Macroeconomics 2 Assignment 2 Policy Implication Report Therefore, fiscal policy is recommended to both countries despite of unavoidable practical problems in implementation

Macroeconomics Assignment Policy Implication Report Lecturer: Woocheol Lee Course name: Macroeconomics Course code: ECON1266 Team member Word Count: Part A: Abstract The COVID-19 pandemic has spread around the world and caused the worst economic crisis since 1930s depression First, the report will review the relationship between policy effectiveness and slopes of IS - LM curves Theoretically, the expansionary fiscal policy is considered effective with steep IS - flat LM, while the expansionary monetary policy exerts stronger impact on flat IS - steep LM Once theory reviewed, relevant macroeconomic data of Thailand and the UK during October 2019 – June 2020 will be collected and analysed, both determining steep IS - flat LM during the pandemic Therefore, fiscal policy is recommended to both countries despite of unavoidable practical problems in implementation Part B: Theoretical review a) Determinants of slope of IS – LM curves The first determinant of the slope of IS curve is interest elasticity of investment, demonstrating how sensitive investment is to fluctuations in the interest rate (r) The more sensitive the investment, the flatter the IS curve is Another determinant is marginal propensity to consume (MPC) - the proportion of additional income being spent on consumption Higher MPC implies a larger expenditure multiplier, meaning a rise in investment due to falling r will result in a higher income increase, hence IS curve becomes flatter Determinants of the slope of LM curve are the income sensitivity (k) and interest sensitivity (h) of money demand (Md) Md depends on income, as higher income requires larger amount of money for spending The more sensitive Md is to income change, the steeper LM curve Additionally, Md depends on r because the higher r, the more people want to invest their money, thus the lower demand for cash Hence, the more sensitive Md is to r change, the flatter LM curve (Revier 2000) b) Slope of IS-LM curve & Policy Effectiveness  Monetary policy Figure 1: The impact of slope of the LM curve on monetary policy’s effectiveness An expansionary monetary policy, for instance, increases money supply (Ms) and decreases r Both LM and LM2 shift rightward by the same distance LM is steeper than LM2, implying Md at LM1 is less responsive to r change, so r at LM must decline more to balance the increase in Ms with Md Lower borrowing cost encourages more investment (I1>I2), hence the shift of LM generate more output than LM Therefore, the steeper LM is, the more effective monetary policy Figure 2: The impact of slope of the IS curve on monetary policy’s effectiveness IS1 is flat, indicating investment demand at IS is sensitive to the fall in r under the expansionary policy Investment increases greatly in response to the decreasing borrowing cost, leading to a significant rise in Y Meanwhile, IS is steep, meaning investment at IS is not so sensitive, hence the increase in Y is insignificant Therefore, flatter IS makes monetary policy more effective  Fiscal policy Figure 3: The impact of slope of the LM curve on fiscal policy’s effectiveness Expansionary fiscal policy, for example, shifts the IS curve rightward given increasing government spending and tax-cut As Y grows, Md increases, leading to higher r LM is steeper than LM1, implying the Md at LM2 is more responsive to income change, hence the rising Y causes Md and r at LM to increase more than at LM The higher borrowing cost reduces private investment at LM more greatly, so net rise in Y at LM is smaller than at LM1, due to larger crowding-out effect Therefore, fiscal policy is more effective given flatter LM Figure 4: The impact of slope of the IS curve on fiscal policy’s effectiveness As mentioned before, fiscal expansion increases Y and r IS1 is flatter than IS2, so investment demand at IS1 is more responsive to r change than at IS2 At IS1, an increase in r leads to a greater fall in private investment than at IS Hence, net rise in Y at IS is smaller than at IS 2, due to larger crowding-out effect Therefore, fiscal policy is more effective when IS is steep Part C: Slope of IS - LM curve in the United Kingdom and Thailand a) The United Kingdom The United Kingdom Categories Interest rate(%) Oct-19 Nov-19 Dec-19 J an-20 Feb-20 Mar-20 Apr-20 May-20 J un-20 0.75 Nominal GDP (million USD) (current) 0.75 0.75 0.75 0.75 0.25 0.1 0.1 719,270.63 711,057.13 590,325.59 GDP growth (annual %) 1.01 -2.08 -21.46 Householdsconsumption expenditure (million USD) (current) 457,455.13 442,989.86 329,723.71 Grossfixed capital formation (million USD) (current) 128,649.76 126,839.53 98,171.38 Consumer Confidence Index (point) -14 -14 -11 -9 -7 -9 -34 -34 Business ConfidenceIndex (point) -44 23 -87 Household Saving Ratio (%) 7.40 9.10 28.10 0.1 -30 0.99 MPC Money Supply (M2) (bn Pound) 2,419 2,438 2,446 2,458 2,485 2,608 2,647 2,677 2,697 Inflation rateCPI (% monthly) -0.16 -0.13 0.01 0.16 -0.08 -0.10 -2.03 0.01 1.56 Bond Yield 0.64 0.77 0.83 0.72 0.63 0.46 0.36 0.27 0.28 Figure 5: Macroeconomic data of The United Kingdom during Oct 2019 – Jun 2020 Source: BoE 2020, CEIC Data n.d Figure 6: Velocity of Money (M2) during the Covid-19 of the world Source: Fred 2020  Slope of the IS curve Besides long-lasting method and supply chain disruption caused by Covid-19, the British economy also severely suffered no-deal Brexit scenario, which altogether depressed firms’ confidence, indicated by the lowest BCI ever of -87 in the UK (Joanna 2020) Therefore, despite constant ‘r’ at 0.75% in Q1/2020, this negative outlook inevitably caused investment fall sharply by 23.4% in Q1-Q2 2020, implying the left shift of IS during the pandemic Remarkably, even when ‘r’ cut to 0.1% showed its effectiveness in Q3/2020 (BoE 2020) and ideally supported by easing lockdown (Osborne 2020), ‘I’ still could not recovery as expected with still 8% lower than pre-Covid Hence, IS slope is steeper during pandemic since firms still concerned about further restriction and political issues, were reluctant to borrow, thus less sensitive to ‘r’ Figure 7: Slope of the IS curve in the United Kingdom before and during the pandemic  Slope of the LM curve The pandemic created the panic among UK’s households Indeed, people tendentially preferred greater liquidity during uncertain times due to high default rate of other assets (Wright 2012) Evidently, consumers hold 10% more banknotes in March but their spending fell by nearly 30% in April (BoE 2020) even before their income decreased in April lockdown policy In other words, ‘hoarding’ phenomenon occurred in Q1/2020 when people kept hoarding money rather than spending or investing, which led to rising money demand despite unchanged ‘Y’, inferring the left shift of LM curve Noticeably, in Q2/2020, although income increased from strong tax cut, Job Retention and $40Bn Covid-package, consumption still under-performed in Q3/2020 with 12% lower than pre-Covid time Explanatorily, the looming future of further lockdown encourages consumers to save more at 28% saving ratio (Reuters 2020), limiting money demand for transaction Consequently, ‘r’ unchanged with the less sensitive of money demand to income, indicating flatter LM due to Covid-19 Figure 8: Slope of the LM curve in the United Kingdom before and during the pandemic Furthermore, during pandemic, cash provides liquidity for urgent health care and acts as a safe haven for storing value with around 0% inflation deriving from demand shock in the UK (BoE 2020) Therefore, even money supply (M2) increased by 8% from monetary policy, 75% of UK residents still chose cash for value-storing place (BoE 2020) Henceforward, rising money supply has a little effect on ‘r’ of other financial assets, inferring the elastic interest sensitivity for real money and a flatter LM Figure 9: Slope of the Md, which infers LM curve, in the UK before and during the pandemic b) Thailand Thailand Categories Interest rate(%) Oct-19 Nov-19 Dec-19 J an-20 Feb-20 Mar-20 Apr-20 May-20 J un-20 1.5 Nominal GDP (million USD) (current) 1.25 1.25 1.25 1.0 0.8 0.8 0.5 139,540.72 132,026.09 113,455.19 GDP growth (annual %) 1.47 -1.98 -12.14 Householdsconsumption expenditure (million USD) (current) 70,426.30 68,705.35 60,880.23 Grossfixed capital formation (million USD) (current) 31,306.18 28405.052 27,472.73 0.5 Consumer Confidence Index (point) 70.7 69.1 68.3 67.3 64.8 50.3 47.2 48.2 49.2 Business ConfidenceIndex (point) 48.1 47.4 45.1 48.5 44.1 42.6 32.6 34.4 38.5 0.37 MPC Money Supply (M3) (Bn Baht) 20,596 20,707 20,853 20,862 20,932 21,752 22,231 22,490 22,420 Inflation rate (% monthly) -0.20 0.20 0.00 -0.30 0.40 0.00 -0.20 0.00 0.10 Bond Yield (%) 1.56 1.61 1.50 1.30 0.97 1.48 1.21 1.25 1.29 Figure 10: Macroeconomic data of Thailand during Oct 2019 – Jun 2020 Source: Tradingeconomics n.d, CEIC Data n.d  Slope of the IS curve As an intertrade-based economy, Covid-19 also shocked business sentiment in Thailand Therefore, even prior to ‘r’ cut in February, ‘I’ shrank by 12% in first half of 2020 resulted from firms’ pessimistic outlook, indicated by the lowest BCI ever at 32.6 in April (The Nation Thailand 2020) Thus, IS curve shifts left due to falling ‘I’ regardless to ‘r’ impact in early outbreaks Notably, when imposed ‘r’ worked in Q3/2020, ‘I’ rebounded quite well with only 4% lower than pre-Covid period Despite concern of further coronavirus wave and uncertain politics, this good recovery was still recorded, coming from the easing lockdown method in July, which raised BCI to nearly pre-Covid level Therefore, Thai firms are quite ready for further ‘r’ change, inferring a quite steeper IS curve over Covid crisis but relatively flatter than the UK’s case Figure 11: Slope of the IS curve in Thailand before and during the pandemic  Slope of the LM curve Likewise, Thai residents were also panic as a concern of projected million unemployed people during pandemic (Apisitniran 2020) Henceforth, almost all Thais felt financially uncertain during the pandemic, which motivated them to hold more cash even before imposed lockdown policy (WARC 2020) In other words, even their income was unchanged before restriction, high money demand for hoarding leads to the left shift of LM curve during pandemic Moreover, although their income raised from $64Bn stimulus package, consumers still spent 4% less than pre-Covid level when 72% of young Thais spent less (WARC 2020) In fact, instead of spending, Thais household used additional income for paying private debt, raised from struggling affordability during no-income lockdown period Evidently, their private debt raised dramatically, contributing to nearly 83% of Thais GDP in Q2/2020 (Reuters 2020) So, Thai money demand for transactions is extremely insensitive to interest rate when their priority is paying debt rather than spending, hence making LM curve flatter Figure 12: Slope of the LM curve in Thailand before and during the pandemic Additionally, cash holding raised from 30% to 40% in Thai portfolio during Covid-19 due to uncertainty and preferred liquidity Conversely, with high default rate, Thais tendentially escaped other financial assets, leading to a decrease in bond price (Phoonphongphiphat 2020) and the worst-performance Asian stock market (Preiss 2020) Therefore, with the 10% higher money supply (M3) in monetary policy, Thais residents still hoarded cash or, ideally, gold (evidently gold price hit all-time high recently (Yuvejwattana 2020)), rather than investing in low-demand financial assets, hence less impacting interest rate Hence, the money demand curve is elastic during pandemic, so, the flatter LM curve Figure 13: Slope of the Md, which infers LM curve, in Thailand before and during the pandemic Part D: Policy recommendations and Expected Outcomes As proven theory, given steep IS flat LM curves in the two nations, fiscal policy implementation is more effective Indeed, the impact of monetary policy is significantly hampered by low business confidence and credit crunch amid the pandemic (BoE 2020) Besides, monetary policy is considered unable to eliminate effective demand shortfalls due to dispersed economic losses across sectors (Woodford 2020) (a) Expansionary monetary policy (b) Expansionary fiscal policy Figure 14: Comparison of effectiveness of expansionary monetary and fiscal policy given steep IS – flat LM curve in the United Kingdom (a) Expansionary monetary policy (b) Expansionary fiscal policy Figure 15: Comparison of effectiveness of expansionary monetary and fiscal policy given steep IS – flat LM curve in Thailand a) The United Kingdom The direct cost of fiscal policy since March is estimated at £184bn, including £66bn of grants and loans for businesses (Fitch Ratings 2020) With lower tax and more jobs created by public projects, households have greater purchasing power which fuels higher demand and consumption Firms earn greater after-tax profit, encouraged to invest Consequently, given flat LM curve, IS curve shifts rightward, making output increase greatly despite minor change in r Crowding-out effect is limited as people tendentially save more during recession, meaning more loanable fund available (Economics Online n.d.) Expansionary monetary policy also helps maintain low interest rates Even fiscal policy has difficulties in recovering aggregate demand to pre-pandemic level due to smaller multiplier given low consumer and business confidence (Woolford 2020) Although being supported by tax-relief and transfer payments, consumers and firms tendentially save and focus on deleveraging, preparing for future tax changes raised by budget deficit and no-deal Brexit outcome (Reuters 2020; Fraser 2020) Policy lag could also dampen the impact of fiscal policy Altogether, fiscal policy is recommended for the UK, especially when its fiscal policy announced targeted at providing sectoral-level intervention (Dalton & Pope 2020) b) Thailand Thai fiscal policy included a fiscal package of THB 1.5 trillion (IMF 2020) Tax reduction and tax deadline extension were imposed, decreasing Thai government revenue (KPMG 2020), despite 4% higher in government expenditure to $105.6bn (Techakitteranun 2020) The policy aimed to encourage consumption and investment, thus stimulating aggregate demand According to part B, a steep IS flat LM framework will lead to a great leap in real income with minor change in r Crowding-out effect would be limited, similarly to the UK Noticeably, fiscal policy would be less effective in Thailand than in the UK Indeed, Thai IS curve is flatter given higher business confidence, which rebounded since May (Figure 10) Besides, as a developing country, Thailand’s economic potential is weaker than the UK, thus the over-usage of fiscal policy could be a burden on government budget As of September 2020, Thailand is facing an all-time high government debt at 42,3% of GDP (CEIC Data n.d.) Lack of transparency in public spending is another hindrance (Promchertchoo 2020) Nonetheless, Thai IS curve is still remarkably steeper than pre-pandemic Moreover, Thai government debt is not yet alarming compared to the world's government debt which hovers at around 100% (Villers 2020) Overall, based on theory and the situation of Thai economy, fiscal policy is suggested Despite some challenges and the hampered effect compared to the UK, the benefits of fiscal policy outweigh its difficulties and it is believed to boost Thailand's economy Part E: Conclusion In conclusion, theoretically, steep IS and flat LM is ideal for applying fiscal policy while monetary policy is suitable given flat IS steep LM curves In the UK and Thailand, macroeconomic data proved that Covid-19 shifts both curves to the lefts and simultaneously made IS steeper but LM flatter, whereas Thai model has flatter IS and LM Therefore, expansionary fiscal policy is recommended for both nations to stimulate investment and consumption, thus aggregate demand Moreover, low interest elasticity of investment also discourages the crowding-out effect, enhancing its effectiveness However, the optimal impact can be hindered as consumers and firms probably save more and prepare for future tax changes, not mention to the policy lag Part F: References Apisitniran, L 2020, ‘Federation of Thai Industries says unemployment could hit 8m’, Bangkok Post, viewed January 2021, BoE 2020, Coronavirus, Bank of England, November, England, November, England, BoE 2020, Coronavirus, Bank of England, BoE 2020, Interest rate and Bank Rate, Bank of England, November, England, BoE 2020, Monetary Policy Summary and minutes of the Monetary Policy Committee meeting ending on November 2020, Bank of England, November, England BoE 2020, Monetary policy summary for the special monetary policy committee meeting on 19 March 2020, Bank of England, November, England CEIC Data n.d., Thailand Government Debt: % of GDP, CEIC Data, viewed 14 December 2020, CEIC Data n.d., Thailand, CEIC data, viewed 13 December 2020, CEIC Data n.d., United Kingdom, CEIC data, viewed 13 December 2020, Dalton, G & Pope, T 2020, ‘The government’s post-Covid 19 stimulus package’, Institute for 15 Government, July, viewed 10 December 2020, Economics Online n.d., ‘Fiscal Multipliers’, Economics Online, viewed 10 December 2020, Fitch Ratings 2020, ‘UK Coronavirus Measures Add to Fiscal Cost, Consolidation Plan to Come’, Ratings, Fitch 10 July, viewed 10 December 2020, Fraser, D 2020, ‘One month to Brexit: Counting the cost of ‘no deal’’, BBC, 29 November, viewed January 2021, Fred 2020, Velocity of M2 Money Stock, Fred Economic Data, viewed January 2020, IMF 2020, Policy Responses to Covid-19 , International Monetary Fund, viewed 13 December 2020, Joanna, P 2020, ‘UK business confidence at all-time low, Deloitte report reveals’, The Guardian, May, viewed 31 December 2020, KPMG 2020, Thailand, KPMG, viewed 13 December 2020, Medina, AF 2020, ‘Thailand Issues Third COVID-19 Stimulus Package’, ASEAN Briefing, 23 April, viewed 13 December 2020, Osborne, H 2020, ‘Coronavirus lockdown eased: what you can and can't from July’, The Guardian, 24 June, viewed January 2020, Partridge, J 2020, ‘UK business confidence at all-time low, Deloitte report reveals’, The Guardian, May, viewed 13 December 2020, Phoonphongphiphat, A 2020, ‘Cash crunch fears rise in Thai corporate bond market on pandemic’, Nikkei Asia, June, viewed January 2021, Preiss, R M 2020, ‘Thai Stocks Unlikely To Recover From Coronavirus Anytime Soon’, Forbes, 12 March, viewed January 2021, Promchertchoo ,P 2020, ‘Calls for more transparency in public spending as Thailand pledges US$61 billion to fight COVID-19’, CNA, 12 June, viewed January 2021, Reuters 2020, ‘Thai Q3 household debt surges to 86.6% of GDP as economy contracts’, 30 Reuters, December, viewed January 2021, Reuters 2020, ‘UK consumer sentiment falls by most since start of pandemic’, Reuters, 23 October, viewed 13 December 2020, Revier, CF 2000, “Policy Effectiveness and the Slopes of "IS" and "LM" Curves: A Graphical Analysis”, The Journal of Economic Education , vol 31, no 4, pp 374-381, viewed 10 December 2020, Techakitteranun, H 2020, ‘Thai House passes 3.2 trillion baht budget - its biggest ever’, The Straits Times, 11 January, viewed 13 December 2020, The Irish Times 2020, ‘Asia’s wealthy prepare to take advantage of post-pandemic market opportunities', The Irish Times, 25 September, viewed 13 December 2020, The Nation Thailand 2020, ‘Thailand’s business confidence index plummets’, The Nation Thailand, viewed January 2021, Tradingeconomics n.d., Thailand, Office for National Statistic, viewed 13 December 2020, Tradingeconomics n.d., United Kingdom, Office for National Statistic, viewed 13 December 2020, Villiers, S 2020, The World in Debt, Atlantic Counci, viewed 14 December 2020, WARC 2020, ‘Pandemic highlights Thailand’s generational differences’, WARC, September, viewed January 2021, Woodford, M 2020, ‘Effective demand failures and the limits of monetary stabilization policy’, National Bureau of Economic Research, September, Cambridge, Massachusetts, United States Wright, RE 2012, Money and Banking, Saylor Foundation, New York, USA Yuvejwattana, S 2020, ‘Thais Dipping Into Gold Savings Muddle Steps to Rein in Baht’, Bloomberg, 29 December, viewed January 2021,  ... 49 .2 Business ConfidenceIndex (point) 48.1 47.4 45.1 48.5 44.1 42. 6 32. 6 34.4 38.5 0.37 MPC Money Supply (M3) (Bn Baht) 20 ,596 20 ,707 20 ,853 20 ,8 62 20,9 32 21,7 52 22, 231 22 ,490 22 , 420 Inflation... gdp#:~:text=Thailand %20 Government %20 Debt%3A %20 %25 %20 of %20 GDP,1997 %20 %2D %20 2 020 %20 %7C %20 Quarterly&text=Thailand %20 Government %20 debt %20 accounted %20 for,39 .2% 20 %25 %20 in %20 the %20 previous %20 quarter.&text=Thailand %20 National %20 Government %20 Debt %20 reached,USD %20 bn %20 in %20 Sep %20 2 020 .> CEIC Data... June 20 20 will be collected and analysed, both determining steep IS - flat LM during the pandemic Therefore, fiscal policy is recommended to both countries despite of unavoidable practical problems