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Chapter 1
A Tour of the World

Section 1.1: Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Australia

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson 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)

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

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. 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.

‡

From 2006 to 2008, the economy was steady:
‡ ‡ ‡

Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

3 issues for Australia ‡ How to respond to the major global financial crisis that began in September 2008: ‡ ‡ ‡ ‡ IMF forecast 2. Unemployment expected to rise towards 5%.2% output growth for 2009 (in fact. it turned out to be much lower). Much uncertainty amongst forecasters.6%. Inflation was expected to fall to 3. ‡ ‡ Is productivity growth high enough for the longer run? Is Australia¶s current account deficit a problem for the longer run? Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

Monetary Policy Response to the Global Financial Crisis ‡ ‡ Monetary policy was gradually tightened to combat the threat of inflation from 2004 until August 2008. Sheen Macroeconomics 3e © 2009 Pearson Australia . monetary policy in Australia changed course due to the global financial crisis. In September 2008. Are there limits to monetary policy? Blanchard.

Fiscal Response to the Global Financial Crisis ‡ ‡ After a sequence of large fiscal surpluses. Sheen Macroeconomics 3e © 2009 Pearson Australia . Will these responses be enough? Are there any limitations? Blanchard. and the it is likely that the surplus will disappear in 2009. the government changed course in late 2008.

Sheen Macroeconomics 3e © 2009 Pearson Australia . easier foreign firm entry etc). These changes were not enough. Australia¶s highly regulated economy was substantially deregulated (freer labour & financial markets.Is productivity growth high enough for the longer run? Probably not. because productivity of its labour force is declining. Seems to be in secular decline.since late 1990s. Blanchard.from 1980s. Australia has been a world leader in ICT usage (but not production). ‡ Large take-up of new information & communications technologies (ICT) . reduced tariffs. despite: ‡ Much microeconomic reform . privatization.

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. Blanchard.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 has continuously declined to below 1 per cent. Since 2001. Sheen Macroeconomics 3e © 2009 Pearson Australia . 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).

What would happen if Australia was unable to borrow in a credit freeze? What would happen to its exchange rate? Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia . Australia borrows from the rest of the world to finance this deficit.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.

Sheen Macroeconomics 3e © 2009 Pearson Australia . and then collapsed about 20 per cent in two months.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. Blanchard.

Sheen Macroeconomics 3e © 2009 Pearson Australia .Section 1.2: The United States Blanchard.

The United States Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

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. Sheen Macroeconomics 3e © 2009 Pearson Australia . Blanchard.The United States ‡ As in Australia.1996-2006 was one of the best decades in recent memory: ‡ ‡ ‡ Output growth was 3.2%). Low inflation rate averaging 2% (compared to 4%).

Output growth recovered until 2007 due to: ‡ aggressive monetary policy (Fed kept interest rate very low ± down to 1%!). Blanchard. economy did poorly in 2001: output growth slowed-down to 0.S.The United States ‡ ‡ The U. Sheen Macroeconomics 3e © 2009 Pearson Australia . ‡ weakening US dollar exchange rate boosting exports.7% with a short recession. ‡ very aggressive fiscal policy ± massive temporary tax cuts by Bush administration leading to big fiscal deficits.

leading to excessive borrowing. Blanchard. growth was negative in 2009 due to the financial crisis. (sub-prime mortgages). Alan Greenspan (former FED Chairman) predicted a recession for 2008 because of the likely burst of the price bubble in housing. Sheen Macroeconomics 3e © 2009 Pearson Australia . Weaknesses in the architecture and regulation of housing finance in the U. In February 2007.The United States ‡ ‡ ‡ ‡ The US began to slow down again in 2007-2008. In fact.S. What caused the housing bubble and the subsequent financial crisis? ‡ ‡ Interest rates kept loo low for too long.

How successful were these responses? Blanchard. Plans to improve financial regulation. Large fiscal stimulus plans. FED is using many innovative ways to create more liquidity to encourage banks to restore normal lending.Responses to the Financial Crisis and the Global ³Great Recession´ in 2008-2009 ‡ ‡ ‡ ‡ Interest rates lowered almost to zero. Sheen Macroeconomics 3e © 2009 Pearson Australia .

Productivity Growth in the United States ‡ ‡ From 1996-2008. it has improved. Will this improvement survive the crisis of 20082009? Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

Sheen Macroeconomics 3e © 2009 Pearson Australia .United States Trade & Current Account Deficits ‡ ‡ Deficit was about 5% of US GDP or $700bn in 2008 How long can this go on for? Blanchard.

Section 1.3: The European Union Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

Blanchard. Together. The standard of living in many of these countries is also close to that of the United States.The European Union ‡ ‡ ‡ 15 European countries (+ 8 east European + Malta & Cyprus) comprise the European Union. or EU27. Sheen Macroeconomics 3e © 2009 Pearson Australia . they form a formidable economic power. with a combined output close to the output of the United States.

Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .The European Union  These EU5 countries generate 75% of total EU27 output.

The European Union EU5 Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

What Will the Euro Do for Europe? ‡ A common currency can: ‡ ‡ ‡ Reduce uncertainties associated with the relative price of currencies. 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. Blanchard. Contribute to economic growth. Sheen Macroeconomics 3e © 2009 Pearson Australia . especially when accompanied by the removal of other obstacles to trade between European countries.

Sheen Macroeconomics 3e © 2009 Pearson Australia .Section 1.4: China Blanchard.

Sheen Macroeconomics 3e © 2009 Pearson Australia .China Blanchard.

at an average of about 9% per year: ‡ Global financial crisis has badly affected Chinese exports. one third the GDP of U.S.. Blanchard.S. China is a major economic power with: ‡ ‡ ‡ four times the population of U. and growth is much lower in 2009.China ‡ In 2008. and thus relatively poor at one eighth of US GDP per capita (PPP). Sheen Macroeconomics 3e © 2009 Pearson Australia . ‡ China has been growing fast for 20 years.

Section 1. Sheen Macroeconomics 3e © 2009 Pearson Australia .5: Looking Ahead Blanchard.

but its GDP <10% of US GDP. India): ‡ ‡ Fastest growing region. India. South Korea. Blanchard. until the global financial crisis.Other parts of the world ‡ Japan: ‡ ‡ ‡ ‡ Dramatic rise since WWII ± µeconomic miracle¶. the second most populous country. Taiwan. ‡ Asia (including Singapore. grew 7. Just as it started to emerge from this slump in 2007. the global financial crisis has hit Japan badly.7% in 2008. Has done badly in last 15 years. Sheen Macroeconomics 3e © 2009 Pearson Australia . Stock market bubble crashed in early 1990s leading to a prolonged slump (average growth 1%).

Argentina has suffered from repeated crises recently. but doing better. Has long suffered economic stagnation. disease and war. Blanchard. Many still struggling with transition from communist to capitalist economies. Chile in relatively good economic shape in 2008 but suffering badly in the global financial crisis. The crisis will affect it badly.Other parts of the world ‡ Latin America: ‡ ‡ ‡ Went from very high to low inflation in 1990s. but now struggling in the 2008-9 crisis. Russia has done well recently due to high oil and gas prices. Improvement by 2008 with growth of about 7% with most countries growing. Sheen Macroeconomics 3e © 2009 Pearson Australia ‡ Central & Eastern Europe: ‡ ‡ ‡ Africa: ‡ .

one of the main sources of information is the International Financial Statistics (IFS).imf.abs.org) For countries that are not members of the OECD. (www. published by the International Monetary Fund (IMF). such as the Organisation for Economic Cooperation and Development (OECD).au) and the RBA. the main source is the Australia Bureau of Statistics (ABS) (www.gov.au) Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .oecd. (www.org) For Australia. gather data for the richest countries. (www.rba.gov.Gathering Economic Data ‡ ‡ ‡ International organisations.

Sheen Macroeconomics 3e © 2009 Pearson Australia .Chapter 2 A Tour of the Book Blanchard.

The measure of aggregate output in the national income accounts is gross domestic product.Section 2. Sheen Macroeconomics 3e © 2009 Pearson Australia . or GDP. Blanchard.1: Aggregate Output ‡ ‡ National income and product accounts are an accounting system used to measure of aggregate economic activity.

Blanchard.GDP: Production and Income ‡ There are three ways of defining GDP: 1. ‡ A final good is a good that is destined for final consumption. Sheen Macroeconomics 3e © 2009 Pearson Australia . GDP is the value of the final goods and services produced in the economy during a given period. ‡ An intermediate good is a good used in the production of another good.

Value added equals the value of a firm¶s production minus the value of the intermediate goods it uses in production. Sheen Macroeconomics 3e © 2009 Pearson Australia .GDP: Production and Income ‡ There are three ways of defining GDP: 2. GDP is the sum of value added in the economy during a given period.  Blanchard.

Sheen Macroeconomics 3e © 2009 Pearson Australia . Blanchard.GDP: Production and Income ‡ There are three ways of defining GDP: 3. GDP is the sum of the incomes in the economy during a given period.

Sheen Macroeconomics 3e © 2009 Pearson Australia . 2. The prices of most goods also increase over time. Nominal GDP increases over time because: 1. ‡ Real GDP is constructed as the sum of the quantities of final goods times constant (rather than current) prices. Blanchard. The production of most goods increases over time.Nominal and Real GDP ‡ ‡ Nominal GDP is the sum of the quantities of final goods produced times their current price.

then: $24. Sheen Macroeconomics 3e © 2009 Pearson Australia .000 $24.000 $312.000 $240.000 Blanchard.Nominal and Real GDP ‡ Using 2007 dollars to compute real GDP.

Blanchard. GDP in constant dollars. or GDP in. Sheen Macroeconomics 3e © 2009 Pearson Australia . say.Nominal and Real GDP ‡ ‡ Nominal GDP is also called dollar GDP or GDP in current dollars. 2007 dollars. Real GDP is also called GDP in terms of goods. GDP adjusted for inflation.

Nominal and Real GDP Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

Nominal and Real GDP ‡ GDP growth equals: (Yt  Yt 1 ) Yt 1 ‡ Periods of positive GDP growth are called expansions. Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia . ‡ Periods of negative GDP growth are called recessions.

Real GDP Growth Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

Sheen Macroeconomics 3e © 2009 Pearson Australia .2: The Other Major Macroeconomic Variables ‡ GDP is obviously the most important macroeconomic variable. 2. But two other variables tell us about other important aspects of how an economic is performing: 1. Unemployment Inflation Blanchard.Section 2.

3% 0.72 million Unemployed 0.The Unemployment Rate Labour force = employed + unemployed L = N + U Unemployment rate: Australia July 2008 Employed 10.72 Blanchard.48 million U u! L 0. Sheen Macroeconomics 3e © 2009 Pearson Australia .48 10.48 u7/2008 ! ! 4.

The Unemployment Rate Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

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 ‡ labourforce ! population working of age Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .The Unemployment Rate ‡ ‡ Only those looking for work are counted as unemployed.

Sheen Macroeconomics 3e © 2009 Pearson Australia . ‡ Blanchard.The Unemployment Rate ‡ 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 prices²the price level. Sheen Macroeconomics 3e © 2009 Pearson Australia . Blanchard. or a negative inflation rate. The inflation rate is the rate at which the price level increases. Deflation is a sustained decline in the price level.

The rate of change in the GDP deflator equals the rate of inflation: ( Pt  Pt 1 ) Pt 1 ‡ Nominal GDP is equal to the GDP deflator times real GDP: $Yt ! Pt Yt Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .The GDP Deflator nominal GDPt $Yt Pt ! ! real GDPt Yt ‡ ‡ The GDP deflator is what is called an index number²set equal to 100 in the base year.

or equivalently. the cost of living.The Consumer Price Index ‡ ‡ The GDP deflator measures the average price of output. The CPI and the GDP deflator move together most of the time. Blanchard. while the consumer price index (CPI) measures the average price of consumption. Sheen Macroeconomics 3e © 2009 Pearson Australia .

Sheen Macroeconomics 3e © 2009 Pearson Australia .The Consumer Price Index and the GDP Deflator Blanchard.

Blanchard. ± inflation can affect taxes through tax bracket creep. . the real wage) and thus income distribution.g.The Inflation Rate ‡ Why do macroeconomists care about inflation? ‡ Economists care about inflation for at least two reasons: It affects relative prices (e. Sheen Macroeconomics 3e © 2009 Pearson Australia . ‡ It creates other distortions ‡ ± changes in relative prices create uncertainty and affect decision making.

say. the level of technology. research. factors such as education. say. up to a decade or so. Sheen Macroeconomics 3e © 2009 Pearson Australia .Section 2. and the quality of government in the long run. the capital stock. Blanchard. and the labour force in the medium run.3: A Road Map ‡ Output is determined by: ‡ ‡ ‡ demand in the short run. say. a half century or more. saving. up to a few years.

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