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15.5 End-of-Chapter Material

In Conclusion

Five or six years ago, economists studied a period that they named “the Great Moderation.” In the period after World War II, and even more specifically from the mid 1980s to the mid 2000s, economic performance in the United States, Europe, and many countries had been relatively placid. These countries enjoyed respectable levels of long-run growth, experienced only mild recessions, and enjoyed low and stable inflation. Many observers felt that this performance was in large measure due to the fact that economists and policymakers had learned how to conduct effective monetary and fiscal policies. We learned from the mistakes of the Great Depression and knew how to prevent serious economic downturns. We also learned from the mistakes made in the 1970s and knew how to avoid inflationary policies.

To be sure, other countries still experienced their share of economic problems. Many countries in Latin America experienced currency crises and debt crises in the 1980s. Many countries in Southeast Asia suffered through painful exchange rate crises in the 1990s. Japan suffered a protracted period of low growth. Some countries saw hyperinflation, while others experienced economic decline. Still, for the most part, mature and developed economies experienced very good economic performance. Macroeconomics was becoming less about diagnosing failure and more about explaining success.

The last few years shook that worldview. The crisis of 2008 showed that a major economic catastrophe was not as unthinkable as economists and others hoped. The world experienced the most severe economic downturn since the Great Depression, and there was a period where it seemed possible that the crisis could even be on the same scale as the Great Depression. Countries like the United States and the United Kingdom faced protracted recessions. Countries such as Greece, Portugal, Ireland, and Iceland found themselves mired in debt crises. Spillovers and interconnections—real, financial, and psychological—meant that events like the bankruptcy of Lehman Brothers reverberated throughout the economies of the world.

Because it resurrected old problems, the crisis of 2008 also resurrected old areas of study in macroeconomics. The events in Europe have prompted economists to review the debate over common currencies and the conduct of monetary policy. There has been increased investigation of the size of fiscal policy multipliers. At the same time, macroeconomists are devoting much attention to topics such as the connection between financial markets and the real economy. But this difficult period for the world economy has also been an exciting time for macroeconomists. The study of macroeconomics has become more vital than ever—more alive and more essential.

Key Links

Exercises

  1. Consider the bank run game. If a government is supposed to provide deposit insurance but depositors doubt the word of the government, might there still be a bank run?
  2. Comparing the Great Depression to the financial crisis starting in 2008, what were the differences in the response of fiscal and monetary policy between these two episodes?
  3. We explained in Section 15.1 "The Financial Crisis in the United States" that an increase in the expected future price of houses leads to an increase in the current price. Draw a supply-and-demand diagram to illustrate this idea.
  4. Consider the crisis from the perspective of China. United States imports from China are roughly $300 billion each year. Due to the recession in the United States, imports from China decreased about 10 percent. If the marginal propensity to spend is 0.5 in China, what is the change in Chinese output predicted by the aggregate expenditure model? How much must government spending increase to offset this reduction in exports?
  5. In the CBO assessment of ARRA, the multiplier from government purchases was assumed to be larger than the multiplier from tax cuts. How would you explain the differences in these multipliers?
  6. If countries within the EMU are supposed to limit their deficits, what must happen to government spending during a recession when tax revenues decrease?
  7. (Advanced) We argued that the provision of deposit insurance prevents bank runs. Is there an analogous policy to prevent currency crises?

Economics Detective

  1. What has been the ECB’s role in the European Financial Stability Facility and in the bailout packages for Greece, Ireland, and Portugal?
  2. Find the details of the recent rescue package for Greece. What were the different views of Germany and France about this bailout? How was the IMF involved?
  3. What predictions were made about job creation under the Obama administration’s stimulus package? What happened to job creation rates in the 2008–10 period?