A Tour of The World: Powerpoint To Accompany

PowerPoint to accompany
Chapter 1
A Tour of the
World
Section 1.1: Australia
Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Australia

Australia
• From an economic point of view, the period

1996-2006 was one of the best in recent
memory.
• Output growth averaged 3.7%, higher than
1970-2006
• Sustained growth was associated with a
steady increase in employment and a steady
decrease in the unemployment rate (=4.8%
expected in 2009)
• The inflation rate remained low throughout the
period (3.4% lower than 1970-2006)

Australia
• The Australian economy had a mild slowdown in

2001:
• Output growth halved to 1.9% in 2001. Recovered to
4.1% in 2002.
• Slowdown was smaller and shorter than in all other
OECD countries.
• From 2006 to 2008, the economy was steady:
• Output grew at about 3%.
• Unemployment remained low at around 4%.
• Inflation remained low – initially within 2-3% target
range of Reserve Bank of Australia (RBA), but reached
4.4% in 2008 mainly due to high global oil prices.

3 issues for Australia
• How to respond to the major global financial

crisis that began in September 2008:
• IMF forecast 2.2% output growth for 2009 (in
fact, it turned out to be much lower).
• Unemployment expected to rise towards 5%.
• Inflation was expected to fall to 3.6%.
• Much uncertainty amongst forecasters.
• Is productivity growth high enough for the
longer run?
• Is Australia’s current account deficit a
problem for the longer run?

Monetary Policy Response to the Global
Financial Crisis
• Monetary policy was gradually tightened to combat the threat

of inflation from 2004 until August 2008. In September 2008,
monetary policy in Australia changed course due to the global
financial crisis.
• Are there limits to monetary policy?

Fiscal Response to the Global Financial
Crisis
• After a sequence of large fiscal surpluses, the government

changed course in late 2008, and the it is likely that the surplus
will disappear in 2009.
• Will these responses be enough? Are there any limitations?

Is productivity growth high enough for the
longer run?
Probably not.
Seems to be in secular decline, despite:
• Much microeconomic reform
- from 1980s, Australia’s highly regulated
economy was substantially deregulated
(freer labour & financial markets, reduced tariffs,
privatization, easier foreign firm entry etc).
• Large take-up of new information &
communications technologies (ICT)
- since late 1990s, Australia has been a world
leader in ICT usage (but not production).
These changes were not enough, because
productivity of its labour force is declining.

Is productivity growth high enough for the
longer run?
The underlying average rate of growth of output per worker decreased in the
mid-1970s. It fell again in the late 1980s to a low point in 1991 when Australia
was in recession, only to recover fast during the 1990s. Since 2001, it has
continuously declined to below 1 per cent. Productivity in terms of hours worked
was higher per worker in the 2000s due to the increased proportion of part-time
workers in Australia (now 15 per cent).
Is Australia’s current account deficit a
problem for the longer run?
Australia’s current account deficit reached 6 per cent of GDP in 2008.

Australia borrows from the rest of the world to finance this deficit.
What would happen if Australia was unable to borrow in a credit freeze?
What would happen to its exchange rate?
Is Australia’s current account deficit
a problem for the longer run?
From an all-time low in 2001, the Australian dollar appreciated gradually

until August 2008, and then collapsed about 20 per cent in two months.

Section 1.2: The United States

The United States

The United States
• As in Australia,1996-2006 was one of the

best decades in recent memory:
• Output growth was 3.4%, 0.3% higher
than average since 1970
• Steady increase in employment and a
steady decrease in the unemployment rate
to an average of 5% (compared to 6.2%).
• Low inflation rate averaging 2%
(compared to 4%).

The United States
• The U.S. economy did poorly in 2001: output

growth slowed-down to 0.7% with a short
recession.
• Output growth recovered until 2007 due to:
• aggressive monetary policy (Fed kept interest
rate very low – down to 1%!).
• very aggressive fiscal policy – massive
temporary tax cuts by Bush administration
leading to big fiscal deficits.
• weakening US dollar exchange rate boosting
exports.

The United States
• The US began to slow down again in 2007-2008.

• In February 2007, Alan Greenspan (former FED
Chairman) predicted a recession for 2008
because of the likely burst of the price bubble in
housing.
• In fact, growth was negative in 2009 due to the
financial crisis.
• What caused the housing bubble and the
subsequent financial crisis?
• Interest rates kept loo low for too long, leading to
excessive borrowing.
• Weaknesses in the architecture and regulation of
housing finance in the U.S. (sub-prime mortgages).

Responses to the Financial Crisis and the
Global “Great Recession” in 2008-2009
• Interest rates lowered almost to zero.

• FED is using many innovative ways to create
more liquidity to encourage banks to restore
normal lending.
• Large fiscal stimulus plans.
• Plans to improve financial regulation.
How successful were these responses?

Productivity Growth in the United States
• From 1996-2008, it has improved.

• Will this improvement survive the crisis of 2008-2009?

United States Trade & Current Account
Deficits
• Deficit was about 5% of US GDP or $700bn in 2008

• How long can this go on for?
Section 1.3: The European Union

The European Union
• 15 European countries (+ 8 east

European + Malta & Cyprus) comprise the
European Union, or EU27.
• Together, they form a formidable
economic power, with a combined output
close to the output of the United States.
• The standard of living in many of these
countries is also close to that of the
United States.

The European Union
 These EU5 countries generate 75% of

total EU27 output.

The European Union EU5

What Will the Euro Do for Europe?
• A common currency can:

• Reduce uncertainties associated with the
relative price of currencies.
• Contribute to economic growth, especially when
accompanied by the removal of other obstacles
to trade between European countries.
• Create difficulties for some countries associated
with the move to a common monetary policy.
Each Euro area country is unable to have its
own monetary policy and restricted in use of its
own fiscal policy.

Section 1.4: China

China

China
• In 2008, China is a major economic power

with:
• four times the population of U.S.
• one third the GDP of U.S., and thus
• relatively poor at one eighth of US GDP per
capita (PPP).
• China has been growing fast for 20 years, at
an average of about 9% per year:
• Global financial crisis has badly affected Chinese
exports, and growth is much lower in 2009.

Section 1.5: Looking Ahead

Other parts of the world
• Japan:
• Dramatic rise since WWII – ‘economic miracle’.
• Has done badly in last 15 years.
• Stock market bubble crashed in early 1990s leading
to a prolonged slump (average growth 1%).
• Just as it started to emerge from this slump in 2007,
the global financial crisis has hit Japan badly.
• Asia (including Singapore, South Korea, Taiwan,
India):
• Fastest growing region, until the global financial
crisis.
• India, the second most populous country, grew
7.7% in 2008, but its GDP <10% of US GDP.

Other parts of the world
• Latin America:
• Went from very high to low inflation in 1990s.
• Chile in relatively good economic shape in 2008 but suffering
badly in the global financial crisis.
• Argentina has suffered from repeated crises recently, but
doing better.
• Central & Eastern Europe:
• Many still struggling with transition from communist to
capitalist economies.
• Russia has done well recently due to high oil and gas prices,
but now struggling in the 2008-9 crisis.
• Africa:
• Has long suffered economic stagnation, disease and war.
Improvement by 2008 with growth of about 7% with most
countries growing. The crisis will affect it badly.

Gathering Economic Data
• International organisations, such as the

Organisation for Economic Cooperation and
Development (OECD), gather data for the
richest countries. (www.oecd.org)
• For countries that are not members of the OECD,
one of the main sources of information is the
International Financial Statistics (IFS), published
by the International Monetary Fund (IMF). (
www.imf.org)
• For Australia, the main source is the Australia
Bureau of Statistics (ABS) (www.abs.gov.au) and
the RBA. (www.rba.gov.au)

Chapter 2
A Tour of the
Book

Section 2.1: Aggregate Output
• National income and product accounts

are an accounting system used to measure
of aggregate economic activity.
• The measure of aggregate output in the
national income accounts is gross
domestic product, or GDP.

GDP: Production and Income
• There are three ways of defining GDP:
1. GDP is the value of the final goods and

services produced in the economy during
a given period.
• A final good is a good that is destined for
final consumption.
• An intermediate good is a good used in
the production of another good.

2. GDP is the sum of value added in the

economy during a given period.
 Value added equals the value of a firm’s
production minus the value of the intermediate
goods it uses in production.

3. GDP is the sum of the incomes in the

economy during a given period.

Nominal and Real GDP
• Nominal GDP is the sum of the quantities of final

goods produced times their current price.
• Nominal GDP increases over time because:
1. The production of most goods increases over
time.
2. The prices of most goods also increase over time.
• Real GDP is constructed as the sum of the
quantities of final goods times constant (rather
than current) prices.

• Using 2007 dollars to compute real GDP, then:
$24,000 $240,000
$24,000 $312,000

• Nominal GDP is also called dollar GDP or

GDP in current dollars.
• Real GDP is also called GDP in terms of
goods, GDP in constant dollars, GDP
adjusted for inflation, or GDP in, say,
2007 dollars.


• GDP growth equals: (Yt  Yt 1 )

Yt 1
• Periods of positive GDP growth are called

expansions.
• Periods of negative GDP growth are called

recessions.

Real GDP Growth

Section 2.2: The Other Major
Macroeconomic Variables
• GDP is obviously the most important

macroeconomic variable. But two other
variables tell us about other important
aspects of how an economic is performing:
1. Unemployment
2. Inflation

The Unemployment Rate
Labour force = employed + unemployed

L = N + U
U
u
Unemployment rate: L
Australia
July 2008
Employed 0.48
10.72 million u7/2008   4.3%
0.48  10.72
Unemployed
0.48 million


• Only those looking for work are counted as

unemployed. Those not working and not looking
for work are not in the labour force.
• People without jobs who give up looking for work
are known as discouraged workers.
• Participation rate
labour force

population of working age

• Why do macroeconomists care about

unemployment?
• Economists care about unemployment for
two reasons:
• Unemployment has important social
consequences.
• The unemployment rate gives them an
indication of whether an economy is
operating above or below its normal level of
activity.

The Inflation Rate
• Inflation is a sustained rise in the

general level of prices—the price
level.
• The inflation rate is the rate at which
the price level increases.
• Deflation is a sustained decline in the
price level, or a negative inflation rate.

The GDP Deflator
n o m in a l G D P t $ Y t
Pt  
real G D Pt Yt
• The GDP deflator is what is called an index
number—set equal to 100 in the base year.
• The rate of change in the GDP deflator
equals the rate of inflation:
( P t  P t1 )
P t1
• Nominal GDP is equal to the GDP deflator times
real GDP: $ Y t  P t Y t

The Consumer Price Index
• The GDP deflator measures the average price of

output, while the consumer price index (CPI)
measures the average price of consumption, or
equivalently, the cost of living.
• The CPI and the GDP deflator move together most of
the time.

The Consumer Price Index and the GDP
Deflator

The Inflation Rate
• Why do macroeconomists care about

inflation?
• Economists care about inflation for at least
two reasons:
• It affects relative prices (e.g. the real wage)
and thus income distribution.
• It creates other distortions
– changes in relative prices create uncertainty and
affect decision making.
– inflation can affect taxes through tax bracket creep.
.

Section 2.3: A Road Map
• Output is determined by:

• demand in the short run, say, up to a few
years;
• the level of technology, the capital stock,
and the labour force in the medium run,
say, up to a decade or so;
• factors such as education, research,
saving, and the quality of government in
the long run, say, a half century or more.

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Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• From an economic point of view, the period

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• The Australian economy had a mild slowdown in

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• How to respond to the major global financial

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• Monetary policy was gradually tightened to combat the threat

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• After a sequence of large fiscal surpluses, the government

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Australia’s current account deficit reached 6 per cent of GDP in 2008.

From an all-time low in 2001, the Australian dollar appreciated gradually

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• As in Australia,1996-2006 was one of the

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• The U.S. economy did poorly in 2001: output

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• The US began to slow down again in 2007-2008.

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• Interest rates lowered almost to zero.

How successful were these responses?

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• From 1996-2008, it has improved.

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• Deficit was about 5% of US GDP or $700bn in 2008

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• 15 European countries (+ 8 east

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

 These EU5 countries generate 75% of

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• A common currency can:

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• In 2008, China is a major economic power

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• International organisations, such as the

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• National income and product accounts

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• There are three ways of defining GDP:

1. GDP is the value of the final goods and

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• There are three ways of defining GDP:

2. GDP is the sum of value added in the

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• There are three ways of defining GDP:

3. GDP is the sum of the incomes in the

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• Nominal GDP is the sum of the quantities of final

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

• Using 2007 dollars to compute real GDP, then: