August 16th, 2010 — economics
Source: Bank of England inflation report August 2010
A while back the Jean Claude Trichet of the ECB said austerity measures should help improve economic confidence
“The idea that austerity measures could trigger stagnation is incorrect,… confidence-inspiring policies will foster and not hamper economic recovery.” – J.C. Trichet (Double Dip Recession)
However, I don’t believe this is the case. In the UK, talk of spending cuts, public sector job losses and public sector wage freezes have all lead to a deteioration in expectations of future financial well being. There has been an increase in expectations of unemployment.
This decline in economic confidence comes at a bad time for the UK economy. Growth in the last quarter was 1.1%, but, this kind of deterioration in economic confidence could lead to lower spending and investment which will make growth difficult.
Recently, Ireland has been discovering that strict austerity policies have led to a fall in economic output (and paradoxically worsened tax revenues and budgetary policy)
The good news for the Euro economy is that the German economy has grown very strongly on the back of exports to the rest of the World. However, this surge in German growth tends to point to an increasingly two speed Europe. (see: Two Speed European economy)
Unfortunately, expectations of unemployment often closely mirror actual unemployment (UK Unemployment)
Related
August 11th, 2010 — economics
Inflation - Source: Bank of England inflation report
A big issue for the UK economy is the existence of inflation when theoretically, there should be much spare capacity in the economy. In the Bank of England’s latest inflation report, they examine why inflation is above target and the prospects for future inflation. See also: Inflation and the Recession
This graph plots three measures of Inflation. RPI (includes housing costs and mortgage interest Payments)
CPI (excludes mortgage interest payments)
CPIY = CPI – indirect taxes such as VAT, stamp duty and excise duty. This gives a guide to underlying inflation, stripping away the distortionary impact of indirect taxes. This suggests underlying inflation is lower than the headline rate.(CPIY statistics.gov)
(There is also a CPI-CT which holds indirect taxes rates constant at the rate prevailing at the start of the year)
One issue is whether the high inflation rate (above target) changes inflation expectations and therefore actually increases the underlying trend rate. In other words, people become accustomed to the higher CPI rate, so when tax rises expire, inflationary expectations become hard to shift leading to higher inflation.
Related
August 6th, 2010 — economics
Adam Smith Statue and blog author Tejvan Pettinger
OK, I jest. The great economist is Adam Smith. I was on holiday in Edinburgh when I came across this statue to Adam Smith (widely considered the father of economics for his ground breaking work – The Wealth of Nations)
Couldn’t resist the obvious tourist pose.
BTW: In the summer holidays my posting schedule tends to go down a little. It will be more frequent in term time.
Related Posts
- The Free Market
- Selfish actions and the public good – one of the principles of the Wealth of Nations. Adam Smith argued that by pursuing selfish ends it often (though not always e.g. monopoly power) led to the improvement of a nations economic welfare
August 5th, 2010 — economics
Readers Question: How Much Loss Can A firm Make before going Bankrupt?
Firms who make a loss, will not necessarily close down. There are various ways that firms can keep going
- Borrowing from Bank. Bank will offer loans if it considers the firm is likely to make a profit in the future.
- Selling shares. A firm can also raise funds by a share issue. Selling shares to raise funds. e.g. Eurotunnel required a large share issue to fund the investment for digging a tunnel.
- Running down reserves from profitable years.
What Determines How Much a Firm can lose Before Going Bankrupt.
Size of Assets. A bank will have more faith in a firm with substantial assets. In a worse case scenario the assets can be sold and bank gain some of its losses back.
Future Prospects. Is the loss a one off or permanent decline in business. e.g. if BP faced a huge bill for the Arizona oil spill, this is likely to be a one off charge and this shouldn’t effect its future profitability. A firm in a declining industry like coal or record shop may not have this future optimism. A firm like General Motors is more uncertain. The car industry has a future, but, do GM have the management to overcome the problems of lack of profitability?
Operating Profit. A big issue is whether the firm looks like it can make an operating profit. If we ignore fixed costs, a firm may be able to cover its variable costs and therefore make a contribution to paying its fixed costs. In this situation, it is preferable for its creditors for a firm to keep going. If it closes down, they would lose everything. But, with an operating profit, they are at least making a contribution to the fixed costs.
Related
July 31st, 2010 — inflation
In a recession, you would expect a fall in the inflation rate. In basic macroeconomics, we would teach.
If AD falls (or increases at a slower rate than AS), then the economy will experience spare capacity. If there is spare capacity in the economy, firms will tend to reduce prices (or a slower inflation rate).
Diagram showing fall in AD and effect on Price Level.
Why Spare Capacity can lead to lower inflation
- Firms have unsold goods, therefore, to improve cash flow they try discounting goods to sell excess supply of goods.
- As unemployment rises, it is harder for workers to bargain for higher wages. Unemployment should reduce wage inflation, which feeds into lower CPI inflation.
- A global recession should usually reduce demand for commodities and therefore reduce the price of commodities.
- Low confidence in economy usually reduces inflation expectation.
Spare Capacity in the UK Economy.
Spare Capacity in UK Source: Paul Fisher Bank of England
This graph shows the UK theoretically should have a lot of spare capacity, therefore, we would expect inflation to be lower. However, inflation hasn’t fallen, but increased recently.
UK Inflation: Source: B of E speech 29 June 2010
Why Inflation hasn’t Fallen
- Impact of VAT. The cut in VAT to 15% and later rise (Jan 2010) to 17.5% increases prices.
- Impact of Depreciation in value of Pound. Fall in value of pound increases cost of imports which feeds into inflation
- Rise in oil and hence petrol prices.
- Rise in spare capacity is less than expected. Helped by zero interest rates, there have been less insolvencies than in previous years. Also the rise in unemployment is less than in previous years
- Firms have sought to maintain good cash flow by not cutting prices.
All these are reasons why inflation hasn’t fallen by more than expected. But, one interesting fact is that UK inflation is much higher than our main competitors like EU and US.
The big question is whether UK inflation really is due to short term temporary factors or whether, it will feed into higher inflation expectations.
Further Reading
July 30th, 2010 — labour markets
Definition of Participation Rate. The participation rate is the number of people of working or actively seeking work as a % of the working population (16-65).
The participation rate is similar to the concept of being ‘economically active’. If a person drops out of the labour market, they are considered economically inactive and no longer participating.
Participation Rate in UK - Source: B of E, Inflation Report July 2010
Why People May Drop out of Labour Force
- Full Time Education -
- Sickness or disability allowance means unable to work.
- Early Retirement. e.g. have good private pension so take early retirement.
- Stay at home to look after children.
Why Participation Rate may Fall in a Recession.
A rise in unemployment doesn’t mean the participation rate has to fall. Because, if you are unemployed (i.e. actively seeking work) then you are still participating. However, in a recession the participation rate often rises. This is because:
- Long Term unemployed may become disillusioned and leave the labour market (e.g. move onto non-unemployment benefits like sickness benefit.
- Full time education may look more attractive than a saturated job market.
- Mothers may stay at home for longer rather than struggle to find a job and pay for child care.
Participation Rate in UK
The above graph show participation rates fell after the 1991 recession. There has also been a fall in the participation rate in 2009. However, so far, the fall in the participation rate has been lower. This is partly because of a rise in the participation rate in the age group 55+. Perhaps older workers are less willing to retire early but taking more opportunity to keep working. Perhaps because of fears over future pension provision.
Voluntary Unemployment and Participation Rate
If someone is voluntarily unemployed, they are generally considered to be not actively seeking work. Therefore, they could be considered economically inactive. However, it depends how voluntary unemployment is classified and measured. Some people may prefer to remain on benefits than take a low paid job, therefore they could be classified as ‘voluntary unemployed’. However, if they are still actively seeking a higher paid job, they may still be viewed as participating in the labour market. This is a potential grey area, which used to lead to much discussion when agreeing on market scheme for Edexcel Paper on Labour markets.
Related
July 29th, 2010 — economics
There is speculation about how long interest rates will stay at zero. – See: – How long will interest rates stay at zero?
Another issue is the limitations of zero interest rates. There is much hope / expectations that fiscal austerity can be offset by loose monetary policy – i.e. if we cut government spending and increase tax, then as long as interest rates are low, AD and economic growth will continue to increase. However, if we still face very low confidence, shortage of money in credit markets – a liquidity trap, then loose monetary policy may still be insufficient to avoid a slow down in the economy.
Of less importance is the potential side effects of prolonged low interest rates. This is particularly a problem for the UK where we have zero interest rates but quite high inflation. This means real interest rates are negative. In theory, this is bad news for savers and good news for borrowers (like the government)
Also, prolonged zero interest rates could in theory create a boom in borrowing, a boom in asset prices like the housing market. However, practical conditions suggest this looks very unlikely. If anything, UK house prices look precarious. I can’t see any banks willing to lend mortgages freely to every Tom, Dick and Harry. An asset bubble is a theoretical problem, but, it’s not what we should be worrying about now.
Related
July 22nd, 2010 — books
Readers Question: I was just wondering if you could recommend some books that might be slight obscure but raise certain issues, or something that is just interesting to you. I am keen to learn around he subject and I want to explore the non-typical side of economics ( e.g applied microeconomics or econometrics)
The first thing is that any reading is beneficial, even if it is short pieces from BBC news, a grasp of current economic issues will put you ahead of many student contemporaries. But, as well as newspaper and magazines, there are a few books which will help spark a greater understanding of wider issues.
Some Economic Books.
Reading From My Blog
My own interests tend towards the Macro applied side of economics, with perhaps labour market and housing market as other interests. I certainly veer away from econometrics. I think this series will be of some interest.
e.g. Economics of the 60s - Economics of the 70s
It gives a simple introduction to the broader issues that occurred in the UK.
Economics for Dummies.
I’m a big fan of simple books. I find that if you give a student a real classic like Milton Friedman, Capitalism and Freedom, they either won’t read it or won’t full appreciate it. To have a good grasp of a debate like Monetarism vs Keynesian ism is a good start, that may cultivate further reading.
50 Economic Ideas You Really Need to Know
a more upmarket version of Economics for Dummies.
Passive Reading vs Active Reading
It’s one thing to read, but, there are no prizes for buying 20 economics books. Reading books is no guarantee it will help. But, if done with the right attitude it can definitely help improve you application and also improve your enjoyment of the subject. As you read, try to:
- Identify possible questions related to the reading.
- How could you critique what you are reading?
- What are main debates which the book raises.
One note: if you find an economics book is as dull and incomprehensible, that’s probably because it is dull an incomprehensible. For example, Keynes’ General Theory of Money 1936, is considered a classic of economics. It created a whole new subdivision of economics – macroeconomics, but, it doesn’t change the fact, it is pretty dull and incomprehensible. If you never see it in a bookshop, that’s because, it’s never going to be a best seller. It’s one of those books, that if you’re an economist you feel obliged to have on your bookshelf, but have no intention of ever reading it from cover to cover.
Related
July 19th, 2010 — economics
There is often much discussion about the impact of tax and benefits on the distribution of income.
This is an interesting graph which shows the impact of different taxes and benefits on income distribution.
- As expected, direct taxes (like income tax) are progressive – i.e. they take a bigger % of income from high earners.
- Indirect taxes (like VAT and cigarette tax) are regressive i.e.t they take a bigger % of income from low earners.
- Within these broad categories, we can see that the most regressive tax is tobacco duty. The most progressive tax is income tax. Note figures are from 2008/09 before introduction of 50% tax rate.
- Another interesting thing is how regressive council tax is. (it certainly takes a very high % of my own disposable income)
Source: Economic and Labour Review
Continue reading →
July 17th, 2010 — economics
The past few years have, at least been good news for those studying economic crisis. We seem to have had a bewildering array of different crisis – credit crunch, financial crisis, fiscal crisis, banking crisis, economic crisis, depression economics, oil price shock, currency crisis, housing crashes and more. We’ve even had a few potential crisis that never materialised – Flu epidemic crisis, volcano crisis.
Arguably, we should be calling continued mass unemployment a crisis. In many ways it is more serious than a currency or credit crisis.
All crisis are to some extent interelated. Here’s a summary of what they involve.
Types of Economic Crisis
Credit Crisis.
This is a crisis primarily involved in the financial sector. It refers to the lack of money and credit for banks and other financial institutions. For example, in 2008, many banks found it difficult to gain sufficient access to credit. They had come to rely on borrowing money on money markets, but due to loan default and a collapse in confidence, banks were reluctant to lend. Some banks ran out of money completely and went bust (in case of Lehman Brothers) or had to be rescued – Northern Rock. See: Credit crisis
Financial Crisis.
This is really another name for a credit crisis. However, it implies a wider implication. As well as difficulty in getting funds it relates to the implications of banks and consumers not being able to borrow leading to banks suffering from insufficient funds. Financial crisis explained
Economic Crisis.
When people talk of an economic crisis, it could involve a variety of serious economic problems such as currency collapse, hyper inflation. Perhaps the most common crisis, is a steep fall in GDP and deep recession. This is the most serious economic crisis as it leads to the most serious impact on human welfare – in terms of economic inactivity and mass unemployment. The credit crisis played a direct role in leading to wider economic problems a year later. See: Economic Crisis
Fiscal Crisis
A fiscal crisis refers to governments struggling to repay its debt and struggling to borrow enough money to meet its budget deficit. If markets fear governments have borrowed too much, and there is little chance of repayments, there will be a selling of the government bonds, pushing up interest rates and giving government bonds a very low credit rating. It then becomes a difficult cycle to break. Markets won’t lend. Governments have to cut deficit by slashing spending. But, slashing spending can cause a fall in GDP and hence even lower tax revenues. A fiscal crisis, usually involves governments seeking outside help such as IMF intervention. e.g. European Fiscal Crisis.
- An economic crisis will worsen a governments budget deficit as tax revenues fall in a recession. Also in a financial crisis, markets are more sensitive to risk and may worry if governments look vulnerable. See also sovereign debt crisis
Currency Crisis.
A currency crisis occurs when there is a rapid fall in the value of the currency as investors become nervous of holding a countries assets. A gradual depreciation (like 20% fall in value of Sterling over past couple of years) would not be seen as a currency crisis. However, in the case of Iceland, the value of the Icelandic currency fell very rapidly as people lost confidence in the Icelandic financial sector. A currency crisis can be caused by a fiscal crisis. If governments look to default on bonds, foreign investors will want to sell any bonds they have causing a fall in exchange rate. A currency crisis can also occur in a semi fixed exchange rate if markets feel a currency is overvalued. e.g. Sterling in 1992 when it was in ERM. What causes currency collapse?
Hyperinflation
When there is very high inflation and the value of money collapses making ordinary transactions difficult. Hyperinflation
Supply Side Shock
A rapid rise in oil prices can depress an economy, leading to higher inflation and lower output. (Shift in SRAS to the left). e.g. UK economy in 1970s
Related
