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Following the 2008 financial crisis, many countries employed fiscal stabilization policies to recover from the recession. This analysis compares the economic responses of China and the United States to their respective fiscal stimuli, focusing on the size of the money supply, inflation rates, exchange rate movements, unemployment rates, and the models and assumptions underlying these outcomes.

China's response involved the implementation of the 4 trillion yuan stimulus plan, which injected nearly $600 billion USD into its economy, approximately 12% of the country's GDP. The US government's measures, including the Economic Stimulus Act, HERA, ARRA, TARP, and bailout efforts, amounted to nearly $3 trillion USD, about 19% of its GDP. These increasing amounts of fiscal stimulus aimed to close output gaps by boosting aggregate demand. The difference in magnitude signifies different approaches and economic contexts.

Comparison of Money Supply and Inflation Rates

Examining the size of the money supply in both nations reveals divergent monetary responses. In China, the increase in the money supply was substantial but moderate relative to its economy, aligning with the targeted fiscal injections aimed at stimulating growth without triggering runaway inflation. Conversely, the US experienced a larger nominal increase in its money supply due to expansive monetary policies accompanying fiscal measures, which resulted in higher liquidity in the economy.

Regarding inflation, China managed to keep inflation relatively controlled during this period, with rates hovering around 2-3%. This stability can be attributed to China's monetary policy management, including interest rate controls and reserve requirement adjustments. The US, however, experienced slightly higher inflation rates, reflecting increased liquidity and supply chain disruptions, with inflation reaching around 3-4%, which was partly problematic for the economic recovery.

Exchange Rate Movements and Unemployment Dynamics

The USD exchange rate experienced notable fluctuations post-crisis, initially depreciating due to economic uncertainties but later appreciating as investor confidence recovered and monetary policies stabilized. China's currency, while unofficially pegged during the crisis, experienced pressure to float freely; its exchange rate gradually appreciated relative to the US dollar, supporting exports and economic stabilization efforts.

Unemployment rates provide insight into the effectiveness of fiscal policies. The natural rate of unemployment in the US remained around 5%, with actual rates temporarily rising above this level during the recession. China's actual unemployment rate sat around 4.5% for over 15 years, indicating relative stability and the effectiveness of its stimulus in preventing a significant rise in joblessness.

Theoretical Models and Assumptions

The observed outcomes align with several economic models, particularly the Aggregate Demand and Aggregate Supply (AD-AS) framework, which predicts that fiscal expansion increases aggregate demand, shifting the AD curve rightward, thereby reducing unemployment and closing the output gap. In the short run, these policies should also lead to higher price levels, implying increased inflation, which was observed to some extent.

The Keynesian model also underscores the importance of fiscal policy in stimulating demand during recessions, especially when monetary policy may be constrained by liquidity traps or zero-lower bounds. Both China and the US arguably employed these models in designing their stimulus measures.

However, some findings challenge assumptions, particularly regarding inflation control and exchange rate flexibility. China's ability to maintain low inflation despite large fiscal and monetary injections suggests a misalignment with traditional models, possibly due to the country's large reserve holdings, capital controls, and targeted monetary policy. Similarly, the appreciation of the USD amid expansive monetary policy during the crisis raises questions about the assumptions concerning the neutrality of money in the short term and the effectiveness of exchange rate regimes.

Closing the Output Gap and Policy Effectiveness

Both countries made significant efforts to close their output gaps through large-scale fiscal stimuli. China's approach, characterized by a sizable fiscal injection and currency stabilization, aimed at rapid infrastructure and development projects, effectively boosted GDP growth and maintained low unemployment. The US used a combination of fiscal stimulus and monetary easing, leading to a gradual reduction in unemployment, but inflation pressures and fiscal deficits posed long-term concerns.

In conclusion, while the general expectations of Keynesian frameworks—fiscal expansion reducing unemployment and closing output gaps—were largely observed, the particular paths and side effects highlight the importance of country-specific factors, policy timing, and assumptions about market Flexibility. China's managed exchange rate and controlled inflation outcomes showcase the role of capital controls and targeted monetary policy, whereas the US experience reflects the complexities of monetary policy transmission and international capital flows during crises.

References

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