A Comparison of Performance of G7 Countries Since Credit Crunch - Essay Example

Performance of G7 countries since Credit Crunch: A comparison Introduction There has been some kind of competition in all the G7 countries since the global experience of a credit crunch in 2007. The performance on the recovery path has been different among members of the G7 group as monitored. This paper is about a comparison in this performance and use of the Dynamic Aggregate Demand and the Dynamic Aggregate Supply model to explain the different growths in the G7 members. Comparison and Contextualisation During the financial melt-down hat was experienced most all the G7 members experienced massive losses in their economies. These losses ran into billions of dollars per year. The results were evidenced in the forms of reduce activity in the stock market and collapse of financial institutions. This caused massive job losses and it had a direct impact on the price of goods. Prices of most commodities went up due to economic effects of cost in production and unavailability of capital which had an inflationary effect on the country’s economy (Buttet & Roy, 2014). Since the occurrence of the credit crunch, countries have been on different recovery paths that have been determined greatly by the policies and financial strategies laid by their leaderships. Since the main focus of this paper is to compare the different growths, the paper shall also look into how the DAD-DAS model has been applied and how it has or has not worked in both the best performing country and the worst performing country in the G7 group (Chiarella et al, 2013). The information available indicates Britain to be the best performing G7 country with a GDP growth rate of 2.6% compared to the United States of America whose GDP growth rate comes second at 2.4% per year. The economic performance in Britain has been attributed to improved consumer confidence, stabilisation of interest rates and reduced inflation rates in the country. Other G7 countries such as Germany, France, Canada, Japan and Italy have recorded low growth rates which have also been attributed to a slow growth in consumer confidence and high inflation rates (Ghosh & Ghosh, 2012). There exists several relationships that make up the DAD-DAS model and they are inflation, interest rates, demand shocks and supply shocks. These are based on the thinking that if there is an expectation of inflation then it will definitely occur. This means that if a population expects inflation to be at a certain level at a particular point in time, then inflation will possibly occur even without the causative effects from other factors. The second reasoning is that excess demand will most likely cause inflation because there will be a situation of more money chasing after scarce goods (Chiarella, 2011). This has the effect of increasing the prices of commodities which consequently affect the economic performance of a country. This same situation occurs for credit. A credit crunch is a situation where there is unavailability of credit that can be used to improve a country’s production levels and subsequently, its Gross Domestic Product. When there is a high demand for credit, the laws of demand and supply come in. the result is an increase in interest rates which is a representative of cost of credit. The different approaches to be used for this paper will be based on the DAD-DAS model and will include analysing the key aspects in the model and applying them to G7 countries economic performances. Different Approaches. The first approach will involve use of interest rates to control a country’s growth rate. Britain has really succeeded in providing credit to investors at friendly interest rates. This has been included in their legislation and even economic policies. A country’s GDP majorly depends on the amounts of goods and services that the country is able to produce. Output is directly related to investment levels which are dependent on interest rates. Availability of credit in Britain has given boost to the production sector thus increasing supply levels. Optimal supply levels have ensured that there is price stabilisation. Stable prices assist in keeping inflation on check and also helps in building consumer confidence in the country’s products. Consumer confidence greatly assists in market stabilisation. This approach of using interest rates to control output has been applied in Britain with a lot of success and has contributed towards making Britain one of the best performing G7 countries since the economic melt-down in 2007. Economic projections indicate that the recorded growth rate of 2.6% could increase to over 4% by the end of year as there is increased employment and increased output by the production sectors (Buttet & Roy, 2011). The second approach to this model involves cost of production. Japan has been ranked as the most poorly performing economy in the G7. The main cause of this has been the high costs of production which are combined by inflation effects. The previously high fuel prices had a negative effect on production. Fuel is a basic raw material or utility cost in most manufacturing and production centres. High fuel process had caused major upsets and shocks in the oil industry. Industry commentators had been giving indications of further prices increases on petroleum products. Later, this caused an inflation in prices as a result of expected inflation. High costs of production in Japan were also caused by high borrowing interest rates. Investors who sought for credit had to pay higher interests and this cost was transferred to the consumer. This caused a shoot in price of commodities which had a subsequent inflationary effect. Currently, the growth rate of Japan’s economy is at 0.1%. This is minimal growth compared to the over 8.9% drop in prices of fuel. This reduction has come with benefits such as reducing household expenditure but it has its disadvantages as well. Price reductions and reduced interest rates would have the effect of making debts more expensive and therefore harder to pay back. The speculative nature of human’s wold also compound the negative impact of reduced prices as some households would hold their expenditures in anticipation of further price falls. The third approach involves the supply function of the DAD-DAS model. Supply is a force dependent on demand and consequently he price. From the law of demand and supply, when the prices of a commodity goes up, supply increase as supplier want to cash-in on the existing high prices. This situation cause entry of more suppliers who the make the commodity readily available and then its price falls. This is the same situation that plays out in the stock and credit markets. A credit crunch causes interest rates to shoot upwards and this cause a decreased credit consumers. The high interest rates attract a lot of credit providers and the end effect is availability of credit that later causes a fall in interest rates. Britain has experienced a steady supply of credit which has been favoured by a stabilising credit market. The increased supply of credit in Britain has enabled investors as well as producers to expand as well as create jobs and reduce unemployment levels. The result of this is increased production and an increase in the overall country’s productivity. Japan has had the problem of unavailability of capital suppliers. The resulting situation has caused a major upset in the stock industry as interest rates have remained high. This situation has suppressed the production sector as well as the economic performance of the country. Policies to reduce government expenditure have not yielded much efforts as they have been rendered as weak measures by the existing market forces. The aforementioned approaches can be used to improve performance of the G7 countries. G7 countries have large economies and because of this, they are prone to effects of market forces and market shocks. One of the major price shocks that affect such large economies are petroleum price market shocks. These economies are huge consumers of petroleum energy and price changes have relatively high impacts on their production capacities and subsequently their Gross Domestic Product. In the DAD-DAS model, there exists an opposite relationship between interest rate and output levels. Thus the economy can be controlled from an interest rate perspective so as to give boost to the desired sectors for faster and higher economic growth. However, it is important to note that the results of any action in DAD-DAS model will have its results in the short term period. Thus most of the perspectives in this model are short term in nature. This means that the long-term effects are to be determined by the efficiency of these measure such that their short term effects will prolong into the future. The efficiency of actions in this model are highly dependent on the available structure for their implementation. This will involve legislation and policy formulations that will ensure the benefits from such models are prolonged into the future and that they are sustained economically. Interest Rates Solution The G7 countries can use a proposed solution of using interest rate to control credit market as well output levels. From the DAD-DAS equation relationship, Yt = Yt - a( r-p) + Et , (Alpanda et al, 2011) a country’s central bank can regulate the interest rates so as to create a favourable credit market. This equation can as well be used to regulate output levels. When the output levels deviate from their targets, the central bank can either reduce or increase the rate of borrowing. This will have the effect of either reducing or increasing the level of output due to availability or scarcity of money for investment purposes. Interest rates can also be used to regulate inflation. If a country’s inflation deviates from the desired level, then the central bank can adjust the borrowing rates to cater for the deviation. High inflation rates are unfavourable for economic growth as it was observed in Japan after the credit crunch period. High inflation sometimes occurs as an effect of credit crunch where there is a lot of money in circulation. High inflation causes a movement along the DAD curve.The corrective measure in such situations would involve a clean-up process so that excess money is collected and reserved by the government. This would include increased government borrowing, increased taxation and reduced government spending. These actions would have their negative effects on a growing economy and thus not favourable in the short term. This leaves the option of central banks increasing the borrowing rates so that less money goes into circulation in form of loans and other forms of credit. In an economy with strong financial policies such as Britain, the nominal rate would be approximately equal but in other G7 economies such as Japan, the nominal rate is determined by the central bank while the actual interest rate is determined by forces of demand and supply, as in the DAD-DAS model. Limitations of Model solution Central banks’ interest rate regulation does not have maximum control over the levels of output and inflation rates. The DAD curve has a negative slope while the DAS curve has a positive slope. Their point of intersection determines the level of output as well as the rate of inflation. These two are determined by shifts of both curves and movements along both curves. This phenomena gives evidence that both interest rate and output levels are still significantly determined by market forces. This model does not easily give the elasticity of interest rate and output levels to each other. When Britain reduced its interest rate so as to boost output and improve the country’s GDP, there was not an accurate measure of the degree of response of output to the change in interest rate. Output’s elasticity to interest rates is a measure that can be used to evaluate the effectiveness of interest rates on regulation and improvement of GDP. Perspective significance and Proposers Interest based approach has been used widely in different economic sectors for regulation and improvement purposes. However, it can find more use among the G7 countries which are still struggling to gain their foot after the recent credit crunch. Use of interest rates can be incorporated in fiscal and monetary policies as they have proved to be effective in increasing output levels and thereby boosting a country’s economic performance. Interest rates also have some flexibility of use as they can be used to achieve either short-term or long-term results. Interest rate solutions can be proposed by financial planners, economic policy makers as well as the managements of different governmental bodies. References Alpanda, S., Honig, A., & Woglom, G. R., 2011. Extending the textbook dynamic AD-AS framework with flexible inflation expectations, optimal policy response to demand changes, and the zero-bound on the nominal interest rate. Optimal Policy Response to Demand Changes, and the Zero-Bound on the Nominal Interest Rate. Asada, T., Chiarella, C., Flaschel, P., & Franke, R. (2012). Monetary macrodynamics (Vol. 127). London: Routledge. Buttet, S., & Roy, U., 2011. Deflation, Depression, and the Zero Lower Bound. Chiarella, C., Flaschel, P., & Semmler, W., 2011. Reconstructing Keynesian Macroeconomics Volume 1: Integrated Approaches. London: Routledge. Ghosh, S., & Ghosh, S., 2012. Teaching dynamic aggregate supply-aggregate demand model in an intermediate macroeconomics class using interactive spreadsheets. In AEA/ASSA Conference, Chicago, January. Chiarella, C., Flaschel, P., & Semmler, W., 2013. Reconstructing Keynesian Macroeconomics Volume 2: Integrated Approaches. London: Routledge. Buttet, S., & Roy, U., 2014. A simple treatment of the liquidity trap for intermediate macroeconomics courses. The Journal of Economic Education, 45(1), 36-55. Read More