The debilitating and crippling effects of the Covid-19 pandemic have forced economic powers to result in economic stimuli in terms of packages and unemployment insurance schemes. The U.S has opted for the former with the Senate approving the nation’s biggest stimulus package totaling $2 trillion (Moneymaker). The European Union have opted for a more lenient approach by adopting unemployment insurance schemes. Unemployment refers to the status of able skilled potential workers who are lacking a job despite actively searching for one. Unemployment in economics theory only applies to those individuals in the labor pool available to work but lack appropriate job opportunities. Unemployment is an essential macroeconomics indicator because it can be used to deduce the aggregate demand in a country. When unemployment is high and rampant, many will are not earning income and hence lack disposable income to use on consumption. The aggregate demand level goes down together with the level of savings and investments.
There are several types of unemployment that exist. These are cyclical, structural, frictional, classical, hidden, and long-term unemployment (Kulesza 530). To begin with, classical unemployment occurs as a result of the supply and demand of labor. It occurs at the point when the real wages are in excess of the market clearing wage. This means that the wages a worker is willing to accept are above the wages an employer is willing to pay. Secondly, cyclical unemployment occurs due to the different cycles that the economy goes through: expansion, peak, contraction, and trough. The expansion phase is characterized by high economic growth, rising employment, and an upward pressure on price levels. The climax of the expansion phase is the peak level where the economy is assumed to be operated at or above the full employment level and inflationary prices are detectable. The economy then enters a correctional phase that begins with the contraction phase with the climax being the trough. The contraction phase is characterized by low economic growth, rising unemployment, and decreasing pressure on price levels. The climax of this downturn is the trough where aggregate demand is at its lowest level. The movement of the economic cycle from the peak to the trough causes cyclical unemployment. When the economy is at its peak, aggregate demand is high hence more laborers are required to produce enough goods and services. However, when the economy is at the trough, aggregate demand is considerably low hence production is reduced to an all-time low. As such, many producers lay off a portion of their laborers resulting in cyclical unemployment.
Thirdly, frictional unemployment refers to temporary unemployment when a worker is transitioning from one job to another. Since it is impossible to move from one job immediately to another, frictional unemployment occurs but it is usually brief. Fourthly, structural unemployment occurs when changes occur in products such as automation of operation. This kind of unemployment is attributed to the existence of a mismatch between the skills possessed by laborers and the skills required by employers. After automation of operations, for example, employers will require tech-savvy employees rather than blue-collar laborers. The initial employees with blue-collar skills end up losing their jobs that are now being performed by machines. Hidden unemployment refers to employment that is captured during the process of data collection. A good case is unemployed persons who have stopped looking for jobs yet they are not pursuing academic skills or engaged in business activities. Lastly, long-term unemployment is unemployment that exceeds one year.
The EU-wide unemployment insurance schemes are targeting the cyclical type of unemployment. The Covid-19 pandemic has resulted in aggregate demand dropping as people cut on their consumption. Low aggregate demand is pushing producers to reduce their production and hence either laying off workers or reducing their work hours. The EU-wide unemployment schemes are a system of soft loans that will offered by the EU to supplement individual governments’ unemployment insurance schemes. The move is aimed at supplementing the loss incurred by employees due to a reduction in their work hours and pays or total retrenchment because of the Covid-19 pandemic. The move will cushion employers from having to pay employees with reduced inputs or no inputs at all due to the negative effects of the pandemic. The move is to ensure that the EU does not sink into a severe recession and to augment the purchasing power of cyclically unemployed workers and those forced to take a pay cut.
This policy has both positive and negative effects that are being highly considered by the EU before the implementation of the policy. First is the cushion effect which will preserve the purchasing power of employees. Since some countries are already implementing employment insurance schemes, this EU boost will enable them to reduce a rampant fall in their economies due to decreasing aggregate demand. The second effect of this move is negative since the unemployment insurance will be issued in the form of soft loans. The EU itself is not in a position to easily raise this money which is the region of £80 million to £100 million given that its 2014-2020 budgetary period is coming to an end and the budget had only allocated £13 billion for this purpose. The EU has resulted to raising this money using the EU budget as a guarantee. Some countries will oppose this move since it will adversely affect the EU balance of payments. Thirdly, some individual countries with running employment insurance schemes will not support the idea since it will involve them taking in more debt that is to be paid once the situation stabilizes.
Monetary policy in the Eurozone is managed by the European Central Bank and the central banks of the nations within the euro area. Monetary policy is achieved by controlling the level of money supply to influence exchange and interest rates in order to achieve a favorable outcome. Fiscal policy, on the other hand, is managed by individual national governments. Fiscal policy involves controlling government budgets, tax policies, and structural policies such as capital and labor market regulations (“How the Economic and Monetary Union Works”). However, all countries need to coordinate their fiscal policies to ensure a smooth operation of the wider European Union.
Aggregate demand represents the total demand for final goods and services at a given price level over a specified period. It is the total demand for a country’s Gross Domestic Product (GDP). Aggregate supply, on the other hand, represents the total amount of goods and services that producers are willing to sell in an economy at a given price level. The aggregate demand curve is similar both in the short and long run. However, the aggregate supply curve is different: it is vertical in the long run and negatively sloping in the short run. Equilibrium in the economy is achieved at the point of intersection of the aggregate demand and supply curves. In the short run, the aggregate demand curve is positively sloped while the aggregate supply curve is negatively sloped as shown in the graph below:
Figure 1: Short-run Equilibrium in the AD-AS model.
Equilibrium is achieved at point E.
In the long run, the aggregate demand curve is positively sloped while the aggregate supply curve is vertical and parallel to the y-axis as shown below:
Figure 2: Long-run Equilibrium in the AD-AS model.
Equilibrium occurs at the point of intersection of P1 and Y1.
Both equilibriums above represent the points of intersection between the general price levels and Real GDP. The general price levels is measured using either the GDP deflator or the Consumer Price Index. As such, there exists an inverse relationship between price levels and the level of Real GDP demanded. Changes in price levels do not occur as a result of changing prices, however, they occur as a result of changes in the constituent elements of aggregate demand: consumption, investments, government spending, and net exports. Money supply is also likely to cause changes in the price levels.
Rising prices in the economy are likely to cause cost push inflation and erode the purchasing power of money. Rising prices will make the factors of production more expensive and reduce the level of output produced. Concurrently, laborers will have to push for higher wages to cope with the high costs of living. The effect is an increased consumption spending and reduced savings. As such, investments are also going to fall since they are directly proportional to the level of savings. Government spending will also reduce since costs of production are high. Net exports will also reduce since the quantity of exports may reduce as export prices increase making our goods expensive. The resultant effect of rising price levels is a lower real GDP demanded.
The European Union has structured a collective monetary policy approach to dealing with the Covid-19 pandemic. The union, through the European Central Bank (ECB), has exploited two major monetary policy actions to deal with the adverse effects of the pandemic on their economy: reducing lending rates and bond repurchase programs. The ECB has reduced its lending rates to negative margins in a bid to smoothen liquidity in the Eurozone. The ECB’s deposit facility rate dropped to –0.75% and is aimed at amplifying the stimulus from negative rates and channeling the funds to those who stand to benefit from it most. The second monetary policy, bond repurchase programs, has always been in existent and preserved for tackling recessionary forces and periods.
The ECB has launched a new Pandemic Emergency Purchase Program (PEPP) with a €750 billion ceiling till the end of the year (“COVID-19 Coronavirus Outbreak and the EU’s Response”). This new PEPP is in addition to earlier announced package totaling €120 billion in a bid to bolster quantitative easing. This temporary program entails debt-buying with the aim of managing interest rates and bolstering the prices of bonds in the bonds markets. The Eurozone fiscal policy actions have been instituted on a country basis. Different governments have legislated massive stimuli packages aimed at rescuing their economies from sharply falling aggregate demand. Germany has so far announced the biggest rescue package worth €550 billion (Ettmeier, Kim & Kriwoluzky n.p.). Other countries’ financial stimuli stand at €45 billion for France, €200 billion for Spain, and €25 billion for Italy.
The most common fiscal policy measures implemented in the face of an economic crisis are reducing taxes through appropriate tax policies and increasing government expenditure. These two fiscal policies have similar advantages and disadvantages since they both work with a similar concept. An economic crisis will influence the government to adopt an expansionary fiscal policy which can be attained by increasing government spending and reducing taxes so as to increase aggregate demand in the economy. The advantages of these two policies include the multiplier effect and ease of implementation. To begin with, increasing government spending will affect consumption, spending, and investment levels. Economic theory posits that as long a country has a positive Marginal Propensity to Consume (MPC), any increase in government spending will lead to a more than proportionate increase in national income (Whalen & Felix 1). The overall increase in national income is the original increase in government spending times the country’s fiscal multiplier.
The disadvantages of the aforementioned fiscal policies are increase in government budgetary deficits and crowding out effect. Governments with large budgetary deficits have to mitigate this anomaly through borrowing. Private investments also depend on borrowing to raise capital funds. Government borrowing has the ability to soak up available financial capital due to the minimal risk involved hence leaving no capital for private investments (“What is Crowding out Effect?”). The private investments are crowded out of the available financial capital.
The Covid-19 pandemic will reduce production as countries shut down production facilities in a bid to slow the spread of the virus. The effect of this will be reduced exports while imports remain unchanged leading to a net negative effect on net exports of a country. Since aggregate demand is the aggregate of consumption, investments, government spending, and net exports, a reduction in net exports will lead to a reduction in aggregate demand. The same outcome will occur for a common market economic institution like the Eurozone. The resultant effect of a reduced net export is a shift in the aggregate demand curve to the left implying a reduction in the GDP demanded at the prevailing price levels as shown in the graph below:
Figure 3: Negative shift in the AD curve.
Source: Khan Academy
The shift moves the equilibrium point from E0 to E1 implying a lesser GDP level demanded at a lower price level. The effect is a reduction in the real GDP level.
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