Author Archive | Tejvan Pettinger

Is zero inflation a good thing?

In the UK, CPI inflation has fallen to 0%. Is this a cause for celebration or a cause for concern?

inflation-monthly-cpi-90-15-with-target

Firstly the government set an inflation target of CPI 2% +/-1 for good reasons. The fear is that if inflation is too low, we may start to get problems associated with deflation. More details here About the problems of deflation. But a quick summary:

  • Rising real value of debt. With low inflation, it becomes harder than expected for people to pay back their debts – they have to spend a higher % of income on debt repayment leaving less income for other spending.
  • Rising real interest rates. The fall in inflation increases real interest rates, whether we like it or not. Rising real interest rates make it less attractive to borrow and invest; it encourages consumers to save. If the economy is depressed, this rise in real interest rates can make monetary policy less effective in encouraging growth.
  • Falling prices can encourage people to delay buying expensive luxury goods – they feel they need to wait a year because prices will be lower.
  • Low inflation is an indication of low growth. A normal period of economic growth would typically give a moderate rate of inflation (2%). If inflation has fallen to 0%, it suggests that there is intense price pressure to encourage spending and the recovery is very fragile.

Evaluation

We have to look at the reason why inflation has fallen. At least part of the fall in UK inflation is due to temporary short term factors, such as falling oil and petrol prices. These temporary factors are unlikely to continue, and could be reversed. It is more important to look at underlying inflationary pressures – core inflation, which excludes volatile prices like food and oil. For example, other measures of inflation like – RPI  is 1% (even though RPI is not the same as core inflation.)

Falling prices could boost real incomes. One of the fears of deflation is that it depresses consumer spending. However, with a fall in the price of basic necessities like petrol and food, consumers find their discretionary income / spending power has increased, this could actually lead to higher spending in the short-term. Continue Reading →

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UK Inflation Rate and Graphs

Current UK Inflation Rate

  • CPI inflation rate: 0.0% (headline rate)
  • (page updated 25 March, 2015)

inflation-monthly-target

What is causing the fall in inflation?

  • Lower cost push inflation – falling oil prices
  • Other commodity prices also falling, such as metals, food.
  • Lower energy prices – gas and electricity
  • Low worldwide inflationary expectations. Europe is experiencing deflation and this is keeping inflation low.
  • Supermarket price wars, with big chains, such as Tesco and Sainsbury attempting to maintain market share from Pound Shops and discounters like Lidl
  • Wage growth still weak, despite early signs of some wage growth.
  • Note: RPI inflation is still 1.0%. Also, core inflation stripping out volatile items such as petrol, oil and energy prices is higher than the headline CPI rate.

Historic inflation

uk-RPI-inflation-1948-2014

The current UK inflation rate compares favourable to much of the post-war period. The 1970s frequently saw double digit inflation. In 2014, the annual RPI was 2.2%.

See also: more historical graphs of inflation

Inflation since 1990

inflation-monthly-cpi-90-15-with-target

CPI and CPIH

  • CPIH – 0.3% in the year to Feb 2015

CPIH is a new experimental index from the ONS. It is based on CPI, plus it includes housing costs, such as mortgage interest payments. Owner occupiers cost (OOH) account for 12% of the CPIH weighting. Mortgage interest payments are the biggest part of OOH. Mortgage interest payments average 10% of household expenditure.

cpi-cpih-inflation

Continue Reading →

Shortage of Lorry Drivers

Despite high unemployment in the UK, there is a shortage of LGV drivers and it is estimated that the UK will need an extra 150,000 drivers by 2020.

lorry-overtake-cyclist

In Nottinghamshire, it is estimated that for every nine vacancies there is only one qualified candidate. (link)

The average age of a (LGV) Large Goods Vehicle driver is 53. Only 2% of drivers are under 25.

Regular readers of this blog will know that I tend to favour green transport – Bicycles, freight by rail, solar power, higher taxes on petrol e.t.c. But, I also know that 99% of the goods that I buy are delivered by LGV vehicles. Lorries are an essential part of the economy – almost as important as perhaps coal miners were in the 1960s and 70s. If one section of workers could bring the UK economy to a standstill, it is LGV drivers.

Why Shortage of Lorry drivers?

1. We don’t value vocational careers / qualifications. Young people don’t see a career in logistics as a long-term career. As a society, we tend to place less value on non-academic qualifications which are essential for the economy.

2. Lack of funding for driver training. It costs £3-£5,000 to gain the necessary qualifications to become a LGV drivers; and only 50% of applicants pass the test. This seems a lot. (Here the Daily Mail blames the shortage of lorry drivers on the EU Regulations which require good driver training – the mandatory Certificate for Professional Competence.)

But, compared to the cost of a three year university degree, training for LGV training is a fraction of the price. (BTW: Given the importance and potential danger of driving LGV vehicles, it is quite right we have very high standards. EU regulations could save lives. The problem is that as a society we are happy to spend £100,000 to put a student through three years of university to get a degree, but we are reluctant to spend £5,000 on LGV training.) Continue Reading →

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Fall in Euro

Recently, the Euro has fallen from 1.5 Dollars to 1 Euro in 2011 to near parity in March 2015.

Fall in Euro

The fall in the value of the Euro has been very steep in the last six months.

This is a very significant depreciation in the Euro, and primarily reflects the greater economic weakness in the Eurozone. Related to the economic weakness, is the decision of the Eurozone to recently begin expansionary monetary policy (quantitative easing).

Why the Euro is falling

1. The ECB are embarking on Quantitative easing – the creation of money to purchase government bonds. Quantatitive easing tends to reduce the value of a currency because:

  • This increase in the money supply tends to reduce the value of the currency (greater supply tends to reduce price.)
  • Q.E raises expectations of higher inflation  – higher inflation tends to reduce the value of a currency because it will become less attractive to buy EU goods.
  • Also purchasing government bonds will reduce bond yields in Europe, making it less attractive for private investors to save money in the Eurozone – you get a lower return on Eurozone assets. Investors would rather save in US assets, where interest rates are more likely to rise and you will get a better rate of return.

2. General weakness of the Eurozone economy. Some analysts believe that EU’s quantitative easing maybe a case of too little too late; they believe Q.E. in Europe may actually have a quite limited effect. This is due to two factors: Continue Reading →

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Was Britain better off in 1914?

Readers Question on Debt and GDP

uk-national-debt

Readers Question: OK so the debt to GDP looks manageable when it is compared to the figure during the world wars but :

Q1. how do you calculate GDP rationally in wartime , did factories sell tanks to the army, were soldiers and workers paid commensurately for their labour ?
GDP will be measured the same in wartime as in peace time. GDP can be measured in three ways – National income, national output and national expenditure (they all should equal the same figure. See: Circular flow of income)
Soldiers were paid a wage by the government and this would have counted towards national income. Similarly the government bought tanks / equipment off private firms. This expenditure on arms would have counted as national expenditure. The arms tanks produced by private firms and government owned enterprises would all have counted towards National GDP.
I don’t have statistics, but I’m fairly certain real GDP increased during the Second World War. Unemployment fell and there was a rise in real GDP. Though, the Second World War was also a time of rationing and limited household spending power. Showing that a rise in GDP, doesn’t necessarily lead to higher living standards. We were spending money on arms, not food.
2 . We were at war, why would similarly excessive debts in peacetime be reasonable?
It depends what you mean by reasonable. I would see reasonable debt as
  • Debt that we can afford to pay back.
  • Debt that is being used to finance something useful for the economy – e.g. infrastructure investment to increase future capacity, expansionary fiscal policy to avoid recession. If the government borrow for the right reasons, then this borrowing can be beneficial for the long-term of the economy, leading to stronger tax revenues in the future. If you cut debt levels, without regard for consequences, it can be damaging – even self defeating.
  • Can the government afford to borrow?
3. Think of the position of the UK in 1914 , BP had just secured practically all the oil in the Middle East, the Empire was immense, we had the biggest fleet in the world, we were a good investment, now the future is less rosy, is it not ?
It depends which way you look at it. You could say Britain had immense wealth in 1914 (compared to the rest of the world). But, firstly, relying on the Empire to increase wealth was wrong from a moral point of view. Quite rightly countries in the Empire were agitating for their independence and the right to benefit from their own countries wealth. Why should the UK benefit from oil in the middle East and resources in India? Empire building is not a good way to improve economic welfare because it involves one country benefiting at the expense of others.
The other thing about Empire is that it can damage the long-term productivity of the economy. If you can rely on wealth from importing raw materials from other countries, then it can reduce incentives to innovate and rely on rising labour productivity. If you look at Germany and Japan post Second World War – they started with very little natural resources, but built a successful economy on successful innovation, technology and improving labour productivity. By comparison, post-war, the UK fell behind – possibly due to complacency from having an ‘easy ride’ during the Empire years. A similar situation is the ‘Dutch Disease‘ – when a country suffers from the result of discovering a lot of raw materials, such as oil. Is it a blessing or curse for a country to discover a lot of oil and gas reserves?
Also, the First World War practically bankrupted the country, and the 1920s and 1930s became a lost decade – with high unemployment and low growth.
One of the biggest mistakes of the 1920s, was pursuing deflationary fiscal and deflationary monetary policy – combined with rejoining the Gold Standard (which kept the value of the Pound overvalued, leading to less exports)
The interesting thing about the First World War, is that after the war, there was a prolonged economic stagnation which failed to reduce government debts – despite attempts at running a primary budget surplus.
4. Generally resources have been de-graded , soils depleted and markets are harder to satisfy , should this not require an ever reduced debt load.
If you have declining natural resources  and environmental depletion, then this can affect long-run rates of economic growth. If the damage to the environment is so severe long-term economic growth is affected, then it will reduce ability to gain future tax revenues, and concepts of what we can pay back, may change. Often we borrow on the assumption, we will continue to grow. If economic growth stopped, then current debts would be less manageable.
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Long-Term inflation forecasts

Reader’s Question: What will be the inflation rate in 2020?

Firstly, I can’t resist a few economics ‘jokes’

  • “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today. “
  • “The First Law of Economists: For every economist, there exists an equal and opposite economist.”
  • The Second Law of Economists: They’re both wrong.
  • Q:Why did God create economists ?
  • A: In order to make weather forecasters look good.

To be honest, it is very difficult to make inflation forecasts for more than 12-18 months time. I feel that if you make inflation forecasts for 5 years in advance, you are really just guessing.

There are so many different scenarios which could happen in the next five years, which we can’t envisage at the moment.

uk-RPI-inflation-1948-2014

My Guess for inflation in 2020

After making a sufficiently long list of disclaimers, I’m happy to stick my neck out on the line and make the rather unexciting prediction that inflation will be 2%. (which happens to the government’s target for CPI inflation). The reason for this prediction is:

Generally, we have become quite good at keeping inflation low. The peak in inflation in 2010 to 5% is misleading, because it was just temporary cost-push inflation in the middle of a recession. Since the 1980s, we haven’t seen any signficant demand-pull inflation.

Inflation is more likely to be low because:

  • The Bank of England was made independent in 1997. (Previously government set interest rates). Independent Central Banks are willing to take politically unpopular decisions to raise interest rates before an election reducing chance of boom and bust. Independent Central Banks are judged on their success in keeping inflation low, so they don’t want to lose their ‘low inflation credibility’.
  • Inflation expectations have fallen. It would take a big change in the economy (like the cost-push inflation of 1970s) to really shift inflation expectations upwards.
  • There is a strong will to reduce inflation. For example, Europe has tolerated very high levels of unemployment and prolonged economic stagnation – but they wouldn’t tolerate high inflation. I don’t see this changing, there is a very strong consensus on keeping inflation low amongst mainstream economists and politicians.
  • Continued improvements in technology and greater competitiveness of markets (e.g. see how competitive supermarkets have become in past few years.)

The greater concern is that we entering a period of disinflation – very low inflation, below the government’s target of 2%. Experience of the past few years and the experience of Japan suggests that these periods of very low inflation can be self-fulfilling and take a long time to get out of.

Long Range Inflation Forecasts may try to take these issues into account.

  • Are we entering a new era of macro economic stability, where central banks have finally mastered the art of managing the economy? The medium term prospects for greater economic stability are quite promising in this regard. People are already suggesting that the boom and bust economic cycle are a thing of the past in the UK
  • Will a shortage of raw materials cause cost push inflation? or will alternatives be found?
  • To what extent will new technology continue to lower costs?
  • Will global warming cause shortage of food and water, therefore pushing up prices of basic necessities?
  • Will overpopulation cause demand to rise faster than supply

Continue Reading →

Venezuela economy and oil dependency

A look at why the Venezuela economy is dependent on oil, why it did not do more to diversify, and the problems of relying on a primary product like oil.

Readers Question: First, why are more than 90% of their exports based on oil? Under Hofstede’s “Uncertainty and Avoidance of Risk”, Venezuela is ranked as a country that goes to great lengths to avoid risk. But basing an entire economy on the prosperity of one commodity seems like the definition of risk. Your thoughts on that are much appreciated.

Firstly a few quick statistics on Venezuela economy. According to Wikipedia

  • Venezuela is an oil dependent economy. Revenue from petroleum exports accounts for more than 50% of the country’s GDP and roughly 95% of total exports.
  • Manufacturing contributed 17% of GDP in 2006
  • Agriculture in Venezuela accounts for approximately 3% of GDP, 10% of the labor force.

Why does an economy base its prosperity around one commodity?

Firstly, Venezuela is not unique. Many countries specialise in oil and then later come to regret this specialisation. I have a Russian student who is asking exactly the same question – Why did Russia not take the opportunity to diversify away from gas and oil. (see: Russian economic crisis)

The problem is that when oil prices are high, it’s tempting to take advantage of the high revenues. Anything else seems much less profitable. Secondly, people may make the assumption oil prices will remain high – so they have plenty of time before needing to diversify the economy.

If you have vast reserves, then in the short term, oil production offers the quickest way to promote economic prosperity, higher tax revenues and higher government spending. By comparison, at the time, manufacturing and agriculture will offer much smaller returns and potential for exports.

In 2007, when oil prices were rising, the Venezuela economy was growing rapidly – 7% a year. With oil revenues, the government was able to begin ambitious spending programmes. Many in 2007/08 may have felt that high oil prices were likely to stay high. (I remember reading articles which predicted oil prices of $200 a barrel. Very few were predicting a collapse in prices to $40.

crude oil prices

St Louis Fed

Why not diversify the economy?

It is easy to say than do. If you have an economy that has a highly profitable oil industry, it is difficult to develop new manufacturing industries. This is for a few reasons.

  • The profitable oil industry will be attracting most investment and skilled labour.
  • Entrepreneurs will be reluctant to create new industries, where Venezuela doesn’t seem to have a comparative advantage; the prospect of profit is low and there is no guarantee they will be able to create new industries. Trying to work in the oil industry may seem more appealing and profitable.
  • The government, in theory could try to diversify the economy. They could tax the oil industry and use the proceeds to subsidise the creation of new manufacturing industry. However, around the world, governments don’t have a great track record of ‘setting up new industries’ – The government is not expert in manufacturing and so it may struggle to decide which industries to create and where to spend money. There is no guarantee the government efforts to subsidise new industries will bear any fruit. Many governments would prefer to take the easier option of benefiting from boom in oil industry and hope the oil price stays high.
  • Governments are not noted for long-term vision and acting on the possibility of changing economic situations. The political process also encourages a short-termism. You don’t tend to win many elections by promising lower income now, and investment which may bear fruit 5-10 years in the future.

Continue Reading →

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Nature of the UK economic recovery

A look at the nature of the UK economic recovery. Is the recovery sustainable? Who has benefited the most from recovery? Which groups of people have not benefited from the recovery?

In the past two years, the UK economy has posted relatively impressive growth figures.

economic-growth-quarterly

The UK posted annual growth of 2.6% between Q3 2014 and Q3 2013. ONS

It is impressive compared to Europe, which is stuck in recession. However, the recovery is less impressive when compared to the lost output since the start of the recession and the long delay that occurred before the economy started to catch up the lost ground.

real-gdp-growth-00-14-trend-line

The recovery has led to a significant decline in unemployment, whilst at the same time leading to low inflation (CPI = 0.5%).

UK unemployment-rate

From one perspective this looks very good – the main three macro-economic objectives (growth, unemployment, inflation) are posting good statistics.

However, the UK recovery is still unbalanced and there are uncertainties about its sustainability. The main areas of concern about the UK economic recovery are: Continue Reading →

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The throw-away economy

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?

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.

Continue Reading →

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