Chapter 1: A Tour of the World

1.1 The Crisis

A recession: a decrease in output => lower interest rates to stimulate demand and avoid a recession.
Other countries were affected through two channels:
o The first channel was trade.
o The second channel was financial
Increasing inflation is an indication that they may be overheating.
What is behind the persistently high unemployment is low output growth due to:
o Housing prices are still declining, and housing investment remains very low.
o Banks are still not in great shape, and bank lending is still tight.
o Consumers who have seen the value of their housing and their financial wealth fall are
cutting consumption.
The crisis has led to serious fiscal problems: As output declined during the crisis, so did government
revenues, leading to a large increase in budget deficits. Deficits have led in turn to a large increase in
public debt over time
1.2 The United States
Output: the level of production of the country as a whole.
Three basic variables:
o Output growth: the rate of change of output
o The unemployment rate: the proportion of workers in the economy who are not employed
and are looking for a job
o The inflation rate: the rate at which the average price of the goods in the economy is
increasing over time
A reduction in the deficit can be achieved by a combination of an increase in taxes and a decrease in
spending. Either one might decrease demand and slow down growth at a time when unemployment is
still very high.
1.3 The Euro Area
The European market is an economic zone where people and goods could move freely.
The monetary policy followed by the European Central Bank has kept interest rates too high, leading to
low demand and high unemployment. The central bank should decrease interest rates and allow for an
increase in demand, and unemployment would decrease.
European states protect workers too much: To prevent workers from losing their jobs, they make it
expensive for firms to lay off workers. One of the unintended results of this policy is to deter firms from
hiring workers in the first place, and this increases unemployment.
European governments provide generous unemployment insurance. But, by doing so, they decrease the
incentives for the unemployed to look for jobs; which increases unemployment.
1.4 China
If we want to compare standards of living, we have to use PPP (for purchasing power parity) measures.
 The adverse effect of exports decrease during the crisis on demand was nearly fully offset by a major
fiscal expansion by the Chinese government, with, in particular, a major increase in public investment.
Sources of growth in China:
o High accumulation of capital: High investment rate (the ratio of investment to output). More
capital means higher productivity and higher output
o Rapid technological progress.