Article summary

In June 2009, Europe's two most powerful central banks, the European Central Bank (ECB) and the Bank of England, decided to hold key interest rates steady, at 1% and 0.5% respectively, and instead rely on other measures to stimulate their respective economies. ECB president Jean-Claude Trichet said the current rate was 'appropriate' based on current economic conditions and that further rate cuts were unlikely, although he did not rule out the possibility of a cut in the future. Both the ECB and the Bank of England started programs to buy government and corporate bonds to help their economies emerge from the recession. The European Central Bank projected a gradual economic recovery in the region next year, with growth rates turning positive by mid-2010, 'reflecting the effects of the significant macroeconomic stimulus under way.'

Source: Saltmarsh. M (2009) 'Interest rates held steady in Europe.' New York 71mes, 4 June.

What would be the 'significant macroeconomic stimulus' referred to in the article, and how would this type of stimulus help with an economic recovery and result in positive growth rates? What might cause the central banks to change their decision and lower interest rates instead of holding them steady?

b Suppose an earthquake has destroyed many power plants, factories and killed many people in a country.

What would be the effect on the economy, and how can It be shown on an AD-AS diagram?

it Explain what policies are available for this country to stimulate economic activity in the short run. How are these actions illustrated in the AD-AS model? What problems may result if they are successful?