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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
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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
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The Australian economy had a mild slowdown in 2001:
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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.

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From 2006 to 2008, the economy was steady:
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Blanchard, Sheen Macroeconomics 3e © 2009 Pearson Australia

Unemployment expected to rise towards 5%. Sheen Macroeconomics 3e © 2009 Pearson Australia . 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? Blanchard.6%. Inflation was expected to fall to 3.2% output growth for 2009 (in fact. it turned out to be much lower).3 issues for Australia ‡ How to respond to the major global financial crisis that began in September 2008: ‡ ‡ ‡ ‡ IMF forecast 2.

Are there limits to monetary policy? Blanchard. monetary policy in Australia changed course due to the global financial crisis. In September 2008. 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.

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? Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .Fiscal Response to the Global Financial Crisis ‡ ‡ After a sequence of large fiscal surpluses.

Blanchard. Australia¶s highly regulated economy was substantially deregulated (freer labour & financial markets.from 1980s.Is productivity growth high enough for the longer run? Probably not. Sheen Macroeconomics 3e © 2009 Pearson Australia . Seems to be in secular decline. easier foreign firm entry etc).since late 1990s. privatization. These changes were not enough. 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 . because productivity of its labour force is declining.

It fell again in the late 1980s to a low point in 1991 when Australia was in recession.Is productivity growth high enough for the longer run? The underlying average rate of growth of output per worker decreased in the mid-1970s. Sheen Macroeconomics 3e © 2009 Pearson Australia . only to recover fast during the 1990s. 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). Since 2001. Blanchard.

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 . 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 . Blanchard. 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.

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

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

4%.2%). 0. Blanchard. Low inflation rate averaging 2% (compared to 4%).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.The United States ‡ As in Australia.1996-2006 was one of the best decades in recent memory: ‡ ‡ ‡ Output growth was 3. Sheen Macroeconomics 3e © 2009 Pearson Australia .

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

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

How successful were these responses? Blanchard. Plans to improve financial regulation. FED is using many innovative ways to create more liquidity to encourage banks to restore normal lending. Large fiscal stimulus plans. Sheen Macroeconomics 3e © 2009 Pearson Australia .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. Will this improvement survive the crisis of 20082009? Blanchard. it has improved.

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. Sheen Macroeconomics 3e © 2009 Pearson Australia .

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

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

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. Each Euro area country is unable to have its own monetary policy and restricted in use of its own fiscal policy. Contribute to economic growth. Create difficulties for some countries associated with the move to a common monetary policy. especially when accompanied by the removal of other obstacles to trade between European countries. Sheen Macroeconomics 3e © 2009 Pearson Australia . Blanchard.

Sheen Macroeconomics 3e © 2009 Pearson Australia .4: China Blanchard.Section 1.

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

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

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

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

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

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

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

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

‡ An intermediate good is a good used in the production of another good. Blanchard. ‡ 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.GDP: Production and Income ‡ There are three ways of defining GDP: 1.

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

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.

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. Sheen Macroeconomics 3e © 2009 Pearson Australia . The prices of most goods also increase over time. Blanchard. 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. 2.

000 $24. Sheen Macroeconomics 3e © 2009 Pearson Australia . then: $24.Nominal and Real GDP ‡ Using 2007 dollars to compute real GDP.000 Blanchard.000 $312.000 $240.

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

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

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

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

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

Sheen Macroeconomics 3e © 2009 Pearson Australia .48 u7/2008 ! ! 4.48 million U u! L 0.48 10.72 Blanchard.72 million Unemployed 0.The Unemployment Rate Labour force = employed + unemployed L = N + U Unemployment rate: Australia July 2008 Employed 10.3% 0.

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

The Unemployment Rate ‡ ‡ Only those looking for work are counted as unemployed. Those not working and not looking for work are not in the labour force. Sheen Macroeconomics 3e © 2009 Pearson Australia . People without jobs who give up looking for work are known as discouraged workers. Participation rate ‡ labourforce ! population working of age Blanchard.

‡ The unemployment rate gives them an indication of whether an economy is operating above or below its normal level of activity.The Unemployment Rate ‡ Why do macroeconomists care about unemployment? ‡ Economists care about unemployment for two reasons: Unemployment has important social consequences. ‡ Blanchard. Sheen Macroeconomics 3e © 2009 Pearson Australia .

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

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. 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 .

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

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

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

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

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