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One year after I arrived at Chicago Booth, the biggest financial crisis of the past half century hit the economy, generating the Great Recession. At that point, I thought I had experienced the largest macroeconomic shock possible. But then, just a little more than a decade later, the pandemic arrived, along with its massive macroeconomic consequences.
We are still facing the aftermath of these big events. Macroeconomists, myself included, have been working to understand what’s been happening, the type of monetary and fiscal policies best suited to help the economy, and the long-term consequences of these policies.
Let me start with the Great Recession. What did we learn from it? The most important lesson has been that financial markets are an integral part of the macroeconomy. We cannot understand the economic outlook of a country without understanding the balance sheets of households, companies, and banks there.
My work focuses on households’ balance sheets as a way to understand the impacts of financial crises. If you had looked at US data in 2007, right before the financial crisis began, you would have seen that households on average had large net wealth relative to the size of the economy, so you might have thought that some financial tightening wouldn’t have been too bad. But if you had dug a little deeper, beyond that aggregate picture, you would have realized that many households were highly indebted, while others were saving a lot. This heterogeneity is key to understanding the economic impact of the financial crisis.
Another important lesson from the experience of the 2007–08 financial crisis is that the disruption in the US financial market had ripple effects all over the world, proof that the financial markets are truly global. That is why, in thinking about the Great Recession and possible policy prescriptions, we cannot forget about the financial and trade linkages between countries. Living in a global economy has huge benefits, which come from integrating cultures and exchanging ideas, technologies, goods, and assets. However, these linkages also make countries more exposed to shocks that originate far away. This was the case during the Great Recession, which quickly spread with dramatic effects from the United States to many countries, including those in Europe and in emerging economies. To give you an example, in my native Italy, the world recession caused a large drop in exports, which led to a reduction in tax revenues and hence severer debt issues, which made Italy more prone to a public debt crisis.
Let me turn to a more recent experience: COVID-19. How can we think about the macroeconomic effects of the pandemic? A defining feature was its uneven nature—that is, it hit different sectors of the economy in different ways. As I find in my work, the effects have traveled from one sector to another, and in some cases what we labeled a supply shock in one sector became a demand shock in another. For concreteness, think about the restaurant industry. When I stopped going out to eat, I also stopped buying fancy clothes (which I love!). When workers in restaurants lost their jobs, they also reduced their demand for other products.
Once again, thinking about the pandemic also made us necessarily reflect on the fact that we live in a global economy, where not only goods and assets but also people travel freely across countries, cultures, markets, and regulations. Unfortunately, traveling during a pandemic has some adverse outcomes, which caused worry and fed some instances of anti-globalization sentiment.
When we think about the macroeconomy today, the elephant in the room is inflation. Should we worry about it? What is behind it? Has monetary policy been too slow to respond? These are all legitimate concerns that economists and policy makers around the world are dealing with.
As the pandemic began to subside, the economy started to recover, but that has also brought new challenges. Fast demand built up in industries that had been idle for a long time, and new regulatory interventions in many countries disrupted global transportation. The combination of these factors created supply-chain bottlenecks that slowed production and at the same time generated strong inflationary pressures.
Once again, global linkages played a big role. Take the US, for example. On one hand, the quick buildup in US spending, especially on manufacturing goods, generated demand pressures in the countries from which the US imports products, thereby spreading inflationary pressures. On the other hand, many intermediate goods that the US relies on are imported from countries that were subject to severe regulatory restrictions due to COVID-19. These restrictions amplified supply-chain disruptions and contributed to the recent surge of inflation.
These are two examples of major macroeconomic events where global integration enabled shocks that originated in one country to travel to other countries. In response, some economic commentators and policy makers have advocated for de-globalization and for increased reliance on domestic production. This view is misguided, as it overlooks the immense benefits of integration, among them that global linkages can help dissipate the effects of large shocks that hit a given economy. This positive effect is often less visible but indeed important. An example could be seen recently in the European natural gas market, where prices spiked after the war in Ukraine restricted access to Russian supplies. Being part of a global economy was helpful in mitigating the effects of this shock, as new supply sources opened and eased the shortage. Prices came down surprisingly quickly. This is a success of the global economy.
Booth is a perfect example of the benefits of global integration, as students and faculty benefit from interacting with classmates and colleagues from various countries and continents. The interaction of people with different experiences and cultures is at the heart of the proliferation of new ideas in all lines of business. In its many forms, global integration is a fundamental force for economic progress and prosperity.
Veronica Guerrieri is the Ronald E. Tarrson Professor of Economics and a Willard Graham Faculty Scholar at Chicago Booth. This essay is adapted from the speech she gave in June at Booth’s graduation ceremony as part of the 537th Convocation of the University of Chicago.
Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub, and Iván Werning, “Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?” American Economic Review, May 2022.
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