croChapter 1: A tour of the world
1.1 THE EUROPEAN UNION
When macroeconomists study an economy, they first look at three variables: * Output – the level of production of the economy as a whole – and its rate of growth. * The unemployment rate – the proportion of workers in the economy who are not
employed and are looking for a job. * The inflation rate – the rate at which the average price of the goods in the economy is
increasing over time.
The economic performance of European countries after the turn of the millennium has not been as good as it was in the 1990s: • Average annual output growth reflected a significant slowdown in all of the largest European economies since 2008, and a recession in 2009. • Low output growth was accompanied by persistently high unemployment. • Average annual inflation was 2.2% in the EU and 2% in the euro area.
Three issues dominate the agenda of European macroeconomists: • High unemployment
• Growth of income per person
• Common currency
How can European Unemployment be Reduced?
There is still disagreement about the causes of high European unemployment: * Politicians often blame macroeconomic policy.
* Most economists believe, however, that the source of the problem is labour market institutions. * Some economists point to what they call labour market rigidities. * Other economists point to the fact that unemployment is not high everywhere in Europe.
What will The Euro do For Europe?
* Supporters of the Euro point first to its enormous symbolic importance. * Others worry that the symbolism of the euro may come with some economic costs. * Equal Interest rates across the Euro Area
1.2 THE UNITED STATES
From an economic point of view, there is no question that the 1990s were amongst the best years in recent memory in the USA. In the recent past, however, the economy has slowed down. Projections do not seem to suggest that the economy has started growing again
What are the Reasons for the Recent Slow Down?
Between 2007 and 2008, US families were affected by four economic shocks which occurred over a short period of time: an increase in oil prices, though now partially reversed; a fall in the price of their homes; a fall of the stock market; and a restriction of credit. * If oil imports become more expensive, this means that in order to import the same amount of oil, importing countries will have to transfer a greater share of their income to the oil producing countries. This will contribute to impoverishing importers and to reducing their consumption. * (The graph relates house prices (adjusted for inflation) to three explanatory variables: population growth, construction costs and interest rates). What is the effect of falling house prices on the economy? To answer this question, con- sider that the value of the homes in which Americans live is about three-quarters of their total wealth. From the start of the financial crisis (summer 2007) until the end of 2009, the value of US homes fell on average by 30%. This means that the wealth of American house- holds has fallen (again on average) by 22.5% (30 × 0.75). What is the effect on consumption? In Chapter 15 you will learn than in normal circumstances a family spends each year a share of its wealth equal to the product of the real interest rate multiplied by the value of wealth. Then, with a real interest rate of 2%, this means that the direct effect (we say ‘direct’ because there are the ‘indirect’ effects, such as the fall in the stock market induced by the fall in real estate prices) of the real estate crisis on household consumption is to reduce spending by about 0.4% (22.5 0.02). * A fall in the stock market reduced the value of households’ wealth invested in equities. * A restriction of credit made it more difficult and expensive to access credit. Should we worry about the US Trade Deficit?
US imports have consistently exceeded US exports to the rest of the...
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