Analysis of Historical Scenarios Using IS-LM-BP
Argentina, 2001
Macroeconomic Facts:
§ Argentina, prior to 2001 was an open economy with liberalized capital markets. Capital mobility was high, but not perfect.
§ In order to limit inflation growth, Argentina pegged in 1991 its currency to the US dollar (recall: PPP theory, ER (Peso/US$) = (P Argentina / P USA)
§ As a result of the East Asian crisis of 1998, foreign investment diminished. Economic activity began to contract. [recessionary gap opens]
§ Lack of foreign investment funds precipitated a banking crisis.
§ As the US dollar gained value after 1998 as a “refuge currency” so did the Peso. The Current Account deteriorated. [BP deficit gap opens]
Macroeconomic Policy Options:
§ Use of expansionary monetary policy:
§ Use of expansionary fiscal policy:
§ Devaluation of Peso:
Policy Option #1- Monetary Policy / Policy Option #2- Fiscal PolicyActual Turn of Events- Currency Devaluation
Japan, 1990s
Macroeconomic Facts:
§ Japan, throughout the 1990s was an open economy with liberalized capital markets. Capital mobility was high, but not perfect.
§ Japan, since 1971, has maintained a system of flexible exchange rates.
§ Due to a combination of financial reasons, Japan has experienced a large economic contraction during the 1990s. [recessionary gap opens]
§ The Japanese industry, traditionally successful, has given the country a positive Current Account balance. [BP surplus gap opens]
Macroeconomic Policy Options:
§ Use of expansionary fiscal policy:
§ Use of expansionary monetary policy:
§ Devaluation of Yen:
Policy Option #1- Fiscal Policy / Policy Option #2- Monetary Policy
Great Britain and the European Monetary System, 1992
Macroeconomic Facts:
§ Germany and Great Britain, as members of the European Economic Community had perfect capital mobility with other EEC members.
§ Germany and Great Britain were also members, among other countries, of the European Monetary System. As such, their exchange rates were fixed.
§ West and East Germany unified in 1991 and the new Germany experienced inflationary pressures that required the use of contractionary monetary policy.
§ GB experienced large capital outflows and, simultaneously, a cyclical slowdown [recessionary gap opens]
§ The fast economic German growth favored British exports [BP surplus gap opens] and put devaluating pressure on the British Pound.
Macroeconomic Policy Options:
§ Use of expansionary monetary policy:
§ Use of expansionary fiscal policy:
§ Defense of the EMS:
Policy Option #1- Monetary Policy / Policy Option #2- Fiscal PolicyActual Turn of Events- Abandoning EMS
United States of America, early XXI Century
Macroeconomic Facts:
§ The United States, throughout the 1990s was an open economy with liberalized capital markets. Capital mobility was very high, almost perfect.
§ The United States, since 1973, has maintained a system of flexible exchange rates.
§ Due to a combination of demand factors, the USA experienced a mild but prolonged economic contraction during the early 2000s. [recessionary gap opens]
§ Increased international competition and industrial outsourcing has given the country a constantly growing negative Current Account balance. [BP deficit gap opens]
Macroeconomic Policy Options:
§ Use of expansionary fiscal policy:
§ Use of expansionary monetary policy:
§ Devaluation of US dollar:
Policy Option #1- Fiscal Policy / Policy Option #2- Monetary PolicyAll information obtained from “Recessions and Depressions” by T.A. Knoop, Praeger, 2004.