As I mentioned in class, this is an unusual posting. I numbered interesting passages in the text of the article and the numbered comments here refer to the numbers inserted in the article.
1. The Euro-zone economy is in a poor shape. Here is the comparison of changes in unemployment in the US and Eurozone since the Great Recession, from a presentation of Mario Draghi. And so Eurozone's central bank - the ECB (European Central Bank), whose president is Mario Draghi, lowers short-term interest rates. This is standard monetary policy.
Here is a comparison of how the Eurozone has been doing since the Great Recession with the Great Depression
We analyze it in chapter 9 and discuss it in detail in chapter 10: Monetary policy.
2. Asset - based securities (ABS) are similar to bonds, in the sense that they pay interest for a specified period of time at a specified rate. The funds for interest payments come from interest received from the underlying assets. For example, student loan-based securities pay interest from repayment of student loans. These assets are risky since the number of people defaulting on student loans may suddenly increase.
The most popular type of ABS are mortgage based securities, simply because the mortgage loan volume is huge. Also, unlike with student loans, there is a collateral: if someone defaults on their mortgage, the house can be repossessed and sold, limiting losses.
We discuss this in chapter 1: The Great Recession. and in chapter 10: Monetary policy.
3. The Eurozone economy is in a poor shape and most countries suffer from very large debts. So the only option for stimulating the economy is monetary policy. The ECB promises to do what is needed.
We discuss it in chapter 10: Monetary policy and in chapter 11: Fiscal Policy, deficits and debt
4. Quantitative easing is a new type of monetary policies introduced during the Great Recession. In the past central banks would not buy ABS and similar securities because of the risk. As I mentioned in class, central banks have very little capital and so cannot take on risk. But once they reduced the policy rate to essentially zero, they needed new approaches.
That will be in chapter 10: Monetary policy
5. The U.S. has been using the unconventional policies big time. An increase in central bank assets raises liquidity in the markets and usually leads to inflation. As I mentioned in class, Germans are very averse to inflation.
We will talk about liquidity, money supply and inflation in chapter 3: Money.
6. Subprime loans were the major reason for the Great Recession.
We discuss them in chapter 1: The Great Recession.
7. It is the interest rate the ECB charges. And it shows the limit of traditional monetary policy, which involved reducing the interest rates. See point 1 above.
The problem with inability of further reducing the central bank policy rate is called the zero - bound problem. We discuss it in chapter 10: Monetary policy
8. Very unusual policy. The goal is to force banks to lend, rather than park their funds at the ECB.
9. If interest rates go down, the currency depreciates.
We discuss it in chapter 4: Exchange rates.
10. If the currency depreciates, net exports rise.
We discuss it in chapter 4: Exchange rates and in chapter 9: The IS-IC model.
11. Inflation is too low. Everyone is scared of deflation.
The negative effect of deflation on unemployment is tenuous. What do we know about deflation? It happened on a large scale twice: during the Great Depression and in Japan's lost decade. It coincided with weak economy and high unemployment. But this does not imply causation.
To make a long story short, I had a cat. When it was young and tried to play with my keys, a car made some noise outside. The cat got scared, associated the keys with danger, and my keys was safe. He did not understand the difference between correlation and causation.
We discuss it in chapter 10: Monetary policy
12. If borrowers are perceived too risky, banks will not lend, making the task of stimulating the economy difficult.
We discuss it in chapter 1: The Great Recession.
Homework: check what happened with the exchange rate of the Euro last week.
You can find it at Yahoo finance; just enter, in the search box on top, EURUSD=X or EURCAD=X or EURXXX=X where XXX stands for a currency abbreviation; you can find the abbreviations here
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