Transcript The Political Economy of Stabilization in Lebanon Ghassan Dibeh

LECTURE NOTES ON MACROECONOMICS
ECO306
CHAPTER 1
GHASSAN DIBEH
Chapter 1 Macroeconomics in the Age of
Crisis
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Starting in 2007 the United States and the World
economy entered a dynamic of accelerated meltdown
with financial markets and the economies of the world
experiencing the worst financial and economic crisis
since the Great Depression of 1929-1933.
The Great Recession
Paul Krugman, the Nobel prize winner in economics in
2008, said the macroeconomics taught in universities
in the past 30 years was “spectacularly useless at
best, and possibly harmful at worst”.
Main Hypotheses of Macro in Past
30 years
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Markets are perfect and complete and ensure that
the economy is always in a state of full employment
equilibrium.
Price flexibility and rational agents’ decisions
concerning production, consumption and employment
will always lead to a state where all the resources in
the economy are fully employed.
Any unemployment that appears is voluntary and
severe recessions (not to say Depressions) that are
persistent deviations of GDP from potential GDP (or
full employment GDP) are transient at best.
Financial Markets in
Macroeconomics
 In financial markets, the agents (traders and investors) are rational
and markets are efficient.
 The efficient market hypothesis (EMH) states that financial markets
produce asset prices that reflect fundamental values.
 Deviations from fundamental value of asset prices are random.
Random behavior in asset markets is a variation on the kind of
dynamics that you would get from a coin tossing experiment.
 These fluctuations are unpredictable and the time path of stock prices
cannot be used in speculative activities. Hence, bubbles generated by
herd behavior (speculators acting like a herd) in markets cannot exist.
 Financial Market Behavior does not by and large have
macroeconomic impact
 Try an online coin tossing experiment at
http://www.socr.ucla.edu/htmls/SOCR_Experiments.html
Great Depression (1929-1933)
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The Great Depression was the economic equivalent of
a tsunami. It was the worst economic crisis that the US
economy and the World economy experienced ever.
In the US, unemployment reached around 30%.
Industrial production fell by 50%
The length of the contraction in the US economy was
the highest in the 20th century lasting for 43 months.
In Germany, the economic crisis was also severe
causing political and social upheavals that led to the
rise of the Nazis to power in 1933.
Great Depression
140
120
100
80
60
40
US Index of Manufacturing Production
20
Germany Index of Production
0
1928
1929
1930
1931
1932
Figure 1. Industrial Production in US and
Germany during Great Depression. Source: NBER
Macrohistory Database.
Deflation in Great Depression
60
50
40
30
20
10
0
1928
1929
1930
1931
1932
1933
US Wholesale Price Index
Figure 2. U.S. Price Deflation during Great
Depression. Source: NBER Macrohistory Database.
The Great Recession 2007-2009
Country
% GDP contraction (year-to-year)
United States
-3.9 Q2
Japan
-8.8 Q1
Britain
-5.6 Q2
Canada
-2.1 Q1
France
-2.6 Q2
Germany
-5.9 Q2
Italy
-6.0 Q2
Russia
-10.9 Q2
Table 1. GDP Contraction in G8 countries during current Crisis
Source: www.economist.com/indicators
Recession; Eurozone
Figure 5. GDP and Industrial
Production in Euro Area during Crisis.
Source: Eurostatistics, Data for shortterm economic analysis. Issue number
9/2009
Comparison between Great Depression and
Early Phase of Great Recession
Comparison between Great Depression
and Early Phase of Great Recession
Great Recession
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Phase I started in the real economy namely in the
housing sector in the US.
The collapse in housing prices triggered defaults in
mortgages which led to collapse and chain-reactions
in balance sheets of banks and funds holding
synthetic securities.
This caused Phase II in the crisis which engendered a
credit crunch. The credit crunch dried up liquidity at
any interest rate and led firms with leveraged
positions to institute a wave of deleveraging further
intensifying the crisis.
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The phase III of the crisis is the feedback of the
credit collapse on the real economies mainly in the
US and Europe with deep recessions in UK,
Germany and the US.
In terms of quantitative measures (GDP contraction
and unemployment), the current crisis is the most
severe crisis in capitalist economies since the Great
Depression surpassing in its effect on GDP and
unemployment the recessions of 1973-74 and
1981-82.
Lessons from Crises
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The private ownership capitalist economy is prone
to episodes of deviation of GDP from potential
output.
Financial markets are prone to speculation and herd
behavior.
Interactions between Financial Markets and the
Economy
Government Intervention through fiscal and
monetary policies is essential for rescuing the
economies from crisis and maintains economic
stability and full employment.
Financial Crises
The world has experienced an
increase in the frequency of
crisis linked to financial and
currency markets in the past
20 years:
1987 US stock market Crash
(Black Monday), Mexico 1995,
1997 Asian crisis, 1998 Russian
crisis, LTCM in 1998, dot-com
collapse in 2001, Enron collapse
in 2001, Argentine Crisis in 2002
and finally the current mega
crisis.
Some probabilities derived from the random walk model taken
from Mandelbrot (2004)
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The August 31, 1987 drop in Dow IA has a
probability of one in 20 million
The October 19, 1987 (Black Monday) when the
Dow Index fell by 29.2%, the odds of that
happening is one in 1050.
A Citigroup study has found that on one day the
dollar dropped against the yen by 7.92% or 10.76
standard deviations, an event that would happen
one in 15 billion years
Fiscal Stimuli in 2008 and 2009 (% of
GDP)
Country
Deficit 2007
Deficit 2008
Deficit 2009
Stimulus 2008
Stimulus 2009
US
-2.9
-5.9
-13.5
1.1
2.0
Germany
-0.2
-0.1
-4.6
0.0
1.6
UK
-2.7
-5.5
-11.6
0.2
1.6
France
-2.7
-3.1
-7.4
0.0
0.7
Effects of Fiscal Stimulus in US
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Blinder and Zandi (2010) made simulations using
Moody’s Macroeconometric Model of the Effect of
the Fiscal Stimulus on GDP and Unemployment in the
US
http://www.economy.com/markzandi/documents/End-of-Great-Recession.pdf
Business Cycles
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Business cycles are fluctuations in aggregate
economic activity.
The cycle consists of expansions occurring at the
same time in many economic activities followed by
similar general recessions, contractions and revivals,
which merge, into the expansion phase of the cycle.
This sequence is recurrent and persistent but not
periodical.
The business cycle duration varies from one year to
ten or twelve years.
US Business Cycle Chronology
Peak
Trough
Contraction
Expansion
Peak to Trough
from previous
current Peak
August 1929
March 1933
43
21
November 1973
March 1975
16
36
July 1981
November 1982
16
12
July 1990
March 1991
8
92
March 2001
November 2001
8
120
December 2007
June 2009
18
73
trough
to
Inflation and Deflation
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Unemployment
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Okun’s Law
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Empirical estimates in the US have shown that
unemployment rises by 1% for every 2.5% fall in
output.