Economics

What is economic growth?

What is economic growth?

• ➔  Economic growth implies growth of production/income in an economy (what one person spends, forms someone else ́s income)

• ➔  It is measured by the change in GDP (The Gross Domestic Product is defined as the market value of the final goods and services produced within a country in a given time period. The GDP indicates how well the economy of a country is doing)

Why is economic growth / GDP important?

1. It implies that there is a high supply and demand -> this leads to more production -> more employment

2. Higher employment also means that more labour is needed -> wages increase due to competition -> people can consume more and are more prosperous

3. Governments receive more tax income to spend on public services

Overall, economic growth equals economic and social prosperity (for a certain time period)

What are problems with the GDP?

➔ The GDP only measures how well the economy is doing but it leaves out the quality of people ́s lives, the environment, etc.

➔ A high GDP does not necessarily lead to high welfare

What effects the GDP?

• Actions of people (4 sectors) in the economy

  • Consumers / households: consumption

  • Companies / producers: investment

  • Government: Government spending

  • Foreign countries: export – import

➔ These 4 sectors are consuming, investing, spending or importing money within the economy which adds up the to the GDP of a country.

What are the two approaches for stimulating economic growth?

Stimulate supply side (1. approach)

Growth is created by companies which is why the government should ensure that companies can function optimally and are able to compete with foreign companies. Classical economics belief the market will automatically fix everything if it has enough freedom.

Keynesian approach (2. approach)

The government should spend more money during a recession to make sure that demand gets supported/stimulated.

What is the interest rate?

Describes the cost of borrowing expressed as a percentage which is determined by supply and demand of money (also by central bank)

Why do interest rates increase in a period of high economic growth?

• In times of economic growth, people start consuming more which leads

  to a higher inflation (increased prices of goods).

• To lower the inflation rate, the interest rate needs to be increased by the ECB so that people save more money and decrease their spending.

Why do interest rated decrease in a period of low economic growth?

In times of low economic growth, people consume little and the inflation rate is low.

By lowering the interest rate, spending becomes more attractive than saving. Low interest rates hence helps to stimulate demand and consumption and therefore lead to an economic growth again.

What are the inflation rate and the interest rates sensitive for?

The are sensitive to demand.

Interest rates low (people consume) -> inflation high (prices go up) -> interest rates high (people stop consuming and start saving to stop inflation) -> inflation low (prices go down again)

What are business cycles?

• Business cycles are comprised of concerted cyclical upswings and downswings in the broad measures of economic activity—output, employment, income, and sales.

• The alternating phases of the business cycle are expansions and contractions (also called recessions).

• Recessions often start at the peak of the business cycle—when an expansion ends—and end at the trough of the business cycle, when the next expansion begins.

Expansion

Large increase in expenditures (and GDP) / economic growth is moderate

Recession

Low increase or even a decrease in expenditures (and GDP) / economic growth is negative

What is the inflation rate?

• Describes an increase in the average price level

• Determined by supply/demand

• Inflation is measured by comparing prices of a representative basket of goods each year

Why does inflation increase in times of high economic growth?

• During times of high economic growth, there is a high level of demand. Expenditures increase since a large number of goods get sold.

• Consequently, prices for products and services, and therefore the inflation rate, rise. This effect is also known as the demand-pull inflation.

What are the downsides of inflation?

• There is less consumption due to high prices

• Employees demand higher wages since prices of products are higher

• Higher wages drive up production costs which then results in a cost-push inflation

• There also is a redistribution of wealth

• Inflation causes a rise in interest rates which makes saving money more

  attractive to people

• Inflation also causes uncertainty and risk

What is the role of the European Central Bank (ECB)?

• ECB’s main goal is to ensure price stability (inflation rate of approximately 2%)

➔ This keeps the economy from growing too fast or too slowly and hence contributes to social and economic welfare

What does the European central bank do when the inflation rate goes under 2% (prices of goods are low)?

the Central bank will lower the interest rates in order to get more people to spend money

What happens if the inflation rate is higher than 2%?

The central bank will raise the interest rates in order to get people to save money

What are the policies that help to stabilize the economy?

• Supportive monetary policies (actions from the central bank: lowering interest rates

• Supportive fiscal policies (actions from government): lowering taxes

What is the exchange rate?

• The price of the currency of one country expressed in the currency of another country (value of the Euro can be expressed in terms of the value of the Dollar)

• It is about the external value of the currency (how much does it afford abroad?)

• Strong currency means that imports are cheaper

What is an advantage of the exchange rate?

Domestic products get cheaper for foreigners

→ Export goes up, economic growth goes up

What is a disadvantage of exchange rates?

Foreign products are more expensive for domestic people

→ Import goes down, price level goes up

How are exchange rates determined?

By supply and demand

Appreciation

• Increase in value of the exchange rate

  • If the demand for euros is high, then price of euros is high

• A country that exports more than it imports will see its currency gain in value (appreciation)

Depreciation

• Decrease in value of the exchange rate

  • If the supply of euros is high, then price of euros is low

• A country that imports more than it exports will see its currency decrease in value (depreciation)

Who buys and sells currencies?

1. Banks

2. Central banks (mainly are focused on the interest rate, but sometimes they might think the exchange rates need some changes as well)

3. Institutional investors

4. Big multinationals

What influences the exchange rate of the euro?

1. Export from Euro countries

2. Import to euro countries

3. Foreign investments

4. Central bank actions

How does export from euro countries influence the exchange rate?

• If goods flow from NL to UK, money flows from UK to NL

• The company in the UK that imports, needs euros to pay with. They buy them from their bank. Therefore, they increase the demand for euros and raise the exchange rate of the euro (appreciation)

How does import to euro countries influence the exchange rate?

• If goods flow from UK to NL, money flows from NL to UK

• The company in NL that imports, needs pounds to pay with. They buy them from the bank. Therefore, they increase the demand for pounds, raising the exchange rate of the pound which automatically lowers the exchange rate of the euro (depreciation)

How does foreign investments influence the exchange rate?

• To invest in euro countries, investors require euros. Demand for euros goes up, exchange rate of euros goes up, increase in value (appreciation)

• Investors invest their money in any place that gives them the best result = high return at low risk! When there is an increase in possible returns (e.g. a country increases its interest rate) or a decrease in risk, investors move their money to different location. Investors tend to respond very quickly to any potential economic risk (Brexit: investors pulled their money out of the UK). Suddenly there’s a large supply of pounds which means that it depreciates.

How do central bank actions influence the exchange rate?

• Purpose of the European Central Bank (ECB): price stability

→ This may require buying up or selling large amounts of currency