Macroeconomics Literature summary - Articles
Article by De Grauwe and Ji (2019): 'Rethinking fiscal policy choices in the euro area'
(Week 2)
Article by Connors and Mitchell (2017): ‘Framing Modern Monetary Theory’ (Week 5)
Article by Lukkezen (2020): ‘The IS/MP - AD/AS model’ (week 6)
Article by Acemoglu, Johnson and Robinson (2002) ; ‘Reversal of Fortune: Geography
and Institutions in the making of the Modern World Income Distribution’ (Week 7)
Article Baldwin & Giavazzi (2015); ‘The Eurozone crisis: A Consensus view of the
causes and a few possible solutions (Week 8)
Article Lu and Teulings (2016) ; ‘Falling Interest Rates, House Prices, and the
Introduction of the Pill’ (Week 9)
Week 2: Aggregate demand, the multiplier and fiscal policy
Article by De Grauwe and Ji (2019): 'Rethinking fiscal policy choices in the euro area'
With an economic slowdown looming in the euro area, how should fiscal policies respond?
This article uses a behavioural macroeconomic framework to investigate the trade-offs
between stabilising output and public debt. It proposes that, when the interest rate is lower
than the growth rate of the economy, fiscal policy can be used as a tool for output
stabilisation while keeping public debt stable. It argues that many EU countries have the
fiscal space to stimulate their economies, which could help in preventing a recession.
Two questions arise about the use of fiscal policies:
1. The first one is how effective these policies are in stimulating the economy. This is
the question of the size of the fiscal multipliers.
2. The second one is how much leeway the fiscal authorities have to perform their
stabilisation responsibilities, taking into account that these authorities have
significant levels of outstanding debt.
In the article a behavioural economic model is presented. In contrast to the existing rational
expectations dynamic stochastic general equilibrium (DSGE) models, this model takes the
view that agents have cognitive limitations preventing them from having rational
expectations. Instead, these agents use simple rules of behaviour, i.e. heuristics. The model
introduces rationality by assuming that individuals learn from their mistakes and are willing
to switch to the better-performing rule. This model produces endogenous business cycles
driven by ‘animal spirits’, i.e. market sentiments of optimism and pessimism that in a self-
fulfilling way create booms and busts and are in turn influenced by these market
movements. One important characteristic of this model is that the effects of policy shocks
depend on the initial conditions, i.e. the state of the economy. This also means that the fiscal
multipliers obtained in this model depend on the state of the economy. This is a key feature
for the analysis of how fiscal policy can be used in different business cycle conditions.
Extreme values of animal spirits tend to amplify the effects of a fiscal expansion and lead to
multipliers exceeding 1.
1
,Interest rate regimes and sustainability of fiscal policies
There is considerable reluctance among policymakers to use fiscal policies for stabilisation
because of a fear that these policies may lead to a surge in government debt and, in so
doing, quickly become unsustainable. There is therefore a need to focus on issues of
sustainability.
Sustainability is very much influenced by the interest rate regime countries face. It is well-
known that when the nominal interest rate on public debt exceeds the nominal growth rate
of GDP, the debt-to-GDP ratio will become unstable (will grow to infinity) unless the
government produces a surplus on its primary budget balance.
Countries that experience an interest rate regime in which r > g, where r is the interest rate
and g the growth rate of GDP, are therefore very much constrained in the use of fiscal
policies. This is much less so in countries where r < g. In the latter countries, the inherent
dynamics of the debt-to-GDP ratio will tend to be stable, i.e. even if the government finances
all interest spending by debt issue, the debt-to-GDP ratio will tend to decline. There is
therefore no need to produce a surplus in the primary budget balance. It is clear that, in the
countries facing a favourable interest rate regime, there is no necessity for the fiscal
authorities to finance interest spending by taxation. This has the effect of producing a softer
budget constraint allowing for more choices in the use of fiscal policies for stabilisation
purposes.
What is the interest rate regime prevailing in different euro area countries today? Since
2013, the first year after the sovereign debt crisis, r – g declined in all euro area countries.
The effect of this decline is that, with the exception of Greece and Italy, all euro area
countries now profit from a favourable interest rate regime in which r-g < 0.
Policy choices
Fiscal policies can be used to stabilise output. The sustainability depends on the interest rate
regime and therefore determines the choices faced by the fiscal authorities.
In interest rate regimes in which the interest rate exceeds the growth rate of the economy,
the use of fiscal policy to stabilise output is severely limited. The use of fiscal policy to
stabilise the business cycle can quickly lead to a loss-loss situation in which both the
government debt and the business cycle are destabilised. In a regime where the interest rate
is lower than the growth rate of the economy, this problem does not arise. This is a regime
that allows the fiscal authorities to follow counter-cyclical policies without destabilising
government debt.
When a country faces favourable trade-offs, this allows them to use anti-cyclical fiscal
policies without destabilising their government debts. On the whole, most euro area
countries today have the capacity to use fiscal policies as a tool to fight a looming recession
without the risk of destabilising their government debt levels.
Many European countries are in a situation in which they could engage in a fiscal stimulus of
more than 2% of their GDP, with some countries reaching 3% or more, while keeping their
debt-to-GDP ratios fixed. The choice these countries face today is the following. They can
either go on the path of sharp declines of their debt-to-GDP ratios, even in the face of a
recession. Or they can judge that, with the present threat of a recession, a (temporary) stop
2
, in the decline in their debt ratios is desirable. Such a decision would create a fiscal space
allowing them to stimulate their economies by 3% to 4% of GDP, a stimulus that would
surely do much in preventing a serious recession. Thus, these countries should consider
changing their budgetary priorities skewed towards fast reductions of their debt-to-GDP
ratios towards one prioritising a fiscal stimulus. The exceptions are Greece, Italy and France,
which have no leeway for stimulus (Greece) or relatively little (Italy and France).
Week 5: Inflation and monetary policy
Article by Connors and Mitchell (2017): ‘Framing Modern Monetary Theory’
This article argues that Modern Monetary Theory (MMT) has struggled to gain attention in
wider economic and political debates due to: (1) An uncomplete understanding of key
macroeconomic terms among economic commentators, especially journalists, and the wider
community (lack of education); and (2) The deployment of key macroeconomic terms
(incorrectly) in the context of pervasive cultural metaphors to support policy interventions
that effectively benefit a privileged few at the expense of the majority. The article provides a
conceptual basis for understanding how the language we use constrains our thinking and it
examines some of the key metaphors used to reinforce the flawed message of orthodox
economics. Key ideas of modern monetary theory – an apolitical model of macroeconomic
operation – are examined and effective ways of expressing those key ideas in a progressive
social and economic framework are proposed.
Macroeconomics concepts, such as real gross domestic product (GDP), inflation and
unemployment rate, the fiscal deficit, and the interest rate make headlines on a daily basis.
Finance segments on national news broadcasts increasingly discuss macroeconomic issues
with frequent recourse to complex terms that are not well-understood by the majority of
media commentators or the public. Consequently, the public discourse reflects significant
errors that render it almost impossible for participants to make informed assessments of
macroeconomic developments independent of the politics involved.
Economic concepts such as the government fiscal deficit contain nuances that make
unambiguous assessment of their meaning difficult. These complexities are lost to the public
but are fundamental to an accurate understanding of the issues.
Problems in communicating the complexities of economic concepts and evidence are
amplified by the ideological assumptions that dominate public debate. Economics as an
academic discipline has come to be defined by a set of beliefs that are associated with the
dominant free market paradigm. The consequence of this is a narrow debate that excludes
the lessons of history and alternative economic paradigms that offer realistic insights into
current economic conditions and related policy options.
It is argued that Modern Monetary Theory (MMT) has a coherent macroeconomic story to
tell and provides new insights into the opportunities available to a government and its
citizens concerning full employment, accessible high- quality health, education, and other
infrastructure. It is argued that MMT has struggled to gain traction in wider economic and
political debates due to: (1) An incomplete understanding of key macroeconomic terms
among economic commentators, especially journalists, and the wider community (lack of
3
Article by De Grauwe and Ji (2019): 'Rethinking fiscal policy choices in the euro area'
(Week 2)
Article by Connors and Mitchell (2017): ‘Framing Modern Monetary Theory’ (Week 5)
Article by Lukkezen (2020): ‘The IS/MP - AD/AS model’ (week 6)
Article by Acemoglu, Johnson and Robinson (2002) ; ‘Reversal of Fortune: Geography
and Institutions in the making of the Modern World Income Distribution’ (Week 7)
Article Baldwin & Giavazzi (2015); ‘The Eurozone crisis: A Consensus view of the
causes and a few possible solutions (Week 8)
Article Lu and Teulings (2016) ; ‘Falling Interest Rates, House Prices, and the
Introduction of the Pill’ (Week 9)
Week 2: Aggregate demand, the multiplier and fiscal policy
Article by De Grauwe and Ji (2019): 'Rethinking fiscal policy choices in the euro area'
With an economic slowdown looming in the euro area, how should fiscal policies respond?
This article uses a behavioural macroeconomic framework to investigate the trade-offs
between stabilising output and public debt. It proposes that, when the interest rate is lower
than the growth rate of the economy, fiscal policy can be used as a tool for output
stabilisation while keeping public debt stable. It argues that many EU countries have the
fiscal space to stimulate their economies, which could help in preventing a recession.
Two questions arise about the use of fiscal policies:
1. The first one is how effective these policies are in stimulating the economy. This is
the question of the size of the fiscal multipliers.
2. The second one is how much leeway the fiscal authorities have to perform their
stabilisation responsibilities, taking into account that these authorities have
significant levels of outstanding debt.
In the article a behavioural economic model is presented. In contrast to the existing rational
expectations dynamic stochastic general equilibrium (DSGE) models, this model takes the
view that agents have cognitive limitations preventing them from having rational
expectations. Instead, these agents use simple rules of behaviour, i.e. heuristics. The model
introduces rationality by assuming that individuals learn from their mistakes and are willing
to switch to the better-performing rule. This model produces endogenous business cycles
driven by ‘animal spirits’, i.e. market sentiments of optimism and pessimism that in a self-
fulfilling way create booms and busts and are in turn influenced by these market
movements. One important characteristic of this model is that the effects of policy shocks
depend on the initial conditions, i.e. the state of the economy. This also means that the fiscal
multipliers obtained in this model depend on the state of the economy. This is a key feature
for the analysis of how fiscal policy can be used in different business cycle conditions.
Extreme values of animal spirits tend to amplify the effects of a fiscal expansion and lead to
multipliers exceeding 1.
1
,Interest rate regimes and sustainability of fiscal policies
There is considerable reluctance among policymakers to use fiscal policies for stabilisation
because of a fear that these policies may lead to a surge in government debt and, in so
doing, quickly become unsustainable. There is therefore a need to focus on issues of
sustainability.
Sustainability is very much influenced by the interest rate regime countries face. It is well-
known that when the nominal interest rate on public debt exceeds the nominal growth rate
of GDP, the debt-to-GDP ratio will become unstable (will grow to infinity) unless the
government produces a surplus on its primary budget balance.
Countries that experience an interest rate regime in which r > g, where r is the interest rate
and g the growth rate of GDP, are therefore very much constrained in the use of fiscal
policies. This is much less so in countries where r < g. In the latter countries, the inherent
dynamics of the debt-to-GDP ratio will tend to be stable, i.e. even if the government finances
all interest spending by debt issue, the debt-to-GDP ratio will tend to decline. There is
therefore no need to produce a surplus in the primary budget balance. It is clear that, in the
countries facing a favourable interest rate regime, there is no necessity for the fiscal
authorities to finance interest spending by taxation. This has the effect of producing a softer
budget constraint allowing for more choices in the use of fiscal policies for stabilisation
purposes.
What is the interest rate regime prevailing in different euro area countries today? Since
2013, the first year after the sovereign debt crisis, r – g declined in all euro area countries.
The effect of this decline is that, with the exception of Greece and Italy, all euro area
countries now profit from a favourable interest rate regime in which r-g < 0.
Policy choices
Fiscal policies can be used to stabilise output. The sustainability depends on the interest rate
regime and therefore determines the choices faced by the fiscal authorities.
In interest rate regimes in which the interest rate exceeds the growth rate of the economy,
the use of fiscal policy to stabilise output is severely limited. The use of fiscal policy to
stabilise the business cycle can quickly lead to a loss-loss situation in which both the
government debt and the business cycle are destabilised. In a regime where the interest rate
is lower than the growth rate of the economy, this problem does not arise. This is a regime
that allows the fiscal authorities to follow counter-cyclical policies without destabilising
government debt.
When a country faces favourable trade-offs, this allows them to use anti-cyclical fiscal
policies without destabilising their government debts. On the whole, most euro area
countries today have the capacity to use fiscal policies as a tool to fight a looming recession
without the risk of destabilising their government debt levels.
Many European countries are in a situation in which they could engage in a fiscal stimulus of
more than 2% of their GDP, with some countries reaching 3% or more, while keeping their
debt-to-GDP ratios fixed. The choice these countries face today is the following. They can
either go on the path of sharp declines of their debt-to-GDP ratios, even in the face of a
recession. Or they can judge that, with the present threat of a recession, a (temporary) stop
2
, in the decline in their debt ratios is desirable. Such a decision would create a fiscal space
allowing them to stimulate their economies by 3% to 4% of GDP, a stimulus that would
surely do much in preventing a serious recession. Thus, these countries should consider
changing their budgetary priorities skewed towards fast reductions of their debt-to-GDP
ratios towards one prioritising a fiscal stimulus. The exceptions are Greece, Italy and France,
which have no leeway for stimulus (Greece) or relatively little (Italy and France).
Week 5: Inflation and monetary policy
Article by Connors and Mitchell (2017): ‘Framing Modern Monetary Theory’
This article argues that Modern Monetary Theory (MMT) has struggled to gain attention in
wider economic and political debates due to: (1) An uncomplete understanding of key
macroeconomic terms among economic commentators, especially journalists, and the wider
community (lack of education); and (2) The deployment of key macroeconomic terms
(incorrectly) in the context of pervasive cultural metaphors to support policy interventions
that effectively benefit a privileged few at the expense of the majority. The article provides a
conceptual basis for understanding how the language we use constrains our thinking and it
examines some of the key metaphors used to reinforce the flawed message of orthodox
economics. Key ideas of modern monetary theory – an apolitical model of macroeconomic
operation – are examined and effective ways of expressing those key ideas in a progressive
social and economic framework are proposed.
Macroeconomics concepts, such as real gross domestic product (GDP), inflation and
unemployment rate, the fiscal deficit, and the interest rate make headlines on a daily basis.
Finance segments on national news broadcasts increasingly discuss macroeconomic issues
with frequent recourse to complex terms that are not well-understood by the majority of
media commentators or the public. Consequently, the public discourse reflects significant
errors that render it almost impossible for participants to make informed assessments of
macroeconomic developments independent of the politics involved.
Economic concepts such as the government fiscal deficit contain nuances that make
unambiguous assessment of their meaning difficult. These complexities are lost to the public
but are fundamental to an accurate understanding of the issues.
Problems in communicating the complexities of economic concepts and evidence are
amplified by the ideological assumptions that dominate public debate. Economics as an
academic discipline has come to be defined by a set of beliefs that are associated with the
dominant free market paradigm. The consequence of this is a narrow debate that excludes
the lessons of history and alternative economic paradigms that offer realistic insights into
current economic conditions and related policy options.
It is argued that Modern Monetary Theory (MMT) has a coherent macroeconomic story to
tell and provides new insights into the opportunities available to a government and its
citizens concerning full employment, accessible high- quality health, education, and other
infrastructure. It is argued that MMT has struggled to gain traction in wider economic and
political debates due to: (1) An incomplete understanding of key macroeconomic terms
among economic commentators, especially journalists, and the wider community (lack of
3
