1. CHAPTER 1 A Tour of The World CHAPTER 1 Prepared by: Fernando Quijano and Yvonn Quijano Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard

2. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 2 of 18 A Tour of the World The United States Figure 1 - 1

3. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 3 of 18 1-1 The United States When macroeconomists study an economy, they first look at three variables:  Output  The unemployment rate  The inflation rate

4. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 4 of 18 1-1 The United States Table 1-1Growth, Unemployment, and Inflation in the United States Since 1970 1970–2006 (average) 1996–2006 (average)200620072008 Output growth rate3.1%3.4%3.3%2.1%2.5% Unemployment rate6.25.04.6 4.8 Inflation rate4.02.02.92.62.2 Output growth rate: annual rate of growth of output (GDP). Unemployment rate: average over the year. Inflation rate: annual rate of change of the price level (GDP deflator). The period 1996-2006 was one of the best decades in recent memory:  The average rate of growth was 3.4% per year.  The average unemployment rate was 5.0%.  The average inflation rate was 2.0%.

5. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 5 of 18 The average rate of growth of output per hour appears to have increased again since the mid-1990s. 1-1 The United States Rate of Growth of Output per Hour in the United States Since 1960. Figure 1 - 2 Has the United States Entered a New Economy?

6. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 6 of 18 1-1 The United States Should We Worry About the U.S. Trade Deficit? The trade deficit increased from about 1% of output in 1990 to about 6% of output in 2006. The U.S.Trade Deficit Since 1990 Figure 1 - 3

7. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 7 of 18 1-2 The European Union The European Union Figure 1 - 4

8. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 8 of 18 Table 1-2Growth, Unemployment, and Inflation in the Five Major European Countries Since 1970 1970–2006 (average) 1996–2006 (average)200620072008 Output growth rate2.3%2.0%2.7%2.6%2.2% Unemployment rate7.48.77.67.06.7 Inflation rate5.41.81.71.82.2 Output growth rate: annual rate of growth of output (GDP). Unemployment rate: average over the year. Inflation rate: annual rate of change of the price level (GDP deflator). 1-2 The European Union

9. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 9 of 18 The economic performance of the five countries in Table 1-2 has been far less impressive than that of the United States over the same period:  Average annual output growth from 1996 to 2006 was only 2.0%.  Low-output growth was accompanied by persistently high unemployment.  The only good news was about inflation. Average annual inflation for these countries was 1.8%, much lower than the 5.4% average over the period 1970 to 2006. 1-2 The European Union

10. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 10 of 18 1-2 The European Union Two issues dominate the agenda of European macroeconomists:  High unemployment  Common currency

11. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 11 of 18 How Can European Unemployment Be Reduced? 1-2 The European Union The unemployment rate in the four largest continental European countries has gone from being much lower than the U.S. unemployment rate to being much higher. Unemployment Rates: Continental Europe Versus the United States Since 1970 Figure 1 - 5

12. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 12 of 18 There is still disagreement about the causes of high European unemployment:  Politicians often blame macroeconomic policy.  Most economists believe, however, that the source of the problem is labor market institutions.  Some economists point to what they call labor market rigidities.  Other economists point to the fact that unemployment is not high everywhere in Europe. 1-2 The European Union How Can European Unemployment Be Reduced?

13. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 13 of 18  Supporters of the Euro point first to its enormous symbolic importance.  Others worry that the symbolism of the euro may come with some economic costs. 1-2 The European Union What Will the Euro Do for Europe?

14. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 14 of 18 Japan 2003 Figure 1 - 6 1-3 Japan

15. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 15 of 18 Since 1960, Japan’s output has grown at an average annual growth rate of 47.%, 1.5% higher than the growth rate of the U.S. over the same time period. This is the good news. Table 1-2 Growth, Unemployment, and Inflation in Japan, 1960-2004 1960-2000 (average) 1994-2000 (average) 20012002 20032004 Output growth rate4.7 1.40.4  0.3 2.53.0 Unemployment rate2.0 3.7 5.0 5.4 5.34.8 Inflation rate5.1  0.1  1.5  1.2  2.5 -2.0 Output growth rate: annual rate of growth of output. Unemployment rate: average over the year. Inflation rate: annual rate of change of the price level (GDP deflator. 1-3 Japan

16. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 16 of 18 In the Japanese economy, the bad news is:  The average annual rate of growth of output from 1994 to 2000 was only 1.4%.  The unemployment rate steadily increased.  As a result of high unemployment, the inflation rate decreased and eventually turned negative. 1-3 Japan

17. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 17 of 18 What Triggered the Slump? The large increase in the index in the second half of the 1980s was followed by an equally sharp decline in the early 1990s. Figure 1 - 7 The Japanese Stock Market Index since 1980

18. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 18 of 18 What Triggered the Slump? The trigger for the slump of the 1990s can be found in the striking movements in Japanese stock prices from the mid-1980s to the early 1990s. In general, stock prices move for one of two reasons:  The fundamentals. Anticipation of higher expected profits lead investors to pay higher stock prices.  Speculative bubbles, or fads, where investors buy stocks at high prices hoping to resell them at even higher prices in the future.

19. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 19 of 18 How Will Japan Recover? Both monetary and fiscal policy were used to increase demand and thereby increase output:  The Japanese central bank decreased interest rates to very low levels.  The Japanese government increased spending on public works and cut taxes to stimulate spending by consumers and firms.  Crucial role of the banking system: cleaning up and consolidating bad loans took long

20. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 20 of 18 1-4 China China Figure 1 - 6

21. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 21 of 18 Since 1980, Chinese output has grown at close to 10% per year, and the forecasts are for more of the same. This is a truly astonishing number: Compare it to the 3.1% number achieved by the U.S. economy over the same period. At that rate, output doubles every 7 years. Table 1-3Growth and Inflation in China Since 1980 1980–20061996–2006200620072008 Output growth rate9.3%8.8%10.7%10.0%9.5% Inflation rate5.43.31.52.52.2 Output growth rate: annual rate of growth of output (GDP). Inflation rate: annual rate of change of the price level (GDP deflator). 1-4 China

22. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 22 of 18 1-5 Looking Ahead These are the questions to which you have been exposed in this chapter:  What determines expansions and recessions? Can monetary policy be used to prevent a recession in the United States? How will the Euro affect monetary policy in Europe?  Why is inflation so much lower today than it was in the past? Can Europe reduce its unemployment rate? Should the United States reduce its trade deficit?  Why do growth rates differ so much across countries, even over long periods? Has the United States entered a New Economy, in which growth will be much higher in the future? Can other countries emulate China and grow at the same rate?

23. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 23 of 18 The global economy in 2008 The „Great Moderation” between about 1984-2007 seems to have come to an end  A time of high growth and low inflation  Attributed to either better monetary policy, or smaller shocks, or both  Also, high growth in emerging markets (China) pushed down manufacturing prices Today almost all macroeconomic problems are coming back, plus change  Dramatic growth slowdown  Inflation has shot up due to prices of primary products  The „subprime” problem: bursting housing bubble leading to a „credit crunch”

24. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 24 of 18

25. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 25 of 18 What can policy do? Monetary policy  Threat of recession: cut interest rate  Threat of inflation: increase interest rate  Credit crunch: provide liquidity Fiscal policy  Increase spending  Cut taxes  Budget deficit, Ricardian households? Problems  Relative price change: must run its course  Liquidity: trust, balance sheets have to be cleaned up

26. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 26 of 18 Gathering Macro Data  International organizations, such as the Organization for Economic Cooperation and Development (OECD), gather data for the richest countries.  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).  The IMF also publishes, twice a year, the World Economic Outlook, an assessment of macroeconomic developments in various parts of the world.  In the United States, an extremely good annual resource is the Economic Report of the President, prepared by the Council of Economic Advisors.

27. Chapter 1: A Tour of the World Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard 27 of 18  European Union (EU)  Organization for Economic Cooperation and Development (OECD)  International Monetary Fund (IMF) Key Terms