Euro Weakens As Greece Bailout Clears Hurdles

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1. “Euro Weakens as Greece Bailout Clears Hurdles Rises: Euro Weakens 0.6% versus the dollar, on track for lowest close since late May†was the title of a WSJ article on July 16, 2015: (Ramage, James. Wall Street Journal, July 16, 2015. Retrieved from http:// Explain how the Greece Bailout has caused the euro to weaken against the dollar. Use the foreign exchange market graphs to demonstrate.

2. “Mortgage Crises Spread Past Subprime Loans†was a title of a NYTimes article on February 12, 2008. (Source: Vikas and Louise Story. “Mortgage Crises Spread Past Subprime Loans.†NYTimes, February 12, 2008. Retrieved from: What type of macroeconomic shock does the article represent? Use the macro picture to show the effect on real GDP, the price level, and unemployment. Explain!

3. Show graphically and explain how non-interventionist believe the economy will self-correct in times of demand-deficient unemployment.

4. The following excerpt is taken from a NYTimes article: “ The Federal Reserve entered a new era on Tuesday, lowering its benchmark interest rate virtually to zero and declaring that it would now fight the recession by pumping out vast amounts of money….†(Source: Andrews, Edmund L. and Jackie Calmes. "Fed Cuts Key Rate to Record Lows," NYTimes, December 16, 2008. Retrieved from:

a. What is the Fed’s “benchmark interest rateâ€?

b. Discuss how the Fed’s action in the article will affect r, I, Y and P. Use appropriate graphs to demonstrate.

Paper For Above instruction

The relationship between external shocks, monetary policy, and macroeconomic outcomes is complex and interconnected. This paper explores how specific events such as the Greek bailout and the mortgage crisis influence currency values, economic stability, and policy responses. Using graphical analysis, I will illustrate how these shocks impact exchange rates, real GDP, price levels, and unemployment. Additionally, the paper discusses the self-correcting nature of the economy under non-interventionist beliefs and examines the Federal Reserve's unconventional monetary policy actions during a recession.

Impact of the Greece Bailout on the Euro

The Greek bailout in 2015 was a significant external shock to the Eurozone economy, primarily impacting investor confidence and currency valuation. When Greece received financial aid to prevent defaulting on its debt, concerns about the stability of the Eurozone diminished temporarily. However, the overarching uncertainty caused investors to reassess the Euro's strength against other currencies, particularly the US dollar. The trajectory of the Euro's value can be explained through the foreign exchange market graphs, which plot the demand and supply for different currencies.

In a typical foreign exchange graph, the vertical axis represents the exchange rate, and the horizontal axis shows the quantity of currency exchanged. After the news of Greece's bailout, investors may have perceived increased risk associated with holding Euro assets, leading to a decrease in demand for the Euro. Consequently, the demand curve shifts leftward, causing the exchange rate (Euro per USD) to fall, reflected in the graph as a downward movement in the demand curve. The result is a depreciation of the Euro against the US dollar, consistent with the 0.6% weakening reported by the WSJ article. This depreciation makes European exports cheaper and imports more expensive, potentially stimulating export growth but also increasing inflationary pressures within the Eurozone.

The Mortgage Crisis as a Macroeconomic Shock

The 2008 mortgage crisis impacted the U.S. economy through a financial sector collapse, leading to a severe macroeconomic shock characterized as a demand-side downturn. The decline in housing prices and the surge in mortgage defaults precipitated a contraction in credit availability, reduction in consumer wealth, and decline in investment. This crisis was fundamentally a demand shock, as it drastically reduced aggregate demand in the economy.

Graphically, the Aggregate Demand (AD) curve shifts leftward from AD1 to AD2, reflecting decreased spending and investment. The decrease in aggregate demand causes real GDP to decline from Y1 to Y2, unemployment to rise as firms lay off workers, and the price level to fall, demonstrating disinflation or deflationary pressures. Simultaneously, the overall macroeconomic picture pointed to a recession, with substantial increases in unemployment and decreases in output and prices, aligning with the data observed during the crisis period.

Self-Correction in a Demand-Deficient Recession

Non-interventionist economic theories emphasize that markets tend to self-correct following demand shocks. According to classical and some neoclassical perspectives, temporary excess supply of labor (i.e., cyclical unemployment) will cause wages and prices to fall gradually, restoring equilibrium. Graphically, this is shown through a vertical long-run aggregate supply (LRAS) and an AD curve that eventually intersect at the full employment level of output, Yf.

In a demand-deficient recession, the initial AD curve shifts left (AD1 to AD2), reducing output and employment. Over time, lower wages and prices increase the real money supply and reduce the cost of inputs, fostering a gradual rightward shift of the short-run aggregate supply (SRAS) curve or a movement upward along the demand curve. The economy ultimately returns to full employment Yf without government intervention, assuming flexible prices and wages, reinforcing the classical belief in self-correction capabilities.

The Federal Reserve’s Policy Response in 2008

The excerpt from the NYTimes describes the Federal Reserve’s response to the impending recession as it lowered its benchmark interest rate to near-zero levels and announced large-scale monetary easing measures. The benchmark interest rate, often called the federal funds rate, is the interest rate at which depository institutions lend reserve balances to each other overnight on an uncollateralized basis.

By reducing this rate, the Fed aimed to influence broader interest rates in the economy, encouraging borrowing and investment. Lower interest rates decrease the cost of borrowing (r), stimulate consumer spending and business investment (I), increase aggregate output (Y), and can lead to higher price levels (P) through increased demand.

Graphically, the initial economy is at equilibrium with an initial interest rate r1 and output Y1. When the Fed reduces its benchmark interest rate to virtually zero, the demand for money decreases, shifting the LM curve downward/rightward in the IS-LM model, which causes the interest rate to fall further and shifts the IS curve outward (due to increased investment). These movements result in higher equilibrium income (Y2) and potentially higher price levels (P) as demand expands overall. Additionally, in the Aggregate Demand/Aggregate Supply (AD-AS) model, the AD curve shifts rightward from AD1 to AD2, signifying increased demand resulting from lower interest rates, pushing the economy toward higher output and price levels.

In conclusion, the Federal Reserve's aggressive monetary easing during 2008 exemplifies unconventional policy aiming to offset declining private sector demand by lowering interest rates and flooding the economy with liquidity, thereby supporting economic recovery.

References

• Ramage, James. (2015). "Euro Weakens as Greece Bailout Clears Hurdles Rises." Wall Street Journal. Retrieved from http://
• Vikas, and Louise Story. (2008). "Mortgage Crises Spread Past Subprime Loans." New York Times, February 12.
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