It's not that simple

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LIYE LIN's picture

It's not that simple

“Just keep printing money!” This was Robert Mugabe might have said when Zimbabwe was facing a recession, but we all know that the only real effect in the long run is inflation, or hyperinflation in Zimbabwe’s case. In the real world, economies usually pursue a mixture of policies to try to stimulate growth. Besides monetary policy, the manipulation of exchange rate and fiscal policies can also help stimulate economic growth. It is rare for governments to implement only one policy to fight recession. Instead, a combination of expansionary policies is normally used to steer the economy back to growth.

Monetary policy controls the total amount of money circulating in the economy. In modern practices, central banks achieve this by affecting the nominal interest rate through open market operations by selling or buying bonds, lowering interest rates when they want to boost economic growth, and vice versa. By lowering interest rates, the costs of investment and buying consumer goods go down and hence bring about a rise in aggregate demand for these goods.

It is widely agreed among economists that the lowering of interest rates to near zero percent helped prevent the recession from becoming the second Great Depression by making credit widely available at a very low cost. After the collapse of Lehmann Brothers, banks stopped lending to one another, resulting in a credit crunch that threatened to bring down the entire banking system. Given this unprecedented paralysis of the banking system, interest rates were pushed to record lows in the United States, Britain and the Euro area, with the United States and Britain holding interest rates at near zero percent. This prevented the total collapse of the banking system worldwide.

The loosening of monetary policy was also aimed at reigniting economic growth. In the United States, the monetary base had tripled from 2008 through 2011, but growth remained lackluster. Despite near zero interest rates, Britain sank back into recession in the first quarter of 2012. Economist Paul Krugman argued that with interest rates already near zero, America and Britain are essentially in a ‘liquidity trap’, where further increases in the money supply fail to stimulate the economies. Such a scenario means that further growth in money supply will have a negligible growth effect on the economy. This shows that in a situation where interest rates are already near or at zero, monetary policy becomes ineffective and cannot be used alone to achieve a recovery. Moreover, with an excessively loose monetary policy, once economies start to recover, the large expansion in monetary base may create inflationary pressures that can threaten to wreak havoc in the future.

An alternative viewpoint is that expansionary monetary policy does not stimulate the economy because the bulk of the increase in money supply goes straight to the banks as deposits. In 2010, the United States had undergone quantitative easing 2 (QE2), yet the economy continued to face slow growth and low inflation. One possible reason was that instead of circulating in the economy and boosting growth through the multiplier effect, most of the stimulus money might have gone straight to the banks to prop up balance sheets and forestall a credit crunch. Conspicuously, the cash balances of big listed corporations in America were in the billions. When money is hoarded instead of circulating in the economy, the multiplier effect diminishes, reducing the impact of monetary policy.

A helicopter drop or burying money in the ground and letting people find them, as described by John Maynard Keynes, are better ways of distributing the stimulus money. However, such activities are prohibitively expensive. In Taiwan, the government had a creative plan to spend the stimulus money. During the recession, the Taiwanese government pursued a US$5.6 billion stimulus package, half of which was for the distribution of grocery vouchers to citizen born before March 31, 2009. Each citizen was able to redeem these vouchers, worth about US$108, and spend them on almost anything. The only drawback was that the vouchers would expire within a few months. This would ensure that no hoarding of vouchers was done and that the stimulus package would be spent and circulated in the economy.

Because the money was in the form of vouchers, the people could not save it in the bank, and the only option was to spend it. Also, by making these vouchers faux money with an expiry date, the central bank would be able to withdraw them when the economy emerged from recession, which presumably would be the case when the expiry date was reached. This would ensure that the excess money in the economy would be withdrawn, reducing the risk of higher than expected inflation when the economy recovered. Indeed, the Taiwanese economy emerged strongly from the recession with a growth rate of more than 10% in 2010. Based on predictions by the Taiwanese government, through the multiplier effect, approximately 1% of GDP would be due to the increase in domestic demand caused by the vouchers. This was indeed an interesting case of monetary policy, where the government pumped in vouchers that acted as money and ensured that the money would be circulating in the economy by allocating a fixed sum to every citizen.

Alternatively, expansionary fiscal policies can be implemented to boost the economy. Such policies comprise of a combination of lower tax rates and higher government expenditures to stimulate aggregate demand. These expenditures can be spent on vital infrastructure such as roads and bridges, or through grants to upcoming industries such as renewable energy. By doing so, money is pumped into the economy to boost aggregate demand, and new industrial sectors that may be an essential part of future growth are supported. However, such a policy will increase budget deficits because more money is spent when lower tax revenues are collected. At a time when western economies are aiming to resolve high debt levels, there may not be an appetite to further increase the level of government debt. Even in the United States, where the budget deficit is 10% of the GDP, there is a fierce debate on whether such a huge deficit in the budget actually helps the economy. America’s economy may be growing by 2% annually, but the employment rate remains stubbornly high. Furthermore, there is a debate on how the United States can pay back its debt in the future without sacrificing growth, as debt levels approach 100% of GDP and is projected to continue rising as budget deficits outpace growth.

Another possible alternative is the use of exchange rate policy. For Singapore, the exchange rate policy is used instead of monetary and fiscal policies, because as a small and open economy, Singapore is heavily dependent on trade. Since Singapore imports nearly everything that it needs, including water, import-push inflation plays a significant role in the local economy, as higher import prices result in a higher sale price in the domestic market. At the start of the financial crisis, high food and oil prices led to record high inflation rates of above 6%. By strengthening the Singapore dollar, import-push inflation will be lowered, but a stronger dollar can also make exports uncompetitive, worsening the recession in Singapore. In the end, the Monetary Authority of Singapore chose to pursue a weaker dollar in order to support growth in the economy at the expense of higher inflation. Singapore’s economy grew 14.7% in 2010, one of the fastest in the world.

For big economies such as the United States and the Euro area, it is politically unacceptable to weaken currencies in order to pursue growth. Lessons from the Great Depression have shown us that such ‘beggar-thy-neighbor’ tactics, where countries depreciate their currencies vis-à-vis other countries in a race to the bottom in order to gain an export advantage, will not have a positive effect on their economies. Further, the Federal Reserve and the European Central Bank have committed their currencies to be freely floating in accordance to market demand and supply, and any intervention by the central banks will be politically unviable.

Five years have passed since the onset of the global financial crisis, yet Western economies remain mired in recession and high levels of debt. Central banks pursued an expansionary monetary policy, through record low interest rates in Europe and the United States. This was aimed at lowering borrowing costs and thus encouraging growth, but Western economies continue to experience stagnation. Additionally, huge budget deficits were recorded in Britain and America, yet both economies continue to suffer from high employment and low growth. Exchange rate policies are not viable for large economies, as they antagonize trading partners, raise protectionist sentiments and ultimately cause more harm to global economic health by shrinking trade. Ultimately, each economic crisis is different in its cause and magnitude, and there is no fixed remedy for stimulating economic recovery.

  1. Lei, Jonathan. (January 19, 2009). Taiwan citizens get vouchers to go shopping., retrieved from
  2. Monetary Authority of Singapore. (2001). Singapore’s exchange rate policy. Retrieved from