Summary
Summary Coursework material
- Module
- Macroeconomic Analysis
- Institution
- School Of Oriental And African Studies
Summary of 9 pages for the course Macroeconomic Analysis at School of Oriental and African Studies (Coursework material)
[Show more]
Seller
FollowContent preview
Macroeconomic Analysis3 macroeconomic paradoxes + COVID-19-related economic developments and the policy implications of
these paradoxes for the handling of the current economic crisis.
“There is an old joke about a drunk who dropped his keys and searches for them under a lamppost.
Someone passes and asks - did you drop your keys here? - and he says - No, I dropped them in the alley, but
I cannot see there, so I am looking here, where there’s enough light -”. This is how Paul Krugman refers to
theories on international trade, which only look to issues on which light has already been shed upon
(Donovan, n.d.).
Similarly, conventional wisdom, epitome of the preferences of the elite, exclusively looks at the area that
finds itself under the light of the lamppost. “The general public would like to see welfare and social
insurance programs strengthened, not cut back, while the elite would like to see them cut back. Then you
ask, where is the conventional wisdom? It’s that the deficit is a terrible problem, and we must cut back on
entitlement programs” (Donovan, n.d.). Krugman does not stop: how about austerity measures to favour
deficit reduction and avoid insolvency? He points out to France’s attempts to reduce its deficit by raising
taxes on the wealthy, while trying to avoid cuttings on social programmes. The reaction of many in the
European Commission is well-summarised by Krugman’s sarcasm: “Oh no, that’s not right, that’s not what
we call austerity. It’s only austerity if you make poor people suffer, that’s showing what it’s really all about ”
(Donovan, n.d.).
The Covid-19 global pandemic is the turning point that forces conventional wisdom to search for St Peter’s
keys in the alley too, in order to unlock Heaven’s doors towards an economic recovery. However, future
prospects forecast an economic scenario that is far away from having a heavenly outlook. Meanwhile, the
pandemic forces conventional wisdom to search in the dark, away from what is conventional, turning to
what is paradoxical instead. In this gloomy atmosphere, government spending might become beneficial,
and austerity measures might become disruptive. This will be the focus of the following analysis.
The essay will discuss some of the macroeconomic paradoxes in light of the Covid-19 outbreak that has led
the global economy to a severe contraction, plunging it into the worst recession since World War II.
According to the World Bank, the global economy will shrink by 5.2% and in a downside scenario by a
further 2.8%, accounting for a total of 8% contraction in 2020 (World Bank, 2020). An introductory
paragraph will first provide a basic explanation of what a macroeconomic paradox is and means. Then the
essay will be divided in three sections, each analysing a paradox in relation to economic developments and
policies adopted to face the current crisis. Firstly, the paradox of thrift will be illustrated, and an
explanation of it will be provided. Secondly, the discussion will turn onto analysing the paradox of debt, as
national economies hit record figures for national indebtedness. Ultimately, the paradox of tranquillity will
be explained and a Minskyan approach will be adopted to understand the economic implications of the
pandemic. A conclusion will eventually summarise the key points of the analysis.
Firstly, an overview accounting for a basic explanation of macroeconomic paradoxes will be beneficial for a
more comprehensive understanding of the following analysis, focused on the three above-mentioned
paradoxes. It is fundamental throughout the discussion to bear in mind Keynes’ theory on the fallacy of
composition: “what is true for the part is not necessarily true for the whole”. It follows that what might be
reasonable at individual level becomes unreasonable, if considered at aggregate level (ie national level),
leading to unintended indirect effects. It is also relevant to note that paradoxes are not always valid. Only if
the direct effects rising from individual action is smaller than the indirect effects rising from collective
action, does the paradox emerge. Hence, it can be argued that austerity to avoid insolvency and reduce
debts can lead to disastrous effects (paradox of insolvency). To consider successful austerity measures
1
, adopted in Canada in 1993 will then not represent a contradiction to the previous argument, given that the
paradox’s effects can either emerge or not, according to the size of primary and secondary effects.
SECTION I
The paradox of thrift and record saving rates
After having offered a brief explanation on macroeconomic paradoxes, the discussion will now move
forward to analyse the paradox of thrift, and its effects during the current economic recession triggered by
the pandemic. Firstly, the Keynesian paradox of thrift (or paradox of saving) acts against a recovery and
high-lights the negative correlation that exists between output and propensity to save; in the sense that an
increase in the propensity to save will lead to a decrease in the growth rate of output. If households
individually decide to boost their finances via higher savings, it might be beneficial for the economy as it
may lead to higher future investments and growth. However, if everyone starts saving, this leads instead to
a reduction of aggregate demand. A decrease in total demand means that goods remain unsold and that
supply exceeds demand; as businesses find themselves with higher production costs plus the costs of
maintaining the unsold stocks, and the machinery, they will eventually decide to either lower wages or to
fire surplus workers, leading to higher unemployment rates, or in the case of lowered wages, to even lower
spending and consumption rates. A vicious spiral is created this way.
Moreover, uncertainty about the future contributes to raising households’ propensity to save, which is
exactly the case generated by Coronavirus. Unprecedented levels in saving rates have been reached during
the Covid-19 pandemic. Chart A clearly graphs the recent spike in savings in the EU in 2020. Households’
savings rate has soared from 12.5% to 17%; the numbers are worse than those in 2008-2009 when savings
rate rose from 12.5% to 14%.
CHART A
Sources: DG-ECFIN, Eurostat and authors’ calculations.
Furthermore, expectations about future income and about future unemployment constitute an essential
component in understanding households’ allocation of income in their spending and saving decisions. As
shown in Chart B unemployment expectations over the next 12 months not only spike, but also exceed the
actual unemployment rate, meaning that fear and pessimistic sentiments are overtaking Europeans
markets. Especially, the pandemic has led to an increase in technology implementation and usage of
2
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller rebeccafaioni. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for £7.49. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
57413 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy revision notes and other study material for 14 years now