Macroeconomics: A European Perspective
2024-2025
Week 1: Introduction and the Goods Market
Chapter 1: Introduction and a tour of the World
,1.1. Pandemic of 2020
- COVID major economic slowdowns and recessions
- Recessions triggered by imbalances in an economy that has accumulated over time
o Think 2008 real estate crisis (caused by over-investment)
- Length of recession dependent on time it takes to correct for pre-existing imbalances
- E.g. Great Depression 1929 took 43 months to fix, the real estate crisis 18 months
- Indicates length of time it took to fix financial systems affected by sub-prime
mortgages
Pandemic recession differs, as:
- Cause due to an exogenous shock. Three ways this affects economy:
o Break in production chains (parts sourced from China – the world’s factory), due
to China shutting down first
o Spread of virus caused restrictions in mobility of people. Those who can’t work
remotely stopped working
o Closure of factories/stores caused family incomes to drop fall in consumption,
paired with fact that not all families received unemployment benefits. Supply
shock also met with a demand shock of lower consumption.
1.2. Crisis of 2008-9
- Sustained economic expansion in 2007. End of 2007 saw this expansion end come to
light.
o US house prices (doubled since 2000) started to drop in value. Not ideal
suggests lower spending by consumers
o Prices began to drop due to poor quality of mortgages
Lowering interest rates by FED would not have helped the initial stages of
housing price decline
o Poor quality mortgages loans given to those unable to meet monthly
payments on them
Falling house prices: value of mortgage exceeded house price, giving an
incentive to default (i.e. violate mortgage agreements; e.g. not paying
monthly instalment)
- Issue of mortgages was deeper rooted
o Mortgages often bundled with other securities and sold to other banks, which
further bundled them up with other securities and sold them to further banks
Making it hard to assess the value of these securities that banks became
reluctant to lend to each other as hard to value their assets and became
highly leveraged
High leverage = more debt than equity
o Unable to borrow, banks found themselves in trouble with Lehman Brothers, a
major bank, going bankrupt. Intertwined banks caused risk of other banks also
going bankrupt
- Stock prices across US, EU and developing
countries dropped massively
- collapsing house prices
- Fear of Great Depression repeat (consumption
and investment dropped)
- Trade and finance channels affected
o Drop in US consumer consumption
abroad
o Drop in US bank lending abroad
2
, As many EU countries had high govt debt, investors were worried,
signalling higher interest rates
Combination of factors: EU govts ran lower deficits, higher taxes,
decreasing output and demand, which led to the Euro crisis.
- Strong monetary and fiscal policies led to a gradual repair in financial systems
Comparison of two last recessions and policy changes:
- Financial crisis
o The financial shock to the US was relatively small (e.g. imagine the issue of a bad
mortgage valued at $200,000 had dropped by 30% to $140,000, bad as it was
for the banks balance sheets, there was no point to repay the loans in the eye of
the consumer, so it made more sense to default. The hit on the balance sheets
were still relatively modest)
o Yet, why did this spiral into a great recession?
Obscurity unclarity regarding mortgage worths
Amplification a relatively small shock was amplified by the fact that
banks had become highly leveraged
They held too little capital to absorb the losses they were suffering
on their mortgages
Too little capital = stop on lending
o Bank policy response balancing credit flow to consumers and firms so it would
not dry out
Repairing balance sheets takes a long time, which ultimately caused the
great recession
- COVID pandemic
o Shock origin: dramatic fall in output (fell to zero) due to lockdown
o Policy response = health interventions
To minimize length of time needed to stop the spread of the output
o Policy response = Income support to workers so that consumption would not
collapse.
1.3. The US
- Assessing size of country economically – look at output and output per person.
o Output growth: rate of change in output
o Unemployment rate – proportion of workers not engaged in employment, but are
actively seeking employment
o Inflation rate – rate at which the average price of goods increases over time
- Table shows longest expansion since 1945
o Evidence that a recession was to come soon, unbeknownst that the recession
would be caused by an exogenous shock like COVID
- Pandemic: hit economies beyond imagination
o FED can fight recession due to the fact they have best policy instruments
Interest rate control
3
, Rates can only go so far = Zero Lower Bound
Situation when the short term nominal interest rate is at or near
zero, causing a liquidity trap and limiting the central banks capacity
to stimulate economic growth
- Why? Everyone would rather hold cash at a zero interest rate as opposed to negative
interest rates paid on bonds
- Slowdown of productivity growth caused concerns for rising inequality
o High productivity? Most are likely to benefit, even if inequality increases
Poor may not benefit as much, but still increased standard of living
Handling future recessions
- Post-financial crisis since June 2009 has seen output grow positively until COVID-19
pandemic
- Even without COVID, the long expansion would have to come to an end at some point
(think trade wars, or rise in uncertainty)
- For policymakers: how to limit a (future) decline in output
o The FED plays a central role
Mandated to fight recessions
Policy instrument control of the interest rate
Decrease = stimulate demand and output and decrease
unemployment
Increase = slow demand and increase unemployment
Fed Funds
- Pandemic 2.5% to 0.5%
- Zero lower bound cannot decrease the
interest rate below zero as this causes
negative rate payments on bonds
Low productivity growth effects
- Short run: dependent on reactions central
banks
- Long run: dependent on growth, productivity
growth (necessary for a sustained increase in
income per person)
- Sceptics regarding the future of productivity
growth
o Yearly fluctuations
o Rising inequality
1.4. EU and Euro Area
- 1957 – formation of common European market
o Free movement of people, goods and services
- Both economic and symbolic solution to state of Europe post-WWII
- 22 countries joined over time to create modern day EU – scopes now extend beyond
solely economic issues. UK exit in 2016.
- 1999 – implementation of common currency – Euro area
Biggest issues for EU today
o Unemployment
4
2024-2025
Week 1: Introduction and the Goods Market
Chapter 1: Introduction and a tour of the World
,1.1. Pandemic of 2020
- COVID major economic slowdowns and recessions
- Recessions triggered by imbalances in an economy that has accumulated over time
o Think 2008 real estate crisis (caused by over-investment)
- Length of recession dependent on time it takes to correct for pre-existing imbalances
- E.g. Great Depression 1929 took 43 months to fix, the real estate crisis 18 months
- Indicates length of time it took to fix financial systems affected by sub-prime
mortgages
Pandemic recession differs, as:
- Cause due to an exogenous shock. Three ways this affects economy:
o Break in production chains (parts sourced from China – the world’s factory), due
to China shutting down first
o Spread of virus caused restrictions in mobility of people. Those who can’t work
remotely stopped working
o Closure of factories/stores caused family incomes to drop fall in consumption,
paired with fact that not all families received unemployment benefits. Supply
shock also met with a demand shock of lower consumption.
1.2. Crisis of 2008-9
- Sustained economic expansion in 2007. End of 2007 saw this expansion end come to
light.
o US house prices (doubled since 2000) started to drop in value. Not ideal
suggests lower spending by consumers
o Prices began to drop due to poor quality of mortgages
Lowering interest rates by FED would not have helped the initial stages of
housing price decline
o Poor quality mortgages loans given to those unable to meet monthly
payments on them
Falling house prices: value of mortgage exceeded house price, giving an
incentive to default (i.e. violate mortgage agreements; e.g. not paying
monthly instalment)
- Issue of mortgages was deeper rooted
o Mortgages often bundled with other securities and sold to other banks, which
further bundled them up with other securities and sold them to further banks
Making it hard to assess the value of these securities that banks became
reluctant to lend to each other as hard to value their assets and became
highly leveraged
High leverage = more debt than equity
o Unable to borrow, banks found themselves in trouble with Lehman Brothers, a
major bank, going bankrupt. Intertwined banks caused risk of other banks also
going bankrupt
- Stock prices across US, EU and developing
countries dropped massively
- collapsing house prices
- Fear of Great Depression repeat (consumption
and investment dropped)
- Trade and finance channels affected
o Drop in US consumer consumption
abroad
o Drop in US bank lending abroad
2
, As many EU countries had high govt debt, investors were worried,
signalling higher interest rates
Combination of factors: EU govts ran lower deficits, higher taxes,
decreasing output and demand, which led to the Euro crisis.
- Strong monetary and fiscal policies led to a gradual repair in financial systems
Comparison of two last recessions and policy changes:
- Financial crisis
o The financial shock to the US was relatively small (e.g. imagine the issue of a bad
mortgage valued at $200,000 had dropped by 30% to $140,000, bad as it was
for the banks balance sheets, there was no point to repay the loans in the eye of
the consumer, so it made more sense to default. The hit on the balance sheets
were still relatively modest)
o Yet, why did this spiral into a great recession?
Obscurity unclarity regarding mortgage worths
Amplification a relatively small shock was amplified by the fact that
banks had become highly leveraged
They held too little capital to absorb the losses they were suffering
on their mortgages
Too little capital = stop on lending
o Bank policy response balancing credit flow to consumers and firms so it would
not dry out
Repairing balance sheets takes a long time, which ultimately caused the
great recession
- COVID pandemic
o Shock origin: dramatic fall in output (fell to zero) due to lockdown
o Policy response = health interventions
To minimize length of time needed to stop the spread of the output
o Policy response = Income support to workers so that consumption would not
collapse.
1.3. The US
- Assessing size of country economically – look at output and output per person.
o Output growth: rate of change in output
o Unemployment rate – proportion of workers not engaged in employment, but are
actively seeking employment
o Inflation rate – rate at which the average price of goods increases over time
- Table shows longest expansion since 1945
o Evidence that a recession was to come soon, unbeknownst that the recession
would be caused by an exogenous shock like COVID
- Pandemic: hit economies beyond imagination
o FED can fight recession due to the fact they have best policy instruments
Interest rate control
3
, Rates can only go so far = Zero Lower Bound
Situation when the short term nominal interest rate is at or near
zero, causing a liquidity trap and limiting the central banks capacity
to stimulate economic growth
- Why? Everyone would rather hold cash at a zero interest rate as opposed to negative
interest rates paid on bonds
- Slowdown of productivity growth caused concerns for rising inequality
o High productivity? Most are likely to benefit, even if inequality increases
Poor may not benefit as much, but still increased standard of living
Handling future recessions
- Post-financial crisis since June 2009 has seen output grow positively until COVID-19
pandemic
- Even without COVID, the long expansion would have to come to an end at some point
(think trade wars, or rise in uncertainty)
- For policymakers: how to limit a (future) decline in output
o The FED plays a central role
Mandated to fight recessions
Policy instrument control of the interest rate
Decrease = stimulate demand and output and decrease
unemployment
Increase = slow demand and increase unemployment
Fed Funds
- Pandemic 2.5% to 0.5%
- Zero lower bound cannot decrease the
interest rate below zero as this causes
negative rate payments on bonds
Low productivity growth effects
- Short run: dependent on reactions central
banks
- Long run: dependent on growth, productivity
growth (necessary for a sustained increase in
income per person)
- Sceptics regarding the future of productivity
growth
o Yearly fluctuations
o Rising inequality
1.4. EU and Euro Area
- 1957 – formation of common European market
o Free movement of people, goods and services
- Both economic and symbolic solution to state of Europe post-WWII
- 22 countries joined over time to create modern day EU – scopes now extend beyond
solely economic issues. UK exit in 2016.
- 1999 – implementation of common currency – Euro area
Biggest issues for EU today
o Unemployment
4
