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Economic Theory

spending at the same time? The answer, you now know, is that the
government borrows the money. For example, to pay for the $787 billion
stimulus bill, the US government issued new debt. People and institutions
(such as banks), both inside and outside the United States, buy this debt –

that is, they lend to the government.
There is another institution – called the monetary authority – that

purchases government debt. It has specific names in different countries: in
the United States, it is called the Federal Reserve Bank; in Europe, it is
called the European Central Bank; in Australia, it is called the Reserve
Bank of Australia; and so on. When the US government issues more debt,

the Federal Reserve Bank purchases some of it. The Federal Reserve Bank
has the legal authority to create new money (in effect, to print new
currency) and then to use that to buy government debt. When it does so,

the currency starts circulating in the economy. Similarly, decisions by the
European Central Bank lead to the circulation of the euro notes and coins
you saw being used to purchase fried chicken. The decisions of the
monetary authority have a big impact on the economy as well.

When the European Central Bank decides to put more euros into
circulation, this has the effect of reducing interest rates, which means it
becomes cheaper for individuals to get a student loan or a mortgage, and it

is cheaper for firms to buy new machinery and build new factories.
Typically, another consequence is that the euro will become less valuable
relative to other currencies, such as the US dollar. If you are planning a
trip to the United States now that your class is finished, you had better

hope that the European Central Bank does not increase the number of
euros in circulation. If it does, it will be more expensive for you to buy US

dollars.
Today, the world’s economies are highly interconnected. People travel
from country to country. Goods are shipped around the world. If you were
to look at the labels on the clothing worn by the customers in KFC, you

would probably find that some of the clothes were manufactured in China,
perhaps some in Malaysia, some in France, some in the United States,
some in Guatemala, and so on. Information also moves around the world.

The customer sitting in the corner using a laptop might be in the process of
transferring money from a Canadian bank account to a Hong Kong
account; the person at a neighboring table using a mobile phone might be
downloading an app from a web server in Illinois. This globalization

brings many benefits, but it means that recessions can be global as well.

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