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The throw-away economy

By on February 23, 2015 in concepts

The throw-away economy refers to the prevalence of consumer goods which only last for a short period of time. When they stop working / no longer relevant, we throw them away and replace them with new goods.

This is in contrast to an economy where resources are more scare – and if a good is purchased, we expect to make it last a considerable time – repairing if necessary.

For example, in the past, if our socks had a hole, we would sew them up (‘darning’ your socks). But, these days, if socks get a hole, it is more convenient to throw them away and buy some cheap socks instead.

If average wages are £10 an hour. Why spend 30 minutes sewing your socks, when you can buy a new pair for £3? In the past, wages were much lower compared to prices. If you only earnt £1 an hour, then it is worth sewing your socks to save buying a new pair for £3.

Therefore, rising real wages make a throw-away economy more likely.

Repair shops

TV repair

TV repair. Photo Katie Chao and Ben Muessig – Flickr

 

In the past, there were many TV repair shops – if your tv or electronic goods broke down, you would try to have them fixed. In today’s world, if a TV broke down, we would be liable to throw away the TV and buy a new one. It is not so expensive and electronic goods are always offering new features. After a couple of years, your electronic goods can feel ‘outdated’ pretty quick. I have a stack of CDs I don’t play in CD players any more.

The problem of the tin openers

broken-tin-opener

Broken tin opener from a Pound Shop

 

The inspiration for this post has been the number of tin-openers we have got through in the past 12 months. We have bought four tin openers, all of which have ceased working after a short period of use. In each case, we have thrown it away and bought a new one. The first two were from Sainsburys and Asda. They cost about £4, and looked fairly robust. But, after a few weeks, they stopped working properly, and then failed completely. My lodger uses the tin-opener most, so I told him since I paid £5 for a tin-opener and it stopped working, he might as well go get one from a Pound shop. The first tin opener did open one can of Heinz soup then it snapped. 99p to open one tin! That is called a false economy!

He took it back to the 99p shop and the workers laughed. They obviously got returned tin openers all the time. He got a replacement, but that broke straight-away, even before opening a tin. Continue Reading →

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How can an economist save the Rain Forest?

By on February 14, 2015 in environment

Readers Question: Endangered rain forests, wild fish, elephants and more are examples of the tragedy of the commons. What would economists recommend to save, rain forests or fish stocks?

 

Firstly, the tragedy of the commons  is a situation where there is overconsumption of a particular product / service because rational individual decisions lead to an outcome that is damaging to the overall social welfare.

The problem with rain forests is that people may feel an economic incentive to chop down trees in order to make a business, e.g. farming, wood for furniture. On their own – a decision to cut down a few trees don’t seem to make much difference. If you buy a table made with wood from a rainforest it doesn’t make that much difference. But, if everyone takes these decisions, we end up with overconsumption and eventually this precious resource is lost.

Economic policies to save the Rainforest

1. Laws and regulations by governments to make areas of rainforest protected.

This is the simplest and easiest. The Brazilian government can simply disallow firms from cutting down more trees, and legally protect rain forests. The problem is that governments may not want to do this because they see it as  viable economic resource they need to make use of.

2. Global co-operation. If we ban cutting down rain forests, some countries may lose economically – Brazil, Indonesia e.t.c. But, the world will benefit from reduced global warming and the benefits of saving rain forests. In an ideal world, all major economies could make a financial contribution to countries who promise to save their rain forests. Therefore countries like Brazil and Indonesia don’t feel like they are losing out. All countries are paying a small amount to gain the bigger long-term benefit of saving the rain forests.

For more ideas, I looked at this page: 10 things you can do to save the rainforest

Primarily these rely on trying to change consumer behaviour. But, how could an economist make the changes more widespread and not optional?

1. “Palm oil, found in half of all processed foods in the US, is a key contributor to rainforest deforestation”

In this case we could tax palm oil which is taken from land which used to be rainforest. Increasing the price of Palm Oil, would discourage consumption and encourage consumers to buy other oils.

The problem is that individual taxes on palm oil will have administration costs. It may also be difficult to know whether Palm oil has come from former areas of rainforest. but, in theory a tax will reduce demand. The money raised could be used to buy rainforest land to protect it.

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Impact of productivity and interest payments on debt

By on February 12, 2015 in debt

Readers question: In all the media coverage of the UK deficit / debt / recovery, two aspects are rarely highlighted / quantified / contextualized.

1. The £50bn interest payments on the debt (opportunity cost / %)
2. UK productivity (output per head / sector / history)

uk-debt-interest-payments-total
I think interest payments on debt are an important metric. The interesting thing is that they have been relatively stable as a % of GDP in the past few decades – and lower than say late 1970s.

UK Debt interest payments

It is not just how much you borrow, but also the cost of borrowing – and the % of national income (or tax revenues) that are used to pay the debt interest payments

For example, in a recession, when borrowing goes up – quite often bond yields fall. Bond yields fall because there is greater demand for saving and greater demand for buying government bonds, which are seen as a relatively safe investment.

Continue Reading →

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UK National Debt

By on February 12, 2015 in uk economy

The UK national debt is the total amount of money the British government owes to the private sector and other purchasers of UK gilts.

  • In Dec 2014, public sector net debt excluding public sector banks (PSND ex) was £1,483.3 billion (80.9% of GDP)
  • Source: [1. ONS public sector finances ] (page updated Feb 12th 2015)

public-sector-debt-ons

Budget deficit – Annual Borrowing

This is the amount the government has to borrow per year.

  • In 2012/13 net borrowing was £115bn (7.4%) (Excluding Royal mail and transfers)
  • In 2013/14 net borrowing is forecast at £105.5bn or 6.5% of GDP (Excluding Royal Mail and transfers)
  • From April to December 2014, public sector net borrowing excluding public sector banks (PSNB ex) was £86.3 billion

UK Net borrowing

uk-net-borrowing-percent-gpd

Latest statistics at OBR

Note this graph excludes sale of Royal Mail which temporarily reduced actual borrowing in 2012-13

net-borrowing-96-12

Figures for 2013-14 onwards are forecasts.

View:  Latest statistics at OBR

Further reading on

Deficit down but Debt up?

One potential confusion is that politicians may say the budget deficit is coming down. But, at the same time, national debt is rising.

  • If annual borrowing falls from £80bn to £50bn, the annual deficit is lower. But, at the same time, the national debt (total debt) is still rising.

% of GDP

The most useful measure of national debt is to look at debt as a % of GDP. For example in 1950, UK national debt was £640bn (at 2005 prices) – but this was 250% of GDP.

 

Continue Reading →

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Greece could benefit from leaving the Euro?

By on February 11, 2015 in economics

Just a short post, inspired by this article by Hamish McRae in Independent – Would it Matter if Greece left the Euro?

So often governments have fought ‘tough and nail’ to stay in an exchange rate system. But, when they finally leave – it is the best thing they ever did, and you’re left thinking – if only they left earlier, it would have saved economic pain. For example:

We don’t really know what would happen if you left the Euro – it is uncharted territory. We can only speculate on potential outcomes. But, perhaps this makes us more conservative and highlight the dangers of leaving.

However, given the Euro has been such an unmitigated disaster for Greece.

  • GDP down from $340bn in 2009 to $240bn 2014.
  • Unemployment of 25%

Could it get any worse?

In the short-term, quite probably. But, is the short term pain not worth becoming masters of your own economic and political destiny?

Greece may lose out in the short term. But, in the long term it will enable them to have their own currency, own monetary policy and own fiscal policy. This should give better prospects of long-term prosperity and economic stability.

The cost of staying in

Suppose Greece does endure another decade of austerity and finally returns to normal growth. Is there any guarantee the crisis of 2007-2015 will not return, at some point? It is quite likely. There is an inbuilt deflationary bias in the Eurozone. The Greek economy is just very different to northern Europe. Future Greeks may be very grateful, if the bold step is taken now.

My main point is, Greece should take the decision for the next 50 years, not just the next 5 months.

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Is it a mistake to focus on inflation?

By on February 9, 2015 in economics

Readers question: should the government focus on achieving a particular macroeconomic objective over the others?

This is a good question. There is a lot that can be said because it encompasses so many different topics.

Firstly, the three main macro-economic objectives:

  • Higher economic growth
  • Low inflation
  • Low unemployment

There are also less important objectives

  • Reducing government borrowing
  • Satisfactory balance of payments
  • Stable exchange rate
  • Protecting the environment

In this post, I will just consider whether  inflation should be seen as the over-riding primary macro-economic objective

Many economists (and Central Bankers) have often stated that low inflation should be the primary macro-economic objective. They argue

  • Low inflation is essential to long term economic prosperity. If inflation is brought under control, then the stability will encourage firms to invest and consumers to spend.
  • If inflation is too high, then it may require lower growth and higher unemployment in the short term. But, this temporary fall in output is worth the long-term benefit of bringing inflation under control.
  • In the long-term there is no conflict – if you keep inflation low, then we will also see strong growth, low unemployment and more competitive exports (helping balance of payments.
  • For example, in 1980, the new Conservative government promised to tackle the high inflation of the 1970s – They used deflationary fiscal and deflationary monetary policy. Inflation did fall, but it caused a severe recession, unemployment rose to 3 million. (In 1981, 365 economists wrote a letter to the Times saying the government should change approach). But, Mrs Thatcher argued she had to stick to the course to rid the economy of inflation.
  • 10 years later, there was another similar experience when the Conservative government again raised interest rates to tackle inflation, leading to another recession. In 1991, the chancellor Norman Lamont wrote

“Rising unemployment and the recession have been the price that we have had to pay to get inflation down. That price is well worth paying.”

– Norman Lamont, Chancellor of the Exchequer. 16th May, 1991 (Hansard) (Unemployment a price worth paying for low inflation)

ECB and their objectives

More controversially, since the credit crisis of 2008, the ECB have appeared to have an over-riding objective to keep inflation low – even though economic growth in Europe has been poor. To many it seems the ECB have been too concerned about low inflation, and have been ignoring other macro-economic objectives, such as economic growth and unemployment. This explains the reluctance of the ECB to pursue quantitative easing (until very recently). It explains why growth in Europe has stalled, and unemployment has increased to 12% – double the rate of the UK and US.

Low inflation as a false goal

 

In this particular circumstance it is arguably a mistake to give undue importance to inflation. Europe desperately needs higher growth, and higher inflation to help

  • Reduce unemployment
  • Avoid the threat of deflation
  • Reduce real debt burdens through increasing cyclical tax revenues
  • Higher inflation would also enable southern Europe countries in the Euro to restore competitiveness without prolonged deflation.

Some economists argue that in the current circumstance of a liquidity trap and stagnant economy, we actually need a higher inflation rate to help improve growth.

Macro-economic objectives depend on the circumstances

There are times, when low inflation could be a desirable goal. If growth is too fast and unsustainable, then using monetary policy to reduce inflation and stabilise the rate of inflation can help to prevent an unnecessary boom and bust.

Low inflation is generally desirable. There are many good reasons to target low inflation in the long term.

However, it is also a mistake to target low inflation and ignore other objectives, which are potentially more important. Arguably the social and political costs of mass unemployment are much greater than a moderate inflation rates. Also, moderate inflation (4-10%) is not good, but also reasonably easy to reduce. The costs of deflation are much higher, and possibly much more difficult to solve.

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Macro Economic Objectives + Conflicts

By on February 9, 2015 in economics
A look at the possible conflicts between different macro-economic objectives.

The main macro economic objectives are:

  1. Positive and sustainable economic growth (UK, long run trend rate is around 2.5%)
  2. Low inflation (UK target 2% +/-1)
  3. Low unemployment / Full employment (e.g. around 3%)
  4. Satisfactory current account on balance of payments (i.e. avoid big current account deficit)
  5. Low government borrowing
  6. Exchange rate stability

You could also consider:

  1. Issues of equity
  2. Environmental factors (long run environmental sustainability)

Economic Growth vs Inflation

The main conflict can come between economic growth and inflation (which leads to a similar conflict between unemployment and inflation). When the economy expands it is more likely that inflationary pressures will increase. Inflation is particularly likely to occur when growth is above the long run trend rate, and AD increases faster than AS.

Inflationary growth

AD-AS-spare-capacity-Yf

For example, in the late 1980s during the Lawson boom, the UK experienced a high rate of economic growth (4-5% a year). This growth rate was above the long run trend rate of growth and this caused inflationary pressure. When the economy is growing very quickly, firms have difficulty employing sufficient skilled labour; this can lead to wage inflation which leads to higher prices. Also if growth is very quick, there may be supply constraints pushing up commodity price increases.  This economic boom of the 1980s proved unsustainable and ultimately led to the recession in 1991 (as the government increased interest rates to try and control inflation.

The excessive economic growth of 1986-1989 led to inflation increasing to 10%. It required interest rates of 12% and the recession of 1991/92 to bring inflation under control.

However, it is possible to have economic growth without causing inflation. If growth is sustainable – if it is close to the long run trend rate, then LRAS will increase at the same rate as AD, and therefore, we will not see inflation.

Low inflationary growth

inflation
In the UK from 1993-2007, we had our longest period of economic expansion on record. The economic growth did not cause inflation. This is sometimes know as the great moderation.

inflation-growth-90-12

The UK great moderation from 1992 to 2008 – low inflation, positive economic growth.

Continue Reading →

Impact of deflationary fiscal policy in UK

By on February 6, 2015 in economics

A report by NIESR suggests that austerity pursued by the government in 2010, needlessly led to a delayed economic recovery and could have cost the UK 5% of GDP or £1,500 per person.

economic-growth-quarterly

The austerity was unnecessary because

  • The lower growth led to delayed rises in tax increases and
  • Interest rates were at 0%, and demand for government bonds high.
  • By delaying budgetary changes until the recovery was stronger, the government could have avoided a double dip downturn and still be able to reduce debt to GDP in the long term.

The impact of the deflationary fiscal policy could have been worse if:

  • The government had stuck to its initial austerity targets for cutting spending even more over the first Parliament
  • If the Bank of England had not used monetary policy to offset the decline in aggregate demand.

 

“The delay in the UK recovery over the first part of the coalition government’s term is at least in part a result of the government’s fiscal decisions. I have argued that these decisions were a mistake… It will be many years before we can settle on a figure for the total cost of that mistake, but measured against the scale of how much governments can influence the welfare of its citizens in peace time, it is likely to be a large cost.”

Professor Simon Wren-Lewis NIESR

Impact of discretionary fiscal policy

Implied discretionary fiscal change

Continue Reading →

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Deflationary Bias in the Eurozone

By on January 30, 2015 in economics, inflation

Readers Question: Is there an inbuilt deflationary bias in the Eurozone?

Note: I originally wrote this post in 2010. Unfortunately, every year there is a reason to update the post and suggest the deflationary bias in the Eurozone keeps getting stronger.

eu-inflation

Deflationary bias means that there is a tendency for economic policy to promote lower growth and lower inflation. It means there are pressures which keep demand subdued leading to lower inflation, higher unemployment and lower growth. Now, we are seeing outright deflation (fall in prices)

I agree that there is a deflationary bias in the Eurozone. This is proved by the long period of low economic growth (2007-15) and an inflation rate that is remaining well below target. Headline inflation in the Eurozone has fallen to -0.2% (Outright deflation, though core inflation, is still 0.7%). Growth is anaemic and unemployment well into double figures (11%) – Unemployment is higher in Europe than many other countries.

European Unemployment Eurozone vs Non-Eurozone economies

eurozone-unemployment

Source: Eurostat

Although core inflation is still positive. Many countries on the periphery are experiencing a real threat of prolonged deflation.

What explains the deflationary bias of the Eurozone?

Low Inflation Target

The ECB have very strong attachment to keep inflation less than the target of 2%. For example, in 2011, temporary cost-push inflation, led to an increase in the EU headline inflation rate. The ECB responded by increasing interest rates. The Bank of England responded by keeping interest rates at 0.5% (even though inflation was much higher in the UK than EU). The Bank of England argued it was important to give importance to wider economic issues of growth and unemployment. The ECB were much less willing to accept, even a temporary deviation from the inflation target over fears temporary inflation would increase inflation expectations. It showed the ECB are much more willing to risk lower growth than risk higher inflation. (see also: ECB v Bank of England)

Whilst the ECB have an inflation target, they have no explicit target for unemployment or economic growth. EU Unemployment has risen to 12%, but there has been little action to increase aggregate demand.

The ECB have worried than any unconventional monetary policy may reduce their credibility and long-term ability to tackle inflation.

Reluctance to pursue unconventional monetary policy

Despite a prolonged period of low inflation, the ECB have been very reluctant to actually implement unconventional monetary policy  (e.g. Quantitative easing). It took outright deflation to finally push the ECB into proper Q.E, in Jan 2015.

The ECB is reluctant to engage in any quantitative easing because

  • They are reluctant to create any possibility of future inflation, printing money is an anathema to German Central Bankers, who wield considerable influence over ECB monetary policy.
  • The ECB has a reluctance to start buying bonds of different countries, deciding which to buy; and there have been constitutional excuses for not printing money.

The result is that countries with many deflationary pressures (strong exchange rate, fiscal austerity) don’t have any monetary stimulus to offset the fall in demand. (e.g. UK can pursue quantitative easing when we experienced deep recession). Countries in Eurozone can not.

Continue Reading →

Policies to solve deflation / low inflation

By on January 29, 2015 in inflation

Deflation means a fall in prices (a negative inflation rate). Policy makers should generally be concerned if there is an inflation rate of less than the target of 2%.

For example, in the Eurozone  Jan 2015, the headline inflation rate is -0.2%. Even if we strip away volatile prices like oil, core inflation is 0.8%. This is a very low rate of inflation.

There are many serious potential problems of low inflation / deflation

  • Higher debt burdens,
  • Decline in spending,
  • Higher unemployment.

See costs of deflation for more detail.

 What options are available to overcome deflation?

Monetary policy

The traditional tool of monetary policy is interest rates. If inflation is too low, the Central Bank can try to cut interest rates. In theory, this should boost spending and aggregate demand. For example, lower rates reduce cost of mortgage payments, giving people more to spend.

AD-increase

A simple theory to increase inflation – cut interest rates, boost AD and increase the PL

 

However, there are times when cutting interest rates are not sufficient. In a liquidity trap – zero interest rates may not encourage sufficient spending. For example, after the credit crunch – lower interest rates failed to boost demand sufficiently. Lower interest rates failed to solve low inflation for many reasons:

  • People preferred to save,
  • People took opportunity to pay off debts
  • Banks didn’t want to lend, so firms couldn’t get loans despite low rates
  • Banks didn’t pass the full base rate cut onto consumers.

Unconventional monetary policy

With a failure of interest rates, the traditional tool of monetary policy, Central Banks have need to consider unconventional monetary policy. Some of these policies are relatively untried.

Helicopter drop – print money

In theory, creating inflation should be the easiest thing – just print money and according to the quantity theory of money – we should get inflation. A particular policy for printing money is termed the ‘helicopter drop’ – where the Central Bank gives newly created money to consumers directly. Central Banks have been reluctant to pursue this strategy, presumably because it goes against the mentality of serious Central Bankers and their inflation fighting credentials. But, it would be a solution to deflation. The most challenging aspect would be knowing about much money to print, to get the right amount of inflation.

Continue Reading →

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