Archive | economics

Deflationary Bias in the Eurozone

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.

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Impact of Immigration on UK Economy

In the past two decades, the UK has experienced a steady flow of net migrants into the economy. Net migration is a significant factor in the growth of the UK population. But, does this net migration help or hinder the UK economy?

net-migratinon-91-14-UK

Net long-term migration to the UK was estimated to be 260,000 in the year ending June 2014. This compares to net migration of 182,000 in the previous 12 months.

In the past five years, the UK population has been boosted by net migration of around 1,000,000.

Inflows and Outflows

net-migration-outflows-inflows

  • In 2011, the top 3 countries for source of migrants was India, China and Pakistan.
  • The top 3 destinations for people emigrating from  the UK was Australia, India and US.

Impact of Net Immigration on UK Economy

1. Increase in Labour Force

Migrants are more likely to be of working age – such as, students, and those looking for jobs. They may  bring dependants, but generally net immigration leads to an increase in the labour force and increases the potential output capacity of the economy.

2. Increase in aggregate demand and Real GDP

Net inflows of people also lead to an increase in aggregate demand. Migrants will increase the total spending within the economy. As well as increasing the supply of labour, there will be an increase in the demand for labour – relating to the increased spending within the economy. Ceteris paribus, net migration should lead to an increase in real GDP. The impact on real GDP per capita is uncertain.

Continue Reading →

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UK Inflation Rate and Graphs

Current UK Inflation Rate

  • CPI inflation rate: 0.5% (headline rate)
  • (page updated 15 January, 2015)

monthly-inflation-cpi

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 1.6%. 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

CPI and CPIH

  • CPIH – 0.6% in the year to Dec 2014

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 →

UK Debt Burden

What is the UK’s debt burden?

Firstly, there are different types of debt to consider

  1. Government debt – See: public sector debt (often referred to as National debt)
  2. Private sector debt – indebtedness of householders, finance sector and non-financial companies.
  3. External debt – the amount we ‘owe’ to other countries

In addition, you might take into account – future liabilities, e.g. pension fund commitments. Also, equally important, is future economic growth, tax revenue and the ability to meet the current debt burden.

Debt  burden as % of income

The most useful way to consider the debt burden. Is to consider:

  1. Debt as a % of income.
  2. Also, the % of income / taxes spent on debt interest payments

Government debt

uk-national-debt

Source: Reinhart, Camen M. and Kenneth S. Rogoff, “From Financial Crash to Debt Crisis,” NBER Working Paper 15795, March 2010. and OBR from 2010.

UK government borrowing fell to record levels in the early 1990s, but since the financial crisis, national debt as a % of GDP has increased to 78% of GDP (2015).

A related to concept to total national debt is the budget deficit. The budget deficit is the annual amount the government is borrowing.

Debt interest payments as % of GDP

Another important consideration is how significant are debt interest payments.

debt-interest-payments-percent-gdo

With low interest rates, the cost of servicing the UK government debt is lower than we might expect. Many economists suggest that when interest rates are low, the government should take advantage and borrow to finance investment.

See also: UK Debt interest payments

The amount spent on debt interest payments is important for understanding the ‘debt burden’ If you take out a mortgage, the crucial thing is not the total amount outstanding, but the percentage of your income that is spent on mortgage monthly payments.

Who is the UK debt burden owed to?

Another important consideration is who does the UK government borrow from?

The majority of UK public sector debt is owned by the UK private sector / Bank of England.

Private sector debt

In addition to government debt it is also important to look at private sector debt. In particular household debt / company debt. For example, at the start of the recession, household debt fell because householders sought to increase savings and pay off their debts, due to low confidence. In this case the government borrowing is partly offsetting the rise in private sector saving.

total-uk-debt

Financial debt is more complicated. The UK tends to have a large share of financial debt as a % of GDP because it has a large finance sector. But, these large liabilities are offset by high financial sector assets. Financial sector debt becomes a problem if assets fall in value. (e.g. during credit crunch)

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How useful is pareto efficiency?

Readers Question: Pareto efficiency occurs (as you say) ‘when it is impossible to make one party better off without making someone worse off’. Assume (and Economics seems to do this a lot) two people live in the world. One is a multi-billionaire and the other has no money at all. If the rich guy gives the other guy a few bob this is not pareto efficient as the former is worse off! Isn’t this complete codswallop? And Pareto won a Nobel Prize for this! Am  I missing something here? What do you think?

Pareto efficiency can have its uses and may form part of the decision making process. But also  it has its limitations.

  • It makes no judgement about the equality of distribution or overall welfare.
  • A distribution of income could be pareto efficient, but not maximise overall social welfare.
  • It could involve some resources being wasted – as long as no one feels worse off.

Because of these limitation it would be a mistake to use it as the final arbiter of a decision or how to manage society.

Is rich man worse off?

Firstly, in the case of the rich man giving a ‘few bob’ to the poor man. Is the rich man actually worse off?

A rich man may get a high utility from this act of philanthropy. He may feel his welfare his higher because he is in a position to give to the poor man. In this case, both are better off.

However, if the billionaire gets no joy from philanthropy, then he may feel he is worse off because he’s given money to a poor man. From a strict pareto point of view, this is pareto inefficient because the billionaire is worse off after this income redistribution.

But, obviously in this case, it would make no sense to use pareto efficiency as a guiding principle. From a utilitarian perspective, overall welfare of society has increased through this income redistribution because of diminishing marginal utility of money. A billionaire wouldn’t really notice not having a few bob, but the poor man could make very good use of it.

Related pages

 

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Ask an Economic Question 2015

You are welcome to ask any questions on Economics. Though you might also like to try google custom search (top right) to see if the topic has been covered before.

I am looking to explain economic principles / ideas/ recent developments in economics. I can’t promise to answer, but will try if it meets the criteria below.

  • Please don’t ask me to do your coursework / assignment e.t.c. (I can usually tell if it is a homework question!)
  • Please don’t ask any maths calculations.
  • The question and answer will be published here where everyone can see it (including your teacher!)
  • I aim to try and simplify economics; as a rough guide I would aim at an understanding similar to a good British A Level student.
  • I am looking to explain economic principles / ideas/ recent developments in economics.
  •  I will answer as a new post, if you leave email address, I’ll usually send quick email. Check home page of blog for new post. With question and answers

If comments are closed: email

mail(at)econoimcshelp.org
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The UK recovery compared

I’ve just got back from my Christmas holidays. I spent two weeks in Croatia (the EU’s newest member, 2013). It was very beautiful by the coast, if somewhat cold.

hairpin-1-1000

Just like students find it hard to write the first essay after a three week holiday, I also struggle to get into the flow of economics after a long break.

To help ease back into the flow, I shall borrow a couple of graphs from the internet

A graph tells us a lot, but can also open up many questions.

Firstly economic growth in UK compared to France and the US

uk-growth-fr-us

Via P. Krugman and How good has UK recovery been? at Mainly Macro.

See also UK vs France recovery from Jan 2015.

Good recovery in past 12 months, but since 2007, UK recovery looks less spectacular. Also, note this graph is GDP per capita – the UK population has been rising, which makes GDP per capita less impressive than raw real GDP.

Also record of austerity

govt-spending-growth

Austerity record, Krugman.

More blogs in the coming days. Questions welcome as usual

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Reducing medical costs in US

Readers Question: The recent issue of health insurance coverage (the fact that everyone must have it or pay a penalty, and that this is causing everyone’s premiums to go up) has me wondering: why can’t the U.S. simply lower overall costs of everything, not just health insurance, but medical treatment costs, as well as all costs of living/all merchandise of any kind, but not lower anyone’s wages? 

Yes, the US could reduce health care costs as a % of GDP without lowering wages and with only a minimal effect on health care standards.

The US spends more on health care than anywhere else in the world.

total health care spending - list of countries

Note, this is health care spending per capita – and the US has one of the highest per capita incomes in the world.

US vs British health care

For all the money the US spend on health care, there isn’t a significant improvement in living standards.

% of health care spending as % of GDP Govt spending as % of total health care Per Capita expenditure 2006 (PPP) Doctors per 10,000 population Nurses / midwives per 10,000 Hospital beds per 10,000 Life Expectancy male obesity
UK 8.2 87.3 2815 23 128 39 80 22%
US 15.3 45.3 6719 26 94 31 78 31%

US health care costs were 7% of GDP in 1970. UK was 4% of GDP in 1970 (Runaway health care costs) Health care costs have been rising very fast in the past few decades. Aspects of the way private health care insurance is set up means this is more likely.

Continue Reading →

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UK Population trends and forecasts

Since 1964 the population of the UK has grown by over 10 million people (18.7%).  About 50% of this growth has occurred in the past 15 years.

UK-population-change

UK-population-change. Source: ONS Population

In recent years, the rate of population growth has exceeded 0.6% a year.

UK population predictions

uk-population

The biggest population growth is predicted in England, and the south east especially.

Population forecasts for UK

2008 2033
UK 61,393 71,623
England 51,460 60,715
Wales 2,990 3,347
Scotland 5,169 5,544
N.I 1,775 2,016

What is causing the growth in the population?

main-drivers-population-change_tcm77-368323 The main cause of population growth in the UK are:

  • Improved life expectancy
  • Net migration

In 2013, net migration was accounting for roughly half of the population growth.

  • In the year ending June 2014. There was net migration of 260,000. Of which just less than half was from the EU (142,000) and the other (168,000) from outside the EU

Birth rate in UK

  • There were 698,512 live births in England and Wales in 2013, a decrease of 4.3% from 729,674 in 2012.
  • In 2013, the Total Fertility Rate (TFR) decreased to 1.85 children per woman, from 1.94 in 2012

total-fertility-rates

The fertility rate of 1.85 per women is higher than many European countries, such as Germany where it is as low as 1.35.

Impact of improved life expectancy

With increased life expectancy being a major driving force of rising population, we will see a significant increase in the number of people over 65. The number of people over 65 will increase from 16% of the population in 2008 to 23% of population by 2033.

In particular, there will be a significant increase in the number of very old 90+, 100+

Graph showing change in age profile of UK

poppyramid_tcm-change-demographics

Net migration is a factor in the increase in working age population demographics.

Rise in one person households

Another factor in the rising population is that there will be a proportionally bigger percentage increase in one-person households. Therefore, the number of households will rise faster than the population.

UK Population Households

 

 

Some economic implications of rising population

  • Increasing demand for housing – both to buy and rent. However, the UK finds it difficult to increase supply. Local pressure groups often resist building of houses on greenbelt land. Therefore a long term forecast for house prices would be upward.
  • Tax revenue. A rising population will make it easier for the government to deal with an ageing population. The UK faces less of a demographic shift than other European countries such as Italy. The burden on pensions and health care will be less than in other European countries
  • Transport. Combined with economic growth, an increasing population will lead to significant increase in demand. Yet, the capacity to increase road space is limited. This is part of government’s rationale for high speed rail travel.
  • See more at: economic impact of rising population

A rising population has both benefits and costs. One big dilemma will be how the UK deals with transport congestion.

Historic population growth

1801 – population of Great Britain was 10.5 million
The population of England doubled from 16.8 million in 1851 to 30.5 million in 1901

Related

Trickle down economics

Trickle down economics is a term used to describe the belief that if high income earners gain an increase in salary, then everyone in the economy will benefit as their increased income and wealth filter through to all sections in society.

However others criticise this belief that if the top earners in society gain an increase in income, everyone benefits as a result. Some studies suggest that increased income inequality can lead to this inequality being solidified through educational opportunities, wealth accumulation and the growth of monopoly / monopsony power. Furthermore, increased inequality may lead to lower rates of economic growth.

A recent report by the OECD found that since the start of the credit crisis in 2008, inequality has widened in many countries; however this inequality has led to lower rates of economic growth not higher.

This graph from an OECD report suggests that inequality is responsible for lower GDP. The OECD estimates that the UK economy would have been more than 20% bigger had the gap between rich and poor not widened since the 1980s.

oecd-inequality

Source: OECD Focus – Inequality and Growth 2014

Trickle down effect and tax cuts

An important element of the trickle down effect is with regard to income tax cuts for the rich. It is argued that cutting income tax for the rich will not just benefit high-earners, but also everyone. The argument is as follows:

  1. If high income earners see an increase in disposable income, they will increase their spending and this creates additional demand in the economy. This higher level of aggregate demand creates jobs and higher wages for all workers.
  2. Alternatively, increased profits for firms may be reinvested into expanding output. This again leads to higher growth, wages and incomes for all.
  3. Lower income taxes increase the incentive to for people to work leading to higher productivity and economic growth. Continue Reading →