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BCO1214MACROECONOMICS Task brief & rubrics

REPORT

Description:

· Choose ONE of the topics detailed below to write a report

· Weight: This task is worth 45% of your overall grade for this subject.

· The session of Week 13 will be an extra tutoring session: you will be able ask the professor for last advice on your project.

Assignment Launch: Week 10.

Submission: Week 13 – Via Moodle (Turnitin). The deadline is 17th of May at 23:59hrs (Barcelona’s time).

Formalities:

· The minimum amount of words to be used is 1500 and the maximm is 2200

· You may want to include images/graphics etc. (for example from their website) to make your reasoning and argumention more visual and explicative

· Font: Arial. Size: 12,5pts. Line spacing: 1,5. Text align: Justified.

· Appendices and References, do not count towards the final wordcount but are strongly recommended (referencing websites, articles, books etc.)

CHOOSE ONE OF THE FOLLOWING TOPICS – DO NOT DO BOTH TOPIC 1 AND TOPIC 2, ONLY DO 1 OF THEM!

Topic 1: Eurozone and Macroeconomic goals

Write a report that assess the role of the Eurozone institutions to achieve macroeconomic goals.

The report should include the following sections:

· Cover Page: Title, Course, Name of Student

· Table of Contents

· Section 1.
(25%) The Eurogroup is debating EU-wide unemployment insurance scheme.

· Define the different types of unemployment and discuss which one is the target of such a measure.

· Analyze the possible effects of this measure using the concepts delivered in class.

· Section 2. (25%) Monetary authorities.

· In the Eurozone, which institution oversees monetary policy, and which one controls fiscal policy?

The main goal of the European Central Bank is controlling the inflation. Why it is so important? To answer this question:

· define aggregate demand and aggregate supply in the long-run and short-run (use graphs), and

· explain the main effects of rising prices in the economy using the concepts delivered in class.

· Section 3. (25%) During the 2008 crisis, the Eurozone countries applied different strategies to prevent a fall of aggregate demand.

· Provide two examples of fiscal policies in face of an economic crisis and discuss their positive and negative effects on aggregate demand. Use the concepts of “multiplier effect” and “crowding-out effect” delivered in class.

· Section 4. (25%) There is evidence of an increasing protectionism in global trade (US and China trade war), which might cause a fall in global trade.

· Explain what the expected impact of the fall in international trade on the Eurozone economy might be. Use the AD/AS model and the concepts delivered in unit 8. This section must include a written explanation and charts.

· Bibliography

Topic 2: The role of Eurozone during the coronavirus crisis

Write a report that assess whether the Eurozone countries have so far responded adequately to the economic challenges that have arisen during the coronavirus crisis.

The report should include the following sections:
· Cover Page: Title, Course, Name of Student
· Table of Contents

· Section 1. (25%) The Eurogroup is debating EU-wide unemployment insurance scheme to mitigate the effects of the coronavirus crisis.

· Define the different types of unemployment and discuss which one is the target of such a measure.
· Analyze the possible effects of this measure using the concepts delivered in class.

· Section 2. (25%) The Eurogroup is discussing issuing Bons to cushion the economic downturn.

· In the Eurozone, which institution oversees monetary policy, and which one controls fiscal policy?
The main goal of the European Central Bank is controlling the inflation. Why it is so important? To answer this question:
· define aggregate demand and aggregate supply in the long-run and short-run (use graphs), and
· explain the main effects of rising prices in the economy using the concepts delivered in class.

· Section 3 (25%) Fiscal and monetary policies

·

· Provide information on fiscal and monetary policies that are being (or are planned to be) implemented as a response to the coronavirus crisis to prevent a fall of aggregate demand.

· Provide two examples of fiscal policies in face of an economic crisis and discuss their positive and negative effects on aggregate demand. Use the concepts of “multiplier effect” and crowding-out effect” delivered in class. This section must include a written explanation.

· Section 4. (25%) Coronavirus crisis will certainly cause a fall of global trade.

· Explain what the expected impact of the fall in international trade on the Eurozone economy might be. Use the AD/AS model and the concepts delivered in unit 8. This section must include a written explanation and charts.

· Bibliography

Outcomes: This task assesses the following learning outcomes:

· understand the forces determining macroeconomic variables such as national output, inflation, unemployment, and interest rates.

· apply macroeconomic terminology and assess macroeconomic policy suggestions.

· evaluate real life situations with a practical application of the acquired tools and knowledge.

RECOMMENDED SOURCES:

· Data: Eurostat

https://ec.europa.eu/eurostat/home

· Information: European Commission

https://ec.europa.eu/info/index_en

Rubrics

Exceptional 90-100	Good 80-89	Fair 70-79	Marginal fail 60-69
Knowledge and Identification of the main Issues 20%	Identifies and demonstrates a sophisticated understanding of the main issues / problems in the case study	Identifies and demonstrates an accomplished understanding of most of the issues/problems.	Identifies and demonstrates acceptable understanding of some of the issues/problems in the case study	Does not identify or demonstrate an acceptable understanding of the issues/problems in the case study
Application 30%	Student applies fully relevant knowledge to the situation provided	Student applies mostly relevant knowledge to the situation provided	Student applies some relevant knowledge to the situation provided. Some minor misunderstandings may be evident.	Student applies little relevant knowledge to the situation provided. Misunderstandings are evident.
Evaluation 30%	Student assembles a coherent response to the question, providing a range of support and justification that leads to a well-reasoned conclusion	Student assembles a good response to the question, providing support and justification that lead to a well-reasoned conclusion	Student assembles a fair response to the question, providing some support and justification that lead to a well-reasoned conclusion. Minor misunderstandings may be evident	Student’s response to the question lacks coherence. Limited support and justification are provided that may or may not be well linked to the conclusion
Communication 20%	Student communicates ideas extremely clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account.	Student communicates ideas clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account.	Student communicates ideas fairly clearly and concisely. Compliance with the guidelines on font, size, line spacing and text align will also be taken into account.	Student attempts to communicate ideas clearly and concisely, with some problems. Student does not follow the guidelines on font, size, line spacing and text align.

Guidance notes to deal with sections 1 and 2 of both topic 1 and topic 2 (you should only do topic 1 or topic 2 but sections 1 and 2 are the same for both of them). Here are some guidance notes on what you should cover in sections 1 and 2. The guidance notes are all underlined. These notes are very detailed and so you will need to be selective and add in diagrams and supporting evidence (citations and references) to complete your work to a high standard.

· Section 1. (25%) The Eurogroup is debating EU-wide unemployment insurance scheme.

Define the Eurogroup

– the set of countries that belong to the Euro. How many are there? Who are they?

For topic 2 also consider coronavirus too here, it´s effect on unemployment – basically it has raised unemployment levels and means more people will need to receive unemployment benefits… which will be very expensive for government and could increase the fiscal deficit and government debt (define both of these things). This could then cause confidence in government bonds to fall! Which could make it harder for European governments to borrow.

What are bonds – a tool to enable the government to borrow from the people.. it´s an alternative to taxation or to printing money as a way to for the government to raise its spending power… for bonds to be sold and to function as a way for the government to raise money people must have trust in the government´s power to repay them! So the issue now is if government spending (e.g. on unemployment benefits) rises then people´s trust in the government´s power to repay bonds may fall! Making it harder for government to sell bonds.

What is the Euro?

It´s a single currency that was created 1999 and it aims to increase trade within the Eurozone by removing currency fluctuations and transaction costs of doing trade across borders (e.g. the fees to swap currencies have been removed because there now is just 1 currency)

Unemployment insurance scheme-

this is a welfare policy that aims to protect workers who have lost their jobs. So in the case that someone is unemployed (define unemployment) people still need an income to live off and this is what the insurance scheme offers… how is it paid for? Taxes… so the way an insurance scheme works is that you pay in to the scheme (in this case through taxes) and if/when the BAD event happens (in this case people becoming unemployed) the insurance scheme that the worker has paid in to kicks in and will pay out money to the workers.. the scheme operates on a large scale, so there are a lot of people paying in small amounts and hopefully at anyone time there are only a few people who need to take money out of the scheme (i.e. only a few unemployed we hope) so they can get a large enough amount to live off, and then the scheme remains affordable.

The scheme can however become unaffordable if unemployment becomes high, as happened after the 2008 Financial Crash and as is happening in today 2020 due to the Coronavirus Crisis.

In Europe, in many countries, unemployment insurance schemes give workers a certain percentage of their salaries (from when they were working), so they are quite generous, whereas in a place like the UK each unemployed person would get a fixed sum of unemployment benefit only each week.

What exactly is the proposed scheme the question is talking about, have a look here to this link:

https://en.wikipedia.org/wiki/European_unemployment_insurance

What the scheme would do (if it came in to existence, NOTE, IT DOES NOT EXIST RIGHT NOW) is it would create a common fund across the Eurozone from which unemployment benefits/unemployment insurance is paid. So places like say Greece where unemployment levels are above the Eurozone average would in effect get their unemployment insurance subsidized by the tax payers of places like Germany where the level of unemployment is below the Eurozone average… so this policy would be like one step towards having a common fiscal policy for the Eurozone.

· Define the different types of unemployment and discuss which one is the target of such a measure (i.e. the insurance scheme that some people are proposing).

Unemployment – when people are willing and able to work but don’t have a job

Types of unemployment:

(a) Cyclical or Keynesian or Demand deficient (3 names for the same thing) – this is the unemployment that occurs typically when there is a recession and AD is low, people lack confidence that their jobs are safe and so they stop spending, we get negative multipliers in this period and this may all be the consequence of excessive spending and borrowing in boom times, and the recession is the period when people have realized they have borrowed too much or lent too much and now they stop lending and borrowing… so we get a negative spiral in the economy which leads to unemployment. When AD is low GDP tends to be low, there is SPARE CAPACITY on the AS curve, workers are not being fully employed, you can show this diagrammatically if you want to.

(b) Structural – this is when jobs disappear because of them moving abroad (e.g. to China, why? Because the costs of production and employment are cheaper there) or maybe this type of unemployment is due to mechanization (machines replacing people)… this is really a very concerning form of unemployment, as it can become long term and permanent and it can involve certain regions (like the South of Spain or the South of Italy or poorer parts of Greece) going in to decline as the jobs are lost there and we get local negative multipliers and good workers choose to leave the area for booming areas and people no longer want to invest in these suffering regions.. crime and poverty in such areas can rise and this can also reduce the desire for people to want to invest in such depressed regions. This is a really worrying form of unemployment.

(c) Seasonal – e.g. in the agricultural sector or tourism sector or leisure (e.g. skiing) sector where there is a high demand for workers at one point in the year and then low demand for workers at another point of the year

(d) Frictional – this is temporary unemployment that occurs when people are between jobs, or just left university and not yet quite found a suitable job… it´s not a very worrying form of unemployment, unlike structural unemployment because that form of unemployment can be long term and with that form of unemployment it can get harder to get a job over time

(e) Classical unemployment/Real wage inflexibility – this is the idea that unemployment is caused (largely or only) by workers refusing to accept lower wages and the view is that the market would always get people a job who want to work, but things like a minimum wage and trade unions who keep wages high artificially according to this theory, prevent people from accepting jobs at lower wages and prevent employers from creating even more jobs… so a min wage according to this theory promotes unemployment… so in this point of view certain protections for workers like the min wage, actually end up hurting some workers as it creates unemployment… this theory tends to blame employee rights and trade unions for unemployment and argues that a less regulated labour market would be a good thing as it would reduce unemployment… Keynesians tend to not generally like this concept that much and argue that unemployment is not so much the fault of the worker but explained by generally poor economic conditions

Which type of unemployment does the European Insurance scheme try to target?

All of them, as the policy would cover people and lead to payments to people who suffer any type of unemployment.

But the policy may most directly target people who are in cyclical and structural unemployment – the policy is aiming to ensure that all nations can afford to pay the unemployed enough money if and when high unemployment occurs as happened after 2008… so a place like Greece was struggling to pay unemployment benefits to people in its recession after 2008 and so this scheme would ensure that the money came from all over the Eurozone to help the places that are suffering the most unemployment and that need to make the most payment to its people.. so it redistributes money from one region to another (from the regions with more money) to the ones with less… so for instance in this policy German tax payers (who are in an economy that offers lots of jobs and better pay) would be subsidizing Greece to pay unemployment benefits to Greek workers who had lost their jobs.. Germany and Greece are both part of the Euro… so it would kind of promotes equality across the Eurozone, it would represent help from the richer Eurozone nations to the poorer ones if this policy was introduced.

· Analyze the possible effects of this measure using the concepts delivered in class.

· The policy should help places with high unemployment (e.g. Greece) – it should help them to pay unemployment benefits to unemployed people

· It should keep the fiscal deficits and governments debts of high unemployment nations in the Eurozone (e.g. Greece) down and this should help to reduce the riskiness of their government bonds down, which should keep interest rates down there and should make it easier for these governments to borrow and fund their spending

· This should also prevent crowding out of the private sector

· But it will do the reverse to the nations that contribute more to the scheme like Germany – they will be subsidizing the payments of unemployment benefits to places like Greece and so tax payments may go up and/or fiscal deficits/government debt could rise in such places and it could force these nations to reduce spending on other things like healthcare as they are contributing more to this scheme

· But it could help to prevent economic crisis and poverty and crime in the unemployment area

· But then again unemployment benefits could create a moral hazard – the idea that those getting the benefits, which could now guaranteed by this scheme, could become lazier and not want to work or simply more and more dependent on benefits and less willing to get off benefits… the pressure on a place like Greece to cut the benefits and make them smaller has been reduced and this could in the long run hurt the aggregate supply levels in Greece if people become dependent on the benefits being given

SUCH a policy could put the Political unity of the Eurozone/EU under stress

… as the people of those places in the Eurozone that subsidise this policy may start to think the policy is unfair and not beneficial to them! They may start to oppose the Eurozone and want to leave it (thinking why should they pay taxes to subsidise people who are not working in other parts of the Eurozone)… so this policy could perhaps be a risky one for the Eurozone to pursue, especially after the UK had just left the EU as it thought being in the EU was not in the UK´s best interests.. such a common unemployment insurance policy may lead to anti EU/Euro feelings rising in the wealthier parts of the EU/Eurozone. So the political viability of this proposed policy could be questioned by you.

Arguably this policy would be one step towards having a common fiscal policy.. but right now in the EU there is no common fiscal policy as such, because most of the governments´ spending budgets are controlled by

· Section 2. (25%) Monetary authorities.

· In the Eurozone, which institution oversees monetary policy, and which one controls fiscal policy?

· The ECB (the European Central bank), which is independent of politicians controls the monetary policy.. monetary policy is the setting of interest rates (cost of getting a loan and the ECB lends money to commercial banks at the base rate that it sets, if this rises then the commercial banks pass this on to us (ordinary people) in the form of higher interest on loans we take from them and vice versa) and also the money supply (how much money is printed). A central bank is the bank of the commercial banks and we as citizens can not get a loan form he central bank.

·
The ECB is independent of politicians

– it can set the policies (interest rates and money supply) as it wishes without intereference of politicians – WHY? Politicians are motivated perhaps to print money and lower interest rates at times as this can be a way to boost the economy and gain popularity temporarily (by raising AD).. but this can cause inflation. The short term benefit of this could be outweighed by a long term cost (inflation) and an independent central bank is less likely to do these things as it does not care about being popular! Politicians may worry however about their short-term popularity rather than what´s in the long term interest of the nation. Therefore we have put monetary policy in the Eurozone in the hands of the ECB as it does not need to win elections. So as it doesn´t care about being popular the ECB can perhaps do what is right, i.e. aim to keep inflation low… well in doing so it may not in recessions set low enough interest of print enough money. So there are pros and cons to having an independent central bank. But it generally has worked quite well and prevented inflation being too high in many nations where independent central banks exists (e.g. USA, Germany before 1999 and the UK, and the Eurozone). Short termism by politicians in the running of their monetary policies was a problem in many Eurozone nations before they joined the Euro, so this has now largely been resolved by them joining the Euro.

· In the Eurozone fiscal policies (the setting of taxes (direct (income and corporation tax) and indirect tax (e.g. IVA in Spain or VAT in the UK) and government spending) are controlled by elected NATIONAL governments – SO there is no one institution in charge of this for the whole Eurozone, each country sets their own tax rates, they collect these taxes and they spend them as they wish (well in response to the wishes of their people if the democratic system is functioning well).. but there is also a common EU fund, so each EU nation will give some money to the EU from the taxes it collects from its people and then the EU through the EC (European Commission) will then spend this money… so there is some small degree of common fiscal policy too in the EU (the EU is not the same thing as the Eurozone) and some G spending is conducted by the EU itself for the whole of the EU, but largely fiscal policy is controlled in the EU by the different national governments of each member state and they can do different things with their fiscal policies. Politically it probably would be difficult to have a common fiscal policy as citizens of one EU nation may not want their taxes to be spent in other EU nations. Right now don´t have a common fiscal policy… BUT if the suggested policy in this questions

· Meanwhile in the Eurozone the different member states do not have control over their monetary policies, this is determined centrally by the ECB and it is a common policy for the whole of the Eurozone.. now this can theoretically be a good thing but it can also be a bad thing if the different nations in the Eurozone have a need for different monetary policies at any one time (e.g. if one member of the Eurozone is in boom and another in recession then having a single monetary policy that is a compromise on the needs of each of these members, will not satisfy any one´s needs).

So for instance Greece after 2008 really needed to have some money printed for its economy and have interest rates lowered but it could not do this by itself, and had to wait for other Eurozone nations to get their agreement to do this.. one of the problems with the Euro (there are lots of pros also however) is that a ONE MONETARY POLICY SIZE DOES NOT FIT ALL.. i.e. what one nation needs in terms of its monetary policy is not what others need at the same time, i.e. we all want different things

The main goal of the European Central Bank is controlling the inflation. Why it is so important? To answer this question:

· define aggregate demand and aggregate supply in the long-run and short-run (use graphs), and

Inflation is when prices generally rise. The target in the Eurozone is 2% CPI inflation or just below this. So we are in the Eurozone aiming for low inflation (but we don´t want it to be too low and we don´t deflation)

Now the price level is seen on the vertical axis of the AS AD diagram, so the vertical axis is what explains inflation, and where AS and AD cross you get an equilibrium and you can read off the vertical axis what the price level will be. Inflation occurs when the P Level rises and this can happen for 2 possible reasons:

1. Cost push inflation – this is when the cost of production are rising (land, labour, capital or enterprise (running a business)) get more expensive and AS is falling (i.e. Moves leftwards).. .then PL would rise and we would get inflation. Draw a diagram showing this (a fall in AS leading to inflation).

2. Demand pull inflation – this occurs when people want to buy more stuff.. when AD (AD=C+I+G+X-M) rises.. so when AD rises we get inflation also. Draw a diagram showing this (a rise in AD giving inflation).

· AS represent the production of things in an economy and AD represents the buying of all things in an economy – these are your definitions basically. AS slopes upwards, explain why and explain the difference between spare and no spare capacity on the Keynesian AS curve. AD slope downwards, why?

· explain the main effects of rising prices in the economy using the concepts delivered in class.

Why is inflation bad? We looked at this in class:

· It reduces the value of real savings and real wages – people can not afford to buy so much stuff. People who saved may have been people who worked hard, we have punished hard workers with inflation, we will reduce the incentive to work hard in the future, then AS may fall. People get poorer if their savings and wages drop in real terms,

· If people can´t afford to buy then AD may fall as well

· If AD and AS fall (for the reasons given above) then the economy shrinks, leading to less GDP, less jobs, lower quality of life

· Inflation leads to exports losing competitiveness – X become more pricey, less desirable around the World, X therefore down and then AD falls, also people at home may prefer to now buy Ms as they are more desirable relatively, so M may rise – so less X can lead to job losses and less AD and less growth in your country

· Menu costs (businesses have to rewrite price labels for their goods as prices change, this is an additional cost that inflation gives them) and shoe leather costs (consumers now have to search again for what is best value for money) – look these up in your notes, these two costs make it harder to buy and sell things and so economic activity can fall as a result of inflation

· Finally, with very high inflation we can get people losing faith in money as a store of value and people may not want to paid in money for their labour or for good/services they sell (because the money is losing value) and in instead want to paid in things instead that do hold their value (e.g. gold) or we may return to the ancient system of bartering (what is this? Swapping goods for goods e.g. half a cow for a chicken) and this (using gold to do deal or even worse bartering) makes doing economic transactions much more difficult (why? Gold is heavy and not easy to transport to the market, and swapping goods is even harder) SO? Then economic activity probably would shrink and we get less growth.

· BUT one winner from inflation however is people who are in debt, as inflation leads to debts falling in value in real terms

SO WHAT? It is important to prevent inflation and the job of a central bank like the ECB is to largely to keep inflation low (at 2% in the ECB´s case) and independent central banks are generally more trusted than governments to achieve this (e.g. the USA has an independent central bank called the Federal Reserve and it also has achieved low inflation in the USA and so did the independent Bundesbank from 1948 to 1999 in Germany also achieve low inflation… while, in 1923 when the politicians ran monetary policy in Germany we saw massive hyperinflation!) , because they (independent central banks) do not have political incentive to boom the economy to win the peoples´ support as they don´t face elections.. so central banks will be less likely to lower interest or print money to raise AD to get a boom to win support and we are less likely to then see the side effect of inflation occurring.

· Section 2 of TOPIC 2 ALSO TALKS BRIEFLY ABOUT THIS. (25%) The Eurogroup is discussing issuing Bonds to cushion the economic downturn.

Bonds are a financial tool that allows governments to raise money to carry out spending (it´s an alternative to tax as a way to raise money for governments and was initially done by nations to fund wars). The selling of bonds is a way for governments to borrow money. Bonds are literally pieces of paper created by governments that people can obtain by lending their money to the government and the paper says that these lenders (investors, who could be anyone with cash who wants to lend their money to the government issuing the bonds) will be repaid with some interest on top.

So bonds can fund government spending. They are an alternative tool to taxation or printing of money to fund spending. During this current Covid-19 crisis we are seeing that governments need to spend more money on various things (hospitals and support for businesses and workers and the very poorest in a time when economies are shrinking, GDP is falling and so they are not going to be collecting as much tax revenue… so how can we solve the government spending problem.. maybe issuing more bonds could be a solution).

So governments may have to borrow more by issuing bonds. But they can´t borrow infinitely as lenders will at some point think that bonds are a risky investment that are not seemingly going to be repaid. The lender will demand higher interest on bonds to compensate for the rising risk. So one possible solution is for governments to print money to buy back existing bonds that have been issued to reduce the government debt and the risk associated with the bonds and then they could issue even more bonds. The UK is doing this now, to the tune of 640billion pounds (this is printed money.. the downside of this is it could cause inflation!! Every solution seems to have another problem, although inflation right now, due to low demand might not be very likely… although it AS falls a lot it could be likely). The Eurozone may also think this (buying back bonds) is a sensible thing to do now. Has the ECB done this? You can research this. What would be the downside of this policy? Possible inflation seems to be the main downside, but this is an emergency and inflation doesn´t seem too likely at the moment unless aggregate supply falls greatly.

Also there is talk of a Eurobond (being created) that could be issued to cover the costs of the crisis, and this would be a bond that is to be repaid by the EU itself rather than national governments only, it would be a liability that would be owed by all of the EU nations together. This would help nations like Italy and Spain who have a higher government debt and who have a particularly bad Coronavirus Criss than say Germany, and by having a common bond that all EU nations will pay for the risk associated with the bond not being paid back would be low, so investors may be quite willing to buy these. It would again also help nations like Italy because they are having a particularly bad coronavirus crisis that will cost a lot to deal with. But would a nation like Germany want to be involved in the creation of such a bond, would it benefit them? Maybe not, why would they want to partner up with a less fiscally secure nation and have this extra liability that they don´t have now and their Coronavirus crisis is right now not so bad, so they don´t need this bond. It would be helpful to Italy though and could keep the EU united in the long run,… unless it upsets German citizens and their support for the EU declines. A Eurobond now would probably increase support for the exisitence of the EU in Italy among Italians right now, but it might test/reduce support for the EU in nations like Germany.

1. Section 3. (25%) During the 2008 crisis, the Eurozone countries applied different strategies to prevent a fall of aggregate demand.

4. Provide two examples of fiscal policies in face of an economic crisis and discuss their positive and negative effects on aggregate demand. Use the concepts of “multiplier effect” and “crowding-out effect” delivered in class.

Fiscal policies are:

1. Taxation policy – in an economic crisis to prevent AD from falling (AD=C+I+G+X-M) you would lower taxes, WHY? To ensure people have more disposable income (in a time when incomes are generally falling) so that they can keep spending (consumption) so that AD does not fall.

1. Government spending policy – in an economic crisis to stop AD falling you would generally in theory want to raise G. G is a component of AD, so if G rises AD rises.

BUT, and this is a large point – the combination of lowering taxes and raising government spending could cause a large fiscal deficit and rising government debt. And in reality after 2008 there were attempts to reduce government spending in particular (a policy known as Austerity) to control fiscal deficits and government debts that had become too high for example in countries like Greece, especially after there were expensive bail outs for banks during the crisis. So it was not really possible for the above approaches to followed after the 2008 crisis in many places in the Eurozone.

But let´s assume that a government does raise G and lower taxes and you may also see the following occur:

1. You may also get a multiplier effect where: extra G creates jobs, which increases incomes, which increases C, which causes more jobs to come in to existence, which could raise income and C further and raise employment and so on and so on.. so the rise in G could kick start the economy and lead to AD rising more and more because C would rise and more and more jobs would be created and more C would occur… so AD could rise a lot. But the multiplier won´t be so large if there are lots of withdrawals (savings, imports and taxation).

Example of multiplier: Barcelona´s town hall spends 100m Euros on building roads in Barcelona. So G rises by 100m Euros and AD rises by 100m Euros. This 100m Euros spent leads to jobs being created for road builders who for simplicity we will say earn 100m Euros in wages (in reality all of this won´t go to them but let´s assume it will). These builders then spend a lot of this extra income (let´s say they spent 60% of what they earn, they have a marginal propensity to consume of 0.6 and the rest if taxed, or saved or spent on Ms, the 3 withdrawals). So then C will rise by 60m Euros… so AD has risen in total by 100m plus 60m Euros, i.e. a total of 160m Euros.. but it doesn´t stop there.. the 60m Euros spent creates even more jobs, as the extra demand needs to be met by more production and this will be done by more workers who will earn more (ok, it´s quite so simple but let´s just accept this simple story for now) and then the 60m Euros spent becomes wages for workers who get these extra jobs to meet the extra spending of the builders… then the workers who earn the 60m Euros will also spend some of it.. let´s say they too spend 60% of what they earn (we don’t know how much of it they will spend but let´s assume it will be 60% for simplicity) and so they will spend 36m Euros (60% of 60m Euros earned) so C will rise by another 36m… so AD rises so far by 100m plus 60m plus 36m Euros… so the initial 100m injection leads to AD rising by even more, in total so far by 196m Euros.. but it actually carries on and on and on and AD keeps rising a little bit more each time,, so then in the next stage of this process (called the multiplier) we will see more C of 0.6 x 36m and then in the next stage a rise of 0.6 x 0.6 x 36m and so on and so on..

In total AD´s rise will be able to be calculated by the following formulae:

Rise in AD = Multiplier x initial injection

Multiplier = 1 / (1 – MPC) where MPC=marginal propensity to consume

So using the number we have in our example we will see the following

Multiplier = 1 /( 1 – 0.6 ) = 1 / 0.4 = 2.5

Rise in AD = 2.5 X 100M Euros = 250m Euros.

1. Crowding out effect: however you could instead get this. When G rises and taxes fall the government fiscal deficit and government debt can rise. This can make bonds riskier and less appealing to investors. They may then demand higher interest on bonds to purchase them. Also the value of a bond already in exisitence can fall and the interest on it (which is fixed already) will rise as a percentage of the now lower value of that bond. So if interest on bonds rises we may see interest in the whole economy generally rise..why? Bonds are usually the most safe (low risk) investment in any economy (why? Because governments like the Lannister family from Game of Thrones usually always pay back their debts, historically they have at least.. why? Because they can always tax their people or print money (well if you join the Euro, like Greece did you do lose this power to print money) to repay debts, so bond buyers are very safe in the feeling that they will be repaid. So if a government bond offers a 3% return and bank deposit offers 3% as well then you would go for the bond, because while putting your money in a bank is also usually very safe it´s not as safe a bonds.. so the bank rate on deposits always has to be a bit higher than the bond rate to attract people to put their money in the bank.

But if government debt rises then bonds get less safe and interest required by investors will rise to buy bonds. So let´s say the bond rate rises from 3% to 3.5% as government debt has risen. Then the bank would also have to raise its interest rates on bank deposits from 3.5% to let´s say 4%. Now the bank would then also have to raise the interest rate at which it lends, from say 4% to 4.5% to keep making a profit. The lending rate of commercial banks will always be higher than the rate it pays to savers so they can make a profit.

So borrowing rates will generally rise and borrowing will fall and C and I would fall and AD would fall. So initially G rose and taxes fell, which should raise C, but what we are saying is that if this then increase government debt interest rates may rise (as explained for the reasons given above) and then C and I may fall for this reason. So the rise in G and C from higher G and lower taxes could be lost from the fall in C and I due to the rise in interest rates that could occur. When G rises in particular and we get a rise interest rates as government debts rise and C and I rise, we say that the PUBLIC SECTOR (which has grown as seen by the rise in G) has CROWDED OUT the private sector.. and if the private sector is more efficient then the rise in F will not actually raise AD overall and it may even lead to a loss of better private sector C and I, meaning more G will not boost AD and will actually be bad for the economy. This was arguably seen in Greece after 2008 where interests rate on government bonds were rising (as they were being rated as being more risky because government debt was rising as a % of GDP) and so interest rates generally were rising.

The crowding out effect is an argument against more G and against governments getting in to fiscal deficits and more government debt AND it also argues the opposite to the multiplier effect which says more G will raise AD a lot, as the crowding out effect argues more G may not actually raise AD.

1. Section 4(25%) There is evidence of increasing protectionism in global trade (US and China trade war), which might cause a fall in global trade..

5. Explain what the expected impact of the fall in international trade on the Eurozone economy might be. Use the AD/AS model and the concepts delivered in unit 8. This section must include a written explanation and charts.

Protectionism – it is policies that try to get people in your country to buy goods and services made in your own country rather than from other countries. The policies will include tariffs (taxes on Ms), quotas (a limit on the number of M) and also subsidies for your goods to make them more competitive, or devaluing your currency or putting up fake administrative barriers on Ms making it harder for them to enter your country. So these policies usually make M go down.

When M falls AD rise. AD=C+I+G+X-M and then M would fall so AD would rise as you are taking less out of the economy. People would increase their domestic C also as they´d be buying more from their home country. The current account deficit usually would fall (or if it was a surplus it would usually rise). Then GDP should rise and employment should rise.

BUT three things:

1. These protectionist policies would likely be bad for consumers in your country – they would be forced to pay more for domestic goods

1. Other countries may do the same to you, i.e. put up trade barriers in response on your goods in retaliation and this could start a trade war… so then it´s likely that your X would go down.. and then in fact AD could fall! Then AD would actually fall

1. When you make M more expensive you may cause your imported inputs (e.g. imported oil or steel) to rise in cost which could hurt your businesses who use these input by raising their production costs and overall AS could fall.

AD could rise if M drops a lot, but if X falls a lot also due to there being retaliatory trade barriers then AD could actually fall.

Next AS probably will fall as imported inputs rise in cost.

Overall globally if free trade decreases then global growth rates would likely shrink and the world would not be as rich as it could be.

Consumers in the Eurozone would very likely suffer as they won´t be able to buy cheaper foreign goods with such ease or at such low prices as before when the there were not so many trade barriers.