European Economics Macro

Week 1:

Introduction:
Peter Rodenburg
E-mail: P.Rodenburg@uva.nl
 Literature:
Baldwin & Wyplosz (B&W), The Economics of European
integration, 6th edition or 7th
Krugman & Wells (KW), Essentials of Economics, 5th
edition, 2020

BW KW
 Lectures:

Lecture: Tuesday

Work groups English: Wednesday 13h, 15h, 17h

Work group Dutch: Thursday 13h

See: UvA MyTimetable / Rooster

• Lectures not recorded

• Older lectures available on Canvas
 Lectures:
Week 1 - Macroeconomics and trade-off of between
unemployment and inflation

Week 2 - International trade, Capital flows & Exchange

rates; OCA theory

Week 3 - Money, European banking and the euro

Week 4 - Keynes, business cycles and fiscal policy

Week 5 - ECB and monetary policy

Week 6 - Credit and Euro crisis

 Remarks:

• Content of week 1, 2, 3 is introductory

• No mathematics / algebra

Do not underestimate this course!

 Examination:

Macro (block 1) Micro (block 2)

Midterm Final exam Midterm Final exam

exam macro macro exam micro micro

Grade macro = (midterm + final macro)/2

Grade micro = (midterm + final micro)/2

Final grade course = (grade macro + grade micro)/2 > 5.5

 Examination:

Final exam:
• 3 Hours
• Closed book
• 6 Questions (1 for each week) each 3-4 subquestions
• No calculations needed
• Tuesday 24 October 15h-18h
 Lecture 1 – Macro Economics

Important topics:
- Microeconomics vs macroeconomics
- Real vs nominal
- Frictional, structural and cyclical unemployment
- Inflation
- Phillips-curve
 Literature week 1

• KW 12 – Macroeconomics, The Big Picture

• KW 13 – GDP & the CPI: Tracking the Macroeconomy
• KW 14 – Unemployment and Inflation
• Krugman – Phillips-curve (Canvas) 8 pages
 Subject lecture today

• Unemployment
• Inflation

• GDP => workgroup Wednesday/Thursday

 What is macroeconomics?

What is microeconomics?

- Economic actors make choices

- Economic actors optimize scarce means

economic actors / agents =

consumers, workers, households, firms, state,
institutions, etc.
 What is macroeconomics?

Macros (big), oikos (house), nomos (custom, rule, law)

 study of (the laws that govern) big households

Macroeconomics is about aggregated variables

Unemployment, inflation, interest rates, exchange

rates, economic growth etc. of a country
What is macroeconomics?

unemployment
What is macroeconomics?

Government Bond interest rates

What is macroeconomics?
What is macroeconomics?
Study of big households
 AD-AS diagram:

p Supply

p*

Demand

q
 When Macroeconomics?

‘Discovery’ of macro economy in 1930s

John Maynard Keynes (1936)

Problem: Concepts hard to measure

Gross Domestic Product (GDP) → work groups

Inflation
Unemployment
Aggregate demand
Business cycle
 Definitions of unemployment
Dutch Statistical Office:
Persons without a job, or work for less than twelve
hours a week, who are actively looking for paid work for
twelve hours or more per week and readily available.
International Labour Office (ILO):
Be without work in the week before the survey but
available for work and have recently taken specific job-
search steps.
KW: p.376
i) jobless, ii) looking for jobs, and iii) available for work
 Measurement of unemployment

• Surveys (sample)
• Claimant count (counting all people receiving benefits)

x 100

Labour force
= sum of workers and unemployed between 16 and 65
 Popular explanations for
unemployment
- Laziness (‘work shy ….’)
- No incentive to work (benefits are too high)
- Wages are too high - excessive wage demands unions

- Credit crisis (building sector declined)

- Emerging competitor countries (China) (outsourcing)
- Budget cuts government (Greece)
- Overrated currency / low competitiveness (Italy?)
- External shock (i.e. Covid lock down)
- Economic uncertainty
 Theories on unemployment

Microeconomic: Neoclassical theory

Macroeconomic: Keynesian theory
 Neoclassicals on unemployment

• Marginal analysis (marginal utility)

• Individual utility maximisation
• Individual choice problem

Unemployment = balancing utility of work (wage) and

disutility work (fatigue, giving up leisure)

Optimum: where marginal benefit equals marginal cost

MB = MC
 Neoclassicals on unemployment

If labour market works well: ‘no’ unemployment

Unemployment = Frictional unemployment

i.e. 'matching' in the labour market takes time

→ Unemployment = short-term problem

→ No government intervention needed
 AD-AS diagram:

KW
p.384
w (wage) AS

We

AD

L (Labour)
 Neoclassical theory:
Structural unemployment:

KW
p.384
 Structural unemployment:

When there are more people seeking jobs in a

particular labor market than there are jobs
available at the current wage rate. (KW, p.384)
(that is = the economy is not in recession or crisis)

=> Wage rate persistently above WE

 Neoclassical theory :
Causes:
• Unions
• Minimum wages
• Employment protection legislation
• Unemployment benefits
• Wedge (difference gross - net salary)

→ Unemployment is 'voluntary'
 How about machines?
Do machines cause persistent unemployment?
 Neoclassical theory :
Summary:

If there is unemployment, it consists of:

• Frictional unemployment (can’t be solved)
• Unemployment due to too high wages (accept lower
wages)

Cause of unemployment is the worker / trade union

(better accept lower wages)
Another cause: the business cycle
 1936: Keynesian revolution
General Theory of Unemployment, Interest and Money

• Macroeconomic analysis
 Keynes on unemployment

Problem:
Insufficient effective demand (aggregate demand)
Þ Products remain unsold (there is overproduction)
Þ Companies lay off workers
Þ Even less demand for products
Þ Government cuts budget
Þ Even less demand for products
 Keynes on unemployment

Keynes: economy is not working at full capacity

→ Cyclical unemployment (caused by business cycle)
→ Involuntary unemployment
→ Government can actively combat unemployment
 Keynes on fighting unemployment

Remedy:
Expansonary fiscal policy (stimulate economy)

Examples:
New Deal
Covid fiscal expansion
Great Depression USA
 Natural Rate of Unemployment
After Keynes 3 categories:
• Frictional unemployment
• Structural unemployment
• Cyclical unemployment

Natural Rate of Unemployment (Friedman,1968)(KW 389)

= Frictional unemployment + Structural unemployment
 Inflation
Inflation: is the average raise in prices of goods and
services consumers buy

Is measured as the rise in Consumer Price Index (CPI)

in a certain time period

KW p. 366
 Inflation
Inflation:
x 100

x 100

KW p. 390
 Inflation

Other price indexes:

• Producer price index (PPI)
• GDP deflator

CPI-index most often used

 GDP deflator vs CPI

GDP deflator:
measures average prices of all new, domestically
produced final goods and services in the economy

Consumer price index (CPI):

measures average prices of the typical expenditure
basket of an (urban) consumer
 Winners and losers of inflation

If inflation is higher than expected debt become less:

Inflation is beneficial for borrowers

Inflation = ‘tax on having money’

The rich pay more 'taxes'
Hyperinflation Germany 1922-23
 Unemployment and inflation

Milton Friedman (1968)

Based on Phillips-curve (1958):

P
inflation

U (unemployment)
Short Run Phillips Curve (SRPC):
Suggests a trade-off between
unemployment and inflation.

Milton Friedman (1968):

• No trade-off between unemployment and inflation
• Inflation only determined by money supply
• Money supply has no effect on real variables
(Employment, output growth, etc).
 Expected inflation & Phillips Curve
Friedman:
People and firms have expectations about future
inflation and act according to these expectations
 Expected inflation & Phillips Curve
Workers:
Expected inflation > current inflation
Raise wage demands

Firms:
Expected inflation > current inflation
Raise prices of their products

Higer expectations raises current inflation!

Government stimulates
economy:
→ A Inflation = 2%
Over time people get used
to 2% inflation
Expected inflation ↑
 Natural Rate of Unemployment

Friedman: No long run trade-off

P
inflation

U (unemployment)
NAIRU = Natural rate
 Natural rate changes!

Phillips-curve shifts!

p
inflation

U (unemployment)
Shifts of the Phillips curve:

USA
 What causes these shifts?

The organization and institutions of the labour market

End