Pertemuan 11
Short run impact of shocks:
| shock type | shifts | P | Y | U |
|---|---|---|---|---|
| Positive demand | →AD | ⇑ | ⇑ | ⇓ |
| Negative demand | ←AD | ⇓ | ⇓ | ⇑ |
| Positive supply | →SRAS | ⇓ | ⇑ | ⇓ |
| Negative supply | ←SRAS | ⇑ | ⇓ | ⇑ |
The effect of fiscal policy
Financial system
the central bank
GDP=C+I+G+X−IM
Increasing government expenditure =G⇑
Decreasing income taxes:
On the contrary, an overheat economy causes a big increase in prices.
Y⇑ in the short run but inflation can be uncontrollable and a bubble may burst.
Government can reduce the speed of price hike by using contractionary fiscal policy like:
Expansionary fiscal policy should be done during a recession:
In general, Indonesian economists are agree to high spending during a recession.
It may not work to offset a supply shock, but most recessions are caused by demand shock.
Without altering tax, increased government spending must come from debt which creates government deficit.
Those debt needs to be paid in the future by rising taxes.
Forward looking people knows this. They might reduce consumption and save to pay the future taxes.
This is called Ricardian Equivalent: income from government consumption will be saved to pay future taxes, eliminating effects of expansionary policy.
In the short-run, people will not save equals to the future tax.
Most people will not even aware about how to calculate the debt and the tax needed to pay them in the future.
Therefore, Ricardian equivalent is not a big problem.
Expansionary fiscal policy is also a race against time.
There are reasons why government disbursement is slow:
Disbursement that is too slow risks overheating and inflation if the economy already returned to the optimal output.
Without proper tax revenue, government needs to run a fiscal deficit which is financed by debt.
Running a deficit and accumulating debt often leads to a more political debate than economics.
Too much debt is problematic because it erodes trust from borrower.
What about Indonesia?
Compared to some countries, Indonesia’s tax revenue is very small. Increasing debt is necessary to boos spending
On the contrary, Indonesia’s government debt level is low. Debt from 1998 crisis was paid during the good times of commodity boom.
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Indonesian bond is expensive. at around 6-7% interest rate, this potentially crowds out private investment!
| Growth in % (except stated otherwise) |
2019 | 2020 | 2021 | 2022 |
|---|---|---|---|---|
| GDP | 5.0 | -2.1 | 4.9 | 5.4 |
| private consumption C | 5.2 | -2.7 | 3.6 | 7.1 |
| Government expenditure G | 3.3 | 1.9 | -0.3 | 1.0 |
| CPI (inflation) | 3.0 | 1.9 | 2.1 | 3.0 |
| Fiscal balance (% GDP) | -2.2 | -6.5 | -5.7 | -4.1 |
COVID crushes demand. G helps, and it was financed by debt.
Source: OECD (2021), OECD Economic Surveys: Indonesia 2021, OECD Publishing, Paris, https://doi.org/10.1787/fd7e6249-en.
For example, oil price increase:
Fukushima shock: can’t just find/make replacement firms.
Negative supply shock leads to stagflation:
So far we have talking about AD-AS, also known as real sector (sektor riil).
The other side of the coin is financial sector:
This time we will learn about money, banking, and the central bank.
Before we use money, we barter.
This is inefficient as some goods are:
Probably the oldest “money”
This is inefficient as some goods are:
At some point, people used gold and silver to facilitate barter.
However, even gold is hard to carry around especially if you are rich.
People stash their gold in a place called bank, and received “bank note” as a proof that they own the gold.
Normally, one needed to go to bank, take the gold, and transact.
But in the end, people use the bank note itself. This bank note is our today’s currency.
Nowadays, banks can create money without having to have a gold in their stash.
Money is any asset that can easily be used to purchase goods and services.
An asset is called liquid if we can easily convert it to cash.
We generally consider cash, bank cheques, and saving account as money because they are liquid.
What are considered non-liquid asset?
Medium of exchange. Everyone has to believe in its value. We normally use IDR. Sometimes, foreign money is used. Goods can also be used under certain circumstances.
Store of value. It has consistent value (not perishable over time)
Unit of account: the commonly accepted measure individuals use to set prices and make economic calculation.
Commodity money is goods that is valuable to many people. Gold and silver, cigarettes, alcohol.
Commodity-backed money is a “paper money” that we can use to redeem a commodity (usually gold). Holders of these bank notes are guaranteed the gold (or other commodity) stated in the notes.
Fiat money is the money we know today. It only backed by the government’s word.
Commodity-backed money makes transaction quicker than commodity money because a bank can generate more notes than it has gold.
Fiat money is even faster because banks do not need to hold anything. Some problems tho:
Bank uses liquid assets in the form of deposit to finance illiquid investments of borrowers.
Banks cannot lend all of its assets: it has to store a small fraction in their own vault or in the central bank.
In Indonesia, bank needs to have a reserve equals to 3.5% of its total loan.
In normal times, people usually don’t do anything with their saving account.
This way, banks can lend most of the money and reserve some for liquidity.
But if many lenders suddenly would like to withdraw money, bank would not have enough money.
When many people wants to withdraw money at the same time, we call it bank run.
Bank runs happen when borrowers hear Bank is near collapsing.
However, just a rumour could create a real collapse if lenders decided to withdraw money together at the same time.
This can be contagious: a lost of faith in one bank could lead to lost of faith to the entire system.
Deposit insurance. Indonesian depositors is insured (partially) by Lembaga Penjamin Simpanan (LPS)
Capital requirements. Bank is required to have a minimum capital or asset to be able to operate in Indonesia.
Reserve requirements. Currently is 3.5% but it used to be higher. It was lowered due to COVID-19 recession.
Discount window, where the central bank can lend money to private banks so they don’t have to sell their asset.
Bank control how much money circulated in the market by moving deposits between loanable funds and its reserves
Suppose Panca has a Rp1 million in his pocket. He decided to deposit it to Bank BeCAk.
But then Joy come to Bank BeCAk to borrow Rp900k to buy shoes.
Bank BeCAk use its reserve it get from Panca:
This leads to increased Rp900k in money supply: now there are Rp1.900k of money supply in the market!
Suppose Joy buy the shoes from Liv.
Liv then deposit the money to another bank named Bank Madara.
But like Bank BeCAk, Bank Madara can loan some of the fund and reducing its reserve!
The more money is circulated, the more expansionary the monetary condition is.
Money supply is reduced when:
These are usually happening in an uncertain time: a recession or even worse, a crisis.
Next week, we will learn how money supply and money demand interact with the real sector
We will also learn how Bank Indonesia plays a role in the economy.
