Economic Policy Simulator

Recently Ι participated in a class on Understanding  Economic Policy-making on the Coursera Platform. The class was taught by Professor Gayle Allard, at the IESE business school in Spain. One of the requirements was to write an economic policy simulator assignment to be graded by peers. This work received a 22 / 30. Below I will like to present the questions and my answers.

Peer graded assignment - Economic Policy Simulator

Student: Bill Timoleon Alexandratos

Your first task is to open the Economic Policy Simulator, read the PDF case study for country 1, and study the data presented for this country. Based on the information in the case, answer questions 1-5 on the country´s problems.  Then use the interactive simulator to develop your ideal policy program for the country, and use your results to answer questions 6-7.

Question 1: What kind of "gaps" do you observe in the business cycle for Country 1 between years 1 and 4? (Maximum 4 points)

From the economic indicators we see that the country has a steady high inflation, high unemployment, and low GDP growth for the past four years. My view is that the governments is caught between fulfilling its obligations financially, and maintain a public profile with spending on social and welfare programs. Government spending is also high, as percent of GDP, so inflationary Gap is clearly seen, even though GDP growing at a low rate. Inflation is also high, and could be partially attributed to inflationary gap, but the main cause is due to infrastructure and bottlenecks in certain sectors of the economy.
The public debt is growing to finance various activities, there is a surplus with high tax revenues at 36%, but the interest payments on the debt has sunk the country further into recessionary Gap.

Question 2: What fiscal policies do authorities appear to be following in Country 1?  Are they appropriate for the gaps you have identified? (Maximum 4 points)

From the case we see that the government is reluctant to cut down on spending for its government agencies.  It is seeking desperately a way to cut spending since the budget deficit is growing wider. The government is willing to support social and welfare programs, Governments that came to power obtained huge loans in order to finance development and spending in all cabinets to satisfy programs.
Taxation is high so one indication is a restrictive fiscal policy to reduce the debt, and bring inflation down which is growing despite projections to the contrary. But on the other hand it is contradictory, for political reasons, to follow a mix of fiscal policies: high taxes, high government spending, and yet GDP growth, unemployment and inflation to be sustained at high levels. They are thinking of pension reforms which will have effect on the budget deficit, as they are thinking on spending, which when at an inflationary Gap, spending on stabilizers have to be decreased. On the other hand, with high unemployment and a recession, they are following an expansive policy by continuing to borrow to finance public spending, but they are following a contractionary policy by not lowering taxes.

Question 3: What monetary policies do authorities appear to be following in Country 1?  Are they appropriate for the gaps you have identified? (Maximum 4 points)

Monetary policy is the means by which a nation's central bank influences demand, supply and the growth of money which affects interest rates. It can be inferred from the economic figures, that, since real GDP growth is slow, hence interest rates are accommodative. Despite this investments are fleeing the country.  Monetary policy is not absorbed in the real GP growth rates from the economic figures. The currency is losing ground on the news that the US is raising in interest rates. Capital is shifting out of the country by relocating Investments for better competition.
 The fact that the country had a hyperinflation for the past four years may be an indication that it was monetizing the deficit by borrowing from the central bank. They want to avoid this now since they have experienced high inflation for several years.. It can also be deduced that high foreign debt borrowing in the past by all governments, and high deficits, had a mild impact on AD.  The fact that the country is negotiating the debt repayment for a prolonged period is an indication that it has high interest rates. Also, in the past it has experienced difficulties in paying interest payments.

Question 4: What would you say are the key problems facing Country 1? (Maximum 7 points)

The first major problem is the foreign debt which the government was lured into by the eulogies of foreign bankers. It is foreign owned by 45%, which means the country is captive in its fiscal policy. Hyperinflation is the second most important along with infrastructure and bottlenecks chocking investment growth. Combined with investment is the currency problem, it is devalued and capital is shifting to the US with higher interest rates. Interest rates influence the value of the currency. Because investments are shifting out of the country is an indication that interest rates are low, and the value of the currency was depreciated.  Another indication is that the country has applied an expansive monetary policy but the effects are not shown in either unemployment or inflation. This may have an effect on the overall GDP equation, with X-M; exports will go up since they look cheap to the outside world. But this policy is a contradiction with a restrictive policy and an appreciation of the currency. If that were the case it would help with inflation where energy prices will decline. We notice that bottlenecks in the power sector have a positive impact on prices. Also from the structure of imports, we see that the country is heavily dependent on oil and derivative products by 13%, interest payments on the debt evaporates the surplus, and structural reform  opposed by the elite. There are also high government regulations of private investment and businesses. The low GDP levels, high inflation and unemployment have led to stagflation.

Question 5: What do you observe as the effect of deregulation on Country 1, using the simulator? (Maximum 2 points)

For year five, i increased the tax rate from 36 to 37%, reduce interest rates from 23 to 21%, no growth again in social spending, and apply structural reform. The results noticed are as follows: The policy combination has the advantage of leading to crowding in. Private sector expands its role; attracted by favorable conditions, in the economy, while that of the public sector diminishes. This will boost efficiency, productivity and long term growth. Easing regulation of the private economy, as desperately needed, will lead to an economic boom with intense job creation. More people working, more tax revenues.
Productivity and efficiency will enhance GDP. Tax increases may also lead to increase in production costs, which will shift the AS curve to the left and a rise in prices.
For year six, taxes 35%, interest rates 19%, increase G to 2.5%. With reduced taxes AS shifts right reducing inflationary pressure.

Introduction to Question 6: Using the simulator to see the results and help you make policy choices, play around with the policy variables to take the economy of country 1 to where you think it should be in years 5 and 6.  

Please observe these two rules in your policy program to keep it realistic:

1) Keep real interest rates positive and
2) do not change taxes or government spending drastically; any increase or decrease must not be more than 10 percentage points over the period (i.e., not more than from 32 to 42, or from 10 to 0).

Question 6: Submit the results you get for Tax rate, Interest rate, Growth public spending, Structural reform, GDP growth, Budget balance, Public debt and Inflation for years 5 and 6. (Extra points will be given for students who manage to bring down the debt as a % of GDP in Year 6.)
(Maximum 6 points)

                                             year 5            year 6
tax rate                                  36%                 36%  
interest rate                           21%                 21%
Growth social spending          -2%                 -3
structural reform                    deregulate       deregulate
GDP Growth                           2.99%             4.9%
Budget Balance                      6.94%             6.54%
Public Debt                             62.3%             69.24%
Inflation                                   7.1%               7.3%
Gov't Spending                       20.21              19.7

Introduction to Question 7: This question deals with the combinations of policies you used to get your results for question 6. This question requires you to specifically comment on what policies you used for fiscal policy, monetary policy and structural reform.

Question 7: Clearly state what you did with fiscal policy, monetary policy and structural reform using the list below. Please also explain why you decided on the chosen policies: 

Fiscal policy - Did you use Expansive, restrictive, or neutral (no change)?
Monetary policy - Did you use Expansive, restrictive or neutral (no change)?
Structural reform - Did you use deregulation, regulation or no change?

(Maximum 6 points)

For year 5, is a crowding in policy, where favorable conditions attract the private sector, expanding its role in the economy, and limiting that of the governments. That is what they wanted to do but is unable to. This will boost productivity and efficiency in the long run, which as we see, the country desperately needs. Deregulation of the private sector is also one of the issues being addressed in the country. The outcome will be also to increase employment.
For year 6, the policy is restrictive to reduce growth and demand, alleviate inflation and help with reducing the deficit.
In both years I used deregulation because it is one of the major problems the economy is facing.