Changes in Macroeconomic Policies in the U.S.

Effects on Less Developed Countries

Andrea Bubula Ilia State University October 31, 2013

Agenda
The Financial Crisis

Policy Response and Challenges The U.S. Government Debt Ceiling

Effects on Less Developed Countries

The Financial Crisis

GDP = C + +IInvestment +G ++ NX GDP = Consumption Gov
Purchases + Net Exports

C GDP
Contraction in Housing Prices, Wealth, and Credit Availability. Increase in Risk Perception

I GDP

Production

The Propagation of the Financial Crisis

Shocks in Credit Markets GDP Drop in the U.S.
Decline in U.S. Imports

Propagation to the Rest of the World

Major Increase in Unemployment Rate

Drop in Housing Prices

Reduced Labor Mobility

Real GDP Growth Rate

FRA 90-07 1.95 2008 -0.08 GER 1.93 0.80 GRE 2.89 IRE 5.87 ITA 1.49 JAP 1.48 GEO
6.91

ESP 3.14 0.89

U.K 2.81

U.S. 2.91

-0.16 -2.11 -1.16 -1.04

2.31

-0.97 -0.34

2009 -3.15 -5.07 -3.25 -5.46 -5.49 -5.53 -3.78 -3.74 -3.97 -3.07 2010 1.66 2011 1.69 2012 0.12 4.02 3.10 0.94 -3.52 -0.77 -6.91 -6.00 1.43 0.35 1.80 0.43 -2.29 4.53 -0.76 2.22 6.25 7.17 6.12 -0.32 0.42 1.80 0.76 2.40 1.81 2.17

-1.54 -0.38

GDP per Capita at Constant Prices (2000 = 100)

FRA 2008 2009 2010 2011 2012 As in
107.4 103.5 104.7 105.9 105.5

GER
111.4 106.1 110.5 113.9 115.0

GRE
130.0 125.5 120.8 112.4 105.5

IRE
119.0 111.6 110.5 109.3 110.0

ITA
103.0 96.6 97.9 97.9 95.2

JAP

GEO

ESP
112.7 107.7

U.K
116.9 111.5

U.S.
108.7 104.5

108.1 181.2 102.1 174.2 106.8 106.1 108.7

183 107.0 112.7 106.1 195 107.3 112.8 107.3 205 105.3 111.6 108.8 2004 2005 2006

2004

2001 2003 1998 2006

Employment and the Unemployment Rate in the U.S.

12.0 140,000 10.0 138,000 136,000 8.0 134,000 6.0 132,000 4.0 130,000 2.0

128,000

0.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

126,000

unemployment

employed

What Explains the Increase in the Unemployment Rate?

Cyclical Factors

Need for a Stimulus

More Difficult Correction

Structural Factors

Conventional Monetary Policy Instrument

Loans to Banks Fed Liquidity Provision

Federal Funds Rate

Money Market Rate

Long Term Rates

Unconventional Monetary Measures: Quantitative Easing and Forward Guidance

New Types of Loans

Liquidity Provision

Fed
Federal Funds Rate

Money Market Rate

Long Term Rates

Fiscal Policy Response

GOAL: Stimulate Spending, GDP, and Employment INSTRUMENTS: Cut in Taxes and Increase in Government Spending C + I + G + NX GDP POLICY: The American Recovery and Reinvestment Act (2009)

Government Budget Balance: Revenues - Spending

FRA 2008 2009 2010 2011 2012 -3.3 -7.6 -7.1 -5.2 -4.7 GER -0.1 GRE -9.9 IRE -7.3 ITA -2.7 JAP -4.1 GEO -1.98 ESP -4.2 U.K -5.1 U.S. -6.7 -3.2 -15.6 -13.9 -4.1 -10.5 -30.9 -0.8 -0.4 -9.1 -12.8 -7.5 -8.3 -5.4 -10.4 -4.5 -3.8 -2.7 -9.4 -9.8 -10 -6.54 -11.2 -10.4 -13.3 -4.78 -0.87 -0.76 -9.4 -8.9 -7 -9.9 -11.2 -8.5 -10.1 -8.2 -8.7

Government Net Debt

FRA 2008 2009 2010 2011 2012 62 72 76 79 84 GER 50 57 56 55 58 GRE 113 129 145 165 171 IRE 25 42 75 95 103 ITA 89 97 99 100 103 JAP 95 106 113 126 135 GEO 28 37 39 34 32 ESP 31 42 50 57 79 U.K 46 61 71 77 84 U.S. 54 66 73 80 84

Risk of Explosive Dynamics

Debtt n future primary deficits Current Debt (1 interest)n n GDP GDP ( 1 growth ) t n t
Low GDP Growth

High Initial Government Debt

Weak Points:

Foreign Ownership of Debt could Aggravate High Interest Rate Prospective of Uncontrolled Spending Self-Fulfilling Prophecies

Debt Crisis Risk

G T

Deficit Debt

Default Risk

Interest Rates

GDP

3.00

0.00 2005-08-01 2005-11-01 2006-02-01 2006-05-01 2006-08-01 2006-11-01 2007-02-01 2007-05-01 2007-08-01 2007-11-01

1.00

2.00

4.00

5.00

6.00

2008-02-01
2008-05-01 2008-08-01 2008-11-01 2009-02-01 2009-05-01 2009-08-01 2009-11-01 2010-02-01 2010-05-01 2010-08-01 2010-11-01 2011-02-01 2011-05-01 2011-08-01 2011-11-01 2012-02-01 2012-05-01 2012-08-01 2012-11-01 2013-02-01 2013-05-01 2013-08-01

Nominal Rate on 10-Year on U.S. Government Bonds

Why has the U.S. Government Borrowing Rate fallen?

U.S. Government default risk has not increased Monetary Policy in the U.S. has kept interest rates low
Crisis in the Eurozone: U.S. Government Bonds are a safe haven

Effects of lower interest rates in the U.S. on Emerging Markets

Assets from Non-crisis EMs become more attractive Significant Capital Inflows to Emerging Markets

Danger of Capital Inflows: Currency Appreciation Increase the Price of Non-Traded Goods Could lead to Inflation Feed a Real Estate Bubble Makes the EM borrow from abroad

Fiscal Correction in the U.S. : Tax Increases and Government Spending Cuts

To Avoid a Debt Crisis

Need for a Fiscal Correction

Fiscal Policy Challenges (1)

A fiscal correction would GDP in the present, worsening the unemployment situation and even the government default risk

The fiscal correction would cause an increase in saving, investment and GDP in the future

Fiscal Policy Challenges (2)

The fiscal correction cannot be frontloaded

Need a mediumrun trajectory

Reducing policy uncertainty is essential

The U.S. Debt Ceiling Crisis

The Ceiling is not a ratio relative to GDP Unless Congress approves an increase in the ceiling, an automatic mechanism stops expenditures.
The government can only spend what is collected as revenue What expenditures will be prioritized? How about the interest payments on government debt?

Why was the negotiation so difficult?

The aftermath of October 2013

Worries about a rerun in February 2014? What spending to cut? The role of lobbies. Will the $ and U.S. assets lose their hegemony? Threat of ratings downgrade The role on foreign holders of U.S. assets: China and Japan The job of world reserve currency is too big for the U.S. to shoulder alone.

The Costs of the Fiscal Crisis: .6% of GDP

Reputational Costs

Increase in Policy Uncertainty: C and I GDP

Reduction in Consumers Confidence: C GDP

Shutting Down Ports: economic activity GDP

Stopping Export financing and import inspections: GDP

The effects of higher interest rates in the U.S. on Emerging Markets (1)
Scenario 1 (most likely): The risk on U.S. assets does not increase Given that risk-free assets pay more, EM assets become less attractive. Capital outflows from Emerging Markets Could be destabilizing: Depreciated Currency Higher interest rates Less C, I and GDP May 2013: Mini Crises in Brazil, India, Indonesia, South Africa and Turkey

The effects of higher interest rates in the U.S. on Emerging Markets (2)
Scenario 2: the risk on U.S. assets increases somewhat Searching for new risk-free assets Not a significant capital outflows from Emerging Markets

A possible drop in U.S. growth rate will cause a drop in world trade and in world GDP.

The effects of higher interest rates in the U.S. on Emerging Markets (3)
Scenario 3 (least likely): The risk on U.S. assets increases significantly Strong Contraction in U.S. GDP Significant reduction in world trade

Financial Crisis that will reduce the supply of credit globally and may likely cause a capital outflows from Ems.

Conclusion
The U.S. economy is still recovering from the effects of the Financial Crisis. The low interest rates at all maturities indicate an effective monetary policy and the absence of default risk. The increase in U.S. government deficit and U.S. government debt require a fiscal correction.

The Recent Debt Ceiling dispute in the U.S. has caused clear costs and no apparent benefits.
Changes in economic policy in the U.S. have signiificant effects on less developed countries. Gradual changes are valuable