Aggregate expenditure: the European Economic Recovery Plan

Table of Content
1 Aggregate expenditure ......................................................................................................... 2
1.1 Theory ........................................................................................................................... 2
1.2 Case study of Euroarea ................................................................................................. 4
2 EERP in time of financial crisis ........................................................................................... 7
2.1 EERP ............................................................................................................................ 7
2.2 Empirical studies .......................................................................................................... 8
3 Conclusion ......................................................................................................................... 12
References ................................................................................................................................ 13
1 Aggregate expenditure
1.1 Theory
GDP is total expenditure of domestic goods and services. According to Robinson (2006),
following Keynes model, GDP contained four main expenditure types which are consumption,
investments, purchase of the Government, and net export (which is equivalent to export minus
import).
 Consumption Expenditure:
Consumption expenditure is the purchase of household sector on final products in a certain
period of time. This consumption accounts for two-third of aggregate expenditure, including the
purchase of households on food, clothes, as well as kitchen equipments. Consumption
expenditure contains three main groups, namely non-durable products, durable products and
services. Non-durable products can be food, clothes, or facial wipe whose use time lasts for a
maximum of one year only. Meanwhile, durable products are car, furniture and kitchen
equipments which can be used for over one year. Such services as health care, education, social
security, and other intangible ones have no relevance with physical goods.
Different consumption expenditures have its own importance in macroeconomics. For
instance, the households have the tendency of reducing their expenditure on durable product,
rather than non-durable ones in case the economy faces the contraction. And in case the economy
becomes more prosperous, the households tend to spend more on services.
 Investment Expenditure:
Business sector takes responsibility for the investments on capital products such as factory or
equipment. This kind of investment seems to be relatively volatile, however, it accounts for
about 10 to 15% of aggregate expenditure.
Investment expenditure contains three main types, including structure, equipment, and
inventory change. Structures can be factory, office building, shopping center, apartment, or
house for the residents. The range of equipment is larger, including machines or techniques for
production process, delivery vehicles, working features, and other techniques which contribute to
the production process of the businesses. Inventory change includes the increase or decrease of
the sources of raw material, intermediate, semi-finished, or finished products, contributing to
make input and output flows become smooth and appropriate with sales orders.
It seems to be hard to make decision on the undertaking of investment expenditure. A small
change of the economy could possible cause a huge increase or a big drop in investments. As a
consequence, investment is considered as the most volatile factor among four expenditures. Also,
it may make investment become one key reason for the instability of business cycle.
 Government Purchase:
Like household sector as well as business sector, government sector also purchases a part of
domestically-produced goods and services. This purchase of the government is called
government purchase. And government purchase accounts for 10 to 15% of total expenditure.
The theories as well as the policy makers pay much attention to the federal level when
studying macroeconomics, and also focus on the importance of three governmental levels,
including federal, state, and local. The purchase of federal government accounts for nearly one-
third of total expenditure. And the rest of total expenditure belongs to the consumption of state
government and local government. Not including all government spending, government purchase
contains only the consumption of final products and that is GDP (Gross Domestic Product). Such
government consumption as transfer payment, including social security or social welfare, is not
calculated in government purchase.
 Net Export:
Foreign sector is related to the purchase of domestic goods and services of non-domestic
citizens. Net export is calculated as the expenditure of foreign sector on GDP. Net export
normally accounts for below 5% of total expenditure, including two main components – import
and export. Import is the consumption of domestic sectors (government, businesses, and
households) on foreign products. Export is the consumption of foreign sectors on domestic goods
and services. And net export is equal to export minus import.
Export is one accurate method as one part of aggregate demand (AD); however, net export is
still applied since three types of expenditures on AD, namely consumption expenditure,
investment expenditure, and government purchase – contain a considerable number of products
imported from foreign nations. Therefore, the subtraction of import from export or the
calculation of net export will aim at eliminating foreign production from AD and calculate AD
on domestic production only.
1.2 Case study of Euroarea
The Figure 1 mentions about the data related to each expenditure element of GDP of EU from
2001 to 2011. The most important element was private final consumption, accounting for almost
60 percent of EU GDP during the given time. Government final consumption accounts for
around 22 percent and gross capital formation accounts for approximate 20 percent in 2011. The
trend of government final consumption was upwards; meanwhile, the trend of gross capital
formation showed higher versatility in the period. There was an increase to the highest level of
about 22 percent from 2003 to 2007 and then, a decrease to the lowest level of roundly 18 in
2009. Although external balance of goods and services accounts for only 1.2 percent of GDP, the
percentages of export and import were relatively high with more than 43 percent and 42 percent
respectively in 2011. According to the Figure 2, there are big differences of expenditure elements
among nations in 2011 and even there is such an inverse relationship between private final
consumption and Government final consumption. For example, the percentages of private final
consumption in the Netherlands, Sweden, and Denmark are low with 45 percent, 48 percent and
49 percent respectively; however, these nations have highest percentages of Government final
consumption with all of over 26 percent. On the other hand, highest percentage of over 65
percent of private final consumption belongs to Greece, Cyprus, and Portugal, but these nations
have such low percentages of Government final consumption. However, Luxembourg is an
exceptional case with low percentage of not only private final consumption but Government final
consumption as well. The highest percentages of gross capital formation of over 25 percent
belong to Romania and Latvia. These nations have high share in terms of industry; meanwhile
Greece, the UK, Malta, and Ireland focus mainly on services industry, and thus they have low
percentage of gross capital formation. Luxembourg and Ireland had their strength in external
balance of goods and services through the particularity of cross-border incomes, and goods and
services flow. For example, the purchase of fuel, cigarettes, or alcohol among non-residents will
be considered as export rate in Luxembourg. On the contrary, such negative external balance
with minus 5 percent and minus 8 percent belongs to Romania and Greece.

Source: Eurostat
Figure 1 Main EU expenditure components


Source: Eurostat
Figure 2 Main expenditure components by country

The decline of consumption and fixed investments, the volatility of net export, and the change
of inventory can cause erratic fluctuations in the growth rate of the economy.

Source: Eurostat
Figure 3 Contributions of aggregate expenditure components to economic growth in EU
2 EERP in time of financial crisis
2.1 EERP
In order to make response to financial crisis, the Governments in Euro area have done many
fiscal stimulus methods under the framework of the EERP (the European Economic Recovery
Plan). Table 1 below will reflect the analysis about these methods made by the EC (European
Commission, 2009). Fiscal stimulus methods account for 1.1% and 0.8% of GDP in 2009 and
2010. These methods are implemented, associated with the stimulus based on the operations of
automatic fiscal stabilizers. These methods do not contain such budgetary activities as capital
injection, financial loan and financial guarantee, or the investments of public corporations.
Table 1 Composition of the EERP

According to Table 1, under the EERP, the support for the purchase of households is nearly
40% of total stimulus package in Euro are in 2009 and 2010. Fiscal methods are formed by the
reduction of VAT, direct tax, social security contribution, and direct aids such as income support
for the households as well as the support for property market. There are many stimulus methods
to support the investments, and firms and organizations, respectively accounting for 30 percent
and 20 percent of total stimulus package. Investment support is represented by public investment
on infrastructure, meanwhile, the methods to support firms and organizations mainly aim at the
reduction of business cost (tax reduction, reduction of social security contribution, subsidy, or
export promotion). The lowest proportion minus 10 percent of total stimulus package is spent on
such methods related to the labour market (wage subsidy, or active labour policy).
2.2 Empirical studies
Top left panel of Figure 4 shows the contributions of government purchase (red line) to real
GDP in Euro area from first quarter of 2007 to second quarter of 2010. It is relatively flat, except
for only a slight decline in fourth quarter of 2009. On the contrary, there was a sharp collapse of
real GDP (blue line) from first quarter, 2008 to second quarter, 2009; a recovery in third quarter
of 2009; and then acceleration in early 2010. It seems very hard to make government purchase
become one stimulus package based on the information of that Figure.
The bottom left panel shows the contributions of private purchase to real GDP. Private
consumption saw a decline during the crisis; however, it increases again in third quarter of 2009.
The variations in consumption are relatively small in comparison with the variations of GDP
growth. But that finding is consistent with permanent income hypothesis related to smooth
consumption. As represented in top right panel, the contributions of fixed investments to real
GDP can explain the variations of GDP growth, associated with the contributions of net export as
well as inventory investment. According to this observation, the factors affecting investments
and net export, namely real interest rate, risk insurance, credit capacity can explain the crisis as
well as the recovery. In terms of policy activities, the factors which can affect the expense as
well as credit availability are interest rate cut of the Central Bank, credit or quantity easing
methods, or guarantee, capital injection for financial organizations.

Figure 4 GDP growth contributions through 2008-2010 recession and recovery
According to Cwik and Wieland (2011), fiscal stimulus in Euro are in 2009 and 2010 will be
examined and calculated by the information from European National Governments. The amount
of EU-11 fiscal stimulus package was more than 1 percent of GDP in 2009 and less than 0.9
percent of GDP in 2010. Those figures are nearly equal to the EC’s numbers of 1.1 percent of
GDP and 0.8 percent of GDP (Table 1) which had been used for stimulus package. Nevertheless,
two authors mainly focused on the evaluation of stimulus package which reflects the spending of
the Government on goods and services, as well as government investment. The amount of
Government spending and investment is about 0.5 percent of GDP in 2009 and 0.2 percent of
GDP in 2010. Once again, those figures are nearly equal to the amount of government spending
as well as investment in the Table 1.
In comparison with Cwik and Wieland (2011), Coenen mainly focuses on the significance of
the complementarities between private consumption and government spending. He also offers an
analysis about the effect of the EERP when considering the tools for government consumption as
well as revenue. Coenen et al. (2010) emphasizes the important role of monetary accommodation
to assess the efficiency as well as the effectiveness of fiscal stimulus package.
The output effect of the EERP is average deviation from the balanced growth path of the
model after applying the standardized fiscal stimulus package, monetary as well as fiscal
accommodation in two years (1.1 percent for year 1 and 0.8 percent for year 2). Through Table
2, the EERP fiscal multiplier as well as the EERP output effect has been revealed. The multiplier
has positive results of 0.52 and 0.57 in both two years and it tends to converge at the point of
0.75. With the assumption that there is a lift in fiscal stimulus methods in early year 3; however,
the effect on real GDP will fade away in a quick manner which could be observed through the
corresponding output effect. It is interesting that these results are compared with those of other
analyses in the reports of the EC 2009 and the ECB 2010. Nevertheless, current study can offer
deeper and more detailed analysis about different factors of the EERP fiscal multiplier.
Table 2 Effects of EERP

3 Conclusion
In this study, the four categories of aggregate expenditure including consumption,
investments, purchase of the Government and net export has introduced. Additionally, the recent
of these four categories in EU area has been reviewed. Moreover, the study also provided
information related to the European Economic Recovery Plans in times of crisis as well as their
effects on GDP growth in EU area.

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References
Coenen, G., Straub, R. and Trabandt, M. (2012). Gauging The Effects of Fiscal Stimulus
Packages In The Euro Area. Board of Governors of the Federal Reserve System. International
Finance Discussion Papers No. 1061
Cwik, T. and Wieland, V. (2010). Keynesian, government, spending, multipliers and spillovers
in the Euro area. European Central Bank (ECB). Working paper series No. 1267
European Commission (2009). European Economic Recovery Plan. Available at:
http://ec.europa.eu/environment/integration/recovery_plan.htm
Eurostat (2011). Europe in figures - Eurostat yearbook 2011. European Commission. Available
at:
http://epp.eurostat.ec.europa.eu/portal/page/portal/product_details/publication?p_product_cod
e=KS-CD-11-001
Eurostat (2012). National accounts - main GDP aggregates and related indicators. European
Commission. Available at:
http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/National_accounts_-
_main_GDP_aggregates_and_related_indicators
Eurostat (2013). GDP and main components - Current prices. European Commission. Available
at: http://appsso.eurostat.ec.europa.eu/nui/show.do?dataset=nama_gdp_c&lang=en
Robinson, S. (2006). Macro models and multipliers: Leontief, Stone, Keynes, and CGE models.
Poverty, Inequality and Development, 205-232.