual dollar, Euro, lei revenues, expenditures, and of the business cycle on the expenditures, revenues, and deficits would be if the budget, taking into account the deficits in a given period. economy were operating at effect of the cycle on potential output. revenues, expenditures, and the deficit. Source: Samuelson, P., Nordhaus, W., 2010 , ECONOMICS Nineteenth Edition, pp. 389.  Activity Recall the definition of the structural and cyclical deficits. For each of the following, analyze the effects on the actual, structural and cyclical deficits: a. A permanent tax cut b. An increase in exports c. A tightening of monetary policy  Borrow now, tax later Should government spending be financed by borrowing or taxation? If the increase If the taxes now… government borrows now… People will know People will have that they will pay to pay more tax. more tax later to It makes no difference repay the debt whether the government choses to tax now, or Source: Kishtainy, N., (2015), ”The Economics Book, Dorling Kindersley ”borrow now, tax later” Limited.  Structural vs. Cyclical deficits For example during a recession, every percentage-point increase in the unemployment rate raises government spending and decrease tax revenues by a total of about $40 billion as of 1989 for the case of US. This increase in the deficit – in the cyclical deficit – comes as unemployment insurance increase, as welfare payments rise and as tax revenues fall. Source: Samuelson, P., Nordhaus, W., 2010 , ECONOMICS Nineteenth Edition, pp. 389.  Applications of Cyclical and Structural budgets ”The deficit is up, therefore the government is stimulating the economy”. If the higher deficit came because the government cut tax rates or raised defense spending, this would indeed tend to increase aggregate demand. On the other hand, if the budget deficit increased because of an economic downturns, then the higher actual deficit would not be a sign of expansion. Source: Samuelson, P., Nordhaus, W., 2010 , ECONOMICS Nineteenth Edition, pp. 389.  Causes of debts The savings gap – poorer countries are unable to save enough to finance the level of investments necessary for self-sustained growth. Overseas borrowing can fill this savings gap by providing resources that domestic savers are unable or unwilling to sacrifice. q The forex gap – for many developing countries, the investments that are crucial economic development requires foreign rather than domestically produced, equipment and expertise. If exports are insufficient to earn forex necessary to finance this investment, overseas borrowing may be the only means of gaining access to the technology vital for rapid growth.  Sources of external finance q Bank loans qOfficial loans q Bond finance qForeign direct investments qDuring the 70s, qExternal financing is qThe acquisition of local qIn the period before 1939, commercial bank available from several capital, investment in the governments of lending to sovereign different types of public equipment is an important developing countries relied governments rose sector organization, source of external finances. heavily on the sale of fixed- very sharply. including multilateral In the eighteenth and interest bonds to foreign development banks like nineteenth centuries, North citizens and financial the World Bank, The IMF, America and Commonwealth relied institutions. The European Bank for heavily on FDI from Reconstruction and Europe. Development.  Debt crisis: Lessons and prospects 1980: Latin America q ”International debt crisis” – first introduced on 13 August 1983 when Mexico unilaterally announced that it could no longer service its $80 billion external debt. q The international debt crisis was initially a banking crisis. q At the beginning of the 80's many countries from Latin America, including Brazil, Argentina and Mexico, borrowed massive amounts of money from the international creditors in order to finance the industrialization process and the infrastructural programs. q The growth rates that were experienced by these economies in that period triggered the interest of the foreign creditors. The total amount of the international loans, increased the value of the external debt from 75 billion USD in 1975 to 315 billion USD in 1983, almost 50% of the GDP. q Between 70s and 80s when the global market reached the recession period and the price of petroleum increased, the emerging countries faced a severe crisis of liquidities. q The oil exporting countries that benefit from the increase of the price of oil between 1973 and 1974 invested their liquidities in the accounts of the international banks. q These banks directed a massive percent of this capital as loans for the Latin-American governments q As a response to this crisis, the majority of the states based their strategy of industrialization on exports.  Debt crisis: Lessons and prospects 1994: the economic crisis from Mexico q Known as the ”peso crisis” was triggered by the depreciation of the Mexican currency against the US dollar; q Started during the presidency of Ernesto Zedill. The crisis is known in the history as the ”el error de diciembrie” and the effect on the southern part was named the Tequila effect. q The depreciation of the Mexican peso highlighted the fragility of the Mexican economy that was based in a high proportion on speculative financing of the budgetary deficits. The country risk of Mexico was increasing due to some military instability and the FDI decreased. q The US gave Mexico financial assistance of 50 trillion USD, but at the end of the crisis the total gain of US was of 500 billion USD.  Debt crisis: Lessons and prospects 1997-1998: The Asian financial crisis q Started in July 1997. Just a decade prior to this date, The South-East states of Asia, namely Thailand, Singapore, Indonesia, Hong-Kong and South-Correa registered one of the most impressive growth rates in the world. q The starting point of the crisis was in Thailand and began with the depreciation of the Thai baht against the US dollar. At that time, Thailand was confronting with high levels of the external debt, caused by the real estate sector. q The national currency of all the states of the Asian Tigers registered massive depreciations. q The external debt of the ASEAN economies increased between 1993 and 1996 from 100% of the GDP to 167% of the GDP, reaching the maximum level of 180% of the GDP. q The solid fiscal policy programs along with the intervention of the IMF that allocated almost 40 billion USD managed to stabilize the national currency of the most affected states, Thailand, Indonesia and South Correa.  Debt crisis: Lessons and prospects 1998: The Russian financial crisis q Known as the Rubble crisis – began on 17th of July 1998, as an effect of the Asian crisis a year before; q A major cause of this crisis was a decrease in the price of the raw materials on the international markets. q 80% of the Russian export was constituted by oil, metals and natural gases. q The main cause invoked was not the decline in the oil price, but the non-payment by the state of the taxes for the energetic industry. q All these generated massive depreciation of the national currency along with productivity decrease and a chronically fiscal deficit. q Inflation reached the threshold of 84 %, the prices of food almost doubled and the prices of imported goods increased almost 4 times than the initial value. q IMF and the World Bank allocated almost 22, 6 billion USD for the reconstruction of the economy. q The rapid recovery of Russia was determined by the increase of the oil price on the international crisis in the following years (1999-2000).  Debt crisis: Lessons and prospects 1999-2002: The Argentine economic crisis q Began with a severe decrease in the GDP rates starting 1999. q Since 1998, Argentine confronted with high rates of unemployment and poverty. q The economic recession Argentina faced at the end of the 90s were a results of a continuous period of instability starting with the military dictatorship between 1976-1983; the disasters generated by the war from Falkland in 1982 and the hyperinflation from 1989. Along this the political instability as well as the level of corruption were reaching unexpected levels. q What accentuated the Argentine crisis was the refusal of IMF to pay a loan of 1,3 billion USD, that lead to violent protest. q The new government accused IMF of inadvertency in providing supportive policies and publishing a set of reports not in line with the reality. At the beginning of 2006, Argentina managed to pay the costs of debt to IMF, by obtaining a loan from the Central bank of Argentine even if the interest rates were double that in the case of IMF (9%).  Debt crisis: Lessons and prospects 2009-2011: Greece q As recently as 1990, the Greek state controlled about 75% of all business assets in the country and tightly regulated other sectors of the economy. The state reduced its stake to about 50% by 2008. q In the decade before the crisis, a significant portion of rising government expenditures was allocated to rising public sector wages and benefits. As recently as 2009, Greek government expenditures accounted for 50% of GDP, with 75% of (non-interest) public spending going to public sector wages and social benefits. q Starting in 2009, investor confidence in Greece’s ability to service its debt dropped significantly. The global financial crisis of 2008-2009 and the related economic downturn strained the public finances of many advanced economies, including Greece, as government spending on programs, such unemployment benefits, increased and tax revenues weakened. Greece’s reported public debt rose from 106% of GDP in 2006 to 126% of GDP in 2009. q The new government revised the estimate of 2009 budget deficit from 6.7% of GDP to 12.7% of GDP. Source: Nelson, R. et all (2010), ” Greece’s Debt Crisis: Overview, Policy Responses, and Implications ”, Congressional Research Service, available at: https://fas.org/sgp/crs/row/R41167.pdf  Debt crisis: Lessons and prospects q As investors became increasingly nervous that the Greek government’s debt was too high, and that it would default on its debt, they started demanding higher interest rates for buying and holding Greek bonds. Higher interest rates compensated investors for the higher risk involved in holding Greek government bonds, but they also drove up Greece’s borrowing costs, exacerbated its debt levels, and caused Greece to veer towards default. q In May 2010, Eurozone leaders and the IMF announced a three-year package of €110 billion (about $158 billion) in loans to Greece at market-based interest rates. q An austerity program outlined in May 2010 aimed to reduce the government’s budget deficit by 11 percentage points through 2013. q The program’s immediate objectives were a deep cut to public spending and enhanced revenue growth through tax increases and a crack-down on tax evasion. Most spending cuts have been to the civil service, including a reduction or freeze on civil service compensation and a civil service hiring freeze. On the revenue side, the government raised the average value-added tax rate and increased taxes on certain commodities (fuel, tobacco, and alcohol). Source: Nelson, R. et all (2010), ” Greece’s Debt Crisis: Overview, Policy Responses, and Implications ”, Congressional Research Service, available at: https://fas.org/sgp/crs/row/R41167.pdf Questions/Suggestions Thank you, see you next session...