UK National Minimum Wage

  • The minimum wage was introduced in the UK in 1999 at £3.30.
  • As of October 2007 the minimum wage for adult workers is £5.52. (It will rise to £5.73 by end of 2008)
  • There is a development rate for workers 18-21 of £4.60
  • For people under 18 (not of compulsory school age) the rate is £3.40
  • Source: National Minimum wage HMRC

In this period 1999 – 2008, ILO  unemployment has fallen from 1,822,000  to 1.61 million or 5.25%. Claimant count method is even lower at less than 800,000
Readers Question and Essay:

Australian Dollar Appreciation

Readers Question: The Aussie dollar has appreciated strongly against the USD in recent times. Discuss the consequences of this rapid appreciation for Australia’s Balance of Payments?

The Australian Dollar has appreciated against the US Dollar because

  • Large US current account deficit
  • Australia has benefited from rising commodity prices, commodities which Australia produces a lot of.
  • US interest rates are lower than Australia and the US economy has been weakening.

April 2008 $1 Aus Dollar = US 0.9300

Effects of AUS Dollar Appreciation

  • It makes Australian exports more expensive. Therefore there will be a fall in demand for Australian exports.
  • Imports into Australia will become cheaper, therefore there will be an increase in demand for imports.
  • This is likely to worsen the current account deficit. However, this assumes that demand for exports and imports is relatively elastic. The Marshall Lerner condition states that if PED of exports + PED of imports > 1 then an appreciation will worsen the current account. Continue Reading →

Investment and The Rate of Interest

Readers Question: Could you please explain to me how the volume of private investment depends on the rate of the interest and marginal efficiency of capital?

Private investment is an increase in the capital stock such as buying a factory or machine. (investment in this context does not relate to saving money in a bank.)

When firms and individuals decide how much investment to make interest rates and marginal efficiency of capital are important.

Interest rates. If interest rates are high then it makes it expensive to borrow money. This will deter investment because investment is often financed through borrowing. Also when interest rates are high it makes it more attractive to save money. Investment is often financed out of retained profit. High interest rates mean that investment is relatively less attractive than saving money in a bank.

  • Assuming inflation is zero, and interest rates are 3%. Then any investment project would need an expected rate of return of at least greater than 3%. If interest rates were 6%, then any investment project would need an expected rate of return of at least greater than 6%, and therefore less investment would occur. Continue Reading →

Repo Rates and Effect on Inflation

2) what is repo and reverse repo rate and its effect on inflation

The repo rate is the difference between the purchase price and reselling price of a security, expressed as a percentage.

If commercial banks are short of money, they enter into an agreement with the Bank of England to sell their Treasury bills or gilt edged securities and then repurchase these securities at a slightly higher price.

For example, they may sell a treasury bill for £100 and then agree to buy it back at £105. The repo rate is effectively a 5% interest rate because that is the % difference between the two.

If the bank of England increases the repo rate it will increase general interest rates throughout the economy. If the repo rate for commercial banks increases they will pass this onto their own consumers. Higher interest rates have the effect of reducing spending, investment and economic growth. This will reduce inflationary pressures in the economy.

Reverse Repo rate is simply a repo agreement from the other perspective. i.e. the buyer of the treasury bill who then buys it back.

Information on Inflation

1) Readers Question What is inflation,

  • Inflation is a sustained increase in the general price level. Inflation means prices go up and the value of money declines.
    See: definition of inflation 

UK inflation

CPI-rpi

 How is inflation calculated?

What is impact on economy if inflation increases or decreases.

  • If inflation increases above the governments target of 2% it is said to have various economic costs, such as creating instability, uncertainty and lower international competitiveness. See costs of inflation 
  • If prices fall, then we have deflation. Deflation can be harmful if it leads to lower demand.
  • See: impact of inflation and deflation 

What Causes Inflation?

Inflation could be caused by:

  • Rising demand in the economy. If demand increases faster than firms ability to produce them, firms will tend to respond by putting up prices. Therefore, we often get inflation if economic growth is very rapid.
  • Rising costs. Inflation can also be caused by an increase in the price of commodities, such as oil. see: cost push inflation
  • Devaluation. This causes both an increase in costs (import prices increase) and also higher demand.
  • Wages. Higher wages increase consumer spending and also costs of firms
  • see: causes of inflation

Is there a trade off between inflation and unemployment?

There can be a trade off between inflation and unemployment, at least in the short term. Higher demand can cause higher economic growth and a reduction in unemployment, but at the cost of higher inflation. See: trade off between unemployment and inflation

How Bad is inflation?

It depends on the type of inflation and how high it is. See: Should we worry about inflation?

Why is inflation good for borrowers and bad for savers?

Inflation reduces value of money and therefore reduces value of savings. However, inflation makes it easier to pay off debts. See: Inflating away our debt

Growth of Developing Countries

Readers Question: To what extent can a government influence the rate of growth of a developing country?

There are various policies the government can use to try and increase the economic growth of developing economies.

Demand side policies.

Cutting taxes, and cutting interest rates. These help to increase aggregate demand and boost short term growth. However, demand side policies are only really appropriate for helping short term problems of slowing demand. Demand side policies do not deal with the fundamental structural weaknesses of an economy.

Supply Side Policies

These are policies which help to increase the long run rate of productivity in an economy. For example, spending money on better education and training helps to increase labour productivity. These policies can help to increase productivity in the long run.

Increasing Savings Ratio

It is argued if a government can increase savings ratio, it enables a higher rate of investment. This can lead to higher rates of growth over time. However, it depends on the efficiency of the investment. Higher savings rates do not always equate to higher growth rates Continue Reading →

When will oil run out?

Readers Question: when will oil run out?

It is difficult to say.

Firstly on the demand side, demand for oil is rising faster than many expected. This is largely being driven by rising growth in developing economies such as India and China. Today we consume an average of 85 million barrels daily. According to the most conservative estimates from the International Energy Agency that figure will rise to 113 million barrels by 2030.

On the supply side the known reserves of oil varies between 1 trillion barrels and 3 trillion.

Unknown Reserves

The amount of oil reserves is uncertain. For example, there could be a lot in the Antarctic. At the moment, this continent is relatively unknown. However, as oil prices rise, it will become difficult for countries to resist the the temptation to increase supply in these fragile areas.

Steady Decline of Oil.

Most oil analysts argue that the production of oil tends to follow a bell curve distribution. Reaching a peak before slowly declining and tailing off towards the end. Continue Reading →

Buying Property in Cyprus

Readers Question: Hello, I found your column an interesting read how ever with some concern to my myself.
I’m currently in a contract terms with buying a property in Cyprus. The property is valued at 153,774Euros and is due to complete by the 30th June 2008.

In today rates the current price in sterling would around £123,500 to buy, however with the pound continuing to fall, how long do you forecast it to continue?

Is it likely to pick up in time for me make some saving on the current exchange rate and reducing my outlay?

I think in a case like this, I would not advise waiting in the hope that the Pound may appreciate against the Euro. As I mentioned in this post, there are many good economic reasons why the Pound is weak against the Euro. I believe it is more likely the Pound will fall further, although I don’t think it will reach 1 Euro to 1 Pound.

To be honest, it is always difficult to correctly predict exchange rates; even the top currency dealers will get it wrong on many occasions.

Getting Rid of Mosquitoes

Readers Question: Why government, rather than private industry, is required for an effective mosquito eradication program?

An effective mosquito eradication program is an example of a public good.

If you exterminate all the mosquitos it has the characteristics of

  1. Non rivalry. – When you benefit from living in an area free of mosquito’s it doesn’t reduce the benefit to anyone else. (unlike a private good where if you consume it, you reduce the amount available)
  2. Non Excludability – Once provided you can’t stop anybody benefitting from it. I

If you get rid of all mosquitoes and prevent malaria, then everyone in the community will benefit.

However, in a free market the service may not be provided; this is because you will benefit even if you don’t pay and contribute to the program. Therefore there is an incentive to wait for others to pay for the program and then ‘free ride’ on the efforts of others.

A private firm will therefore, struggle to get sufficient people to pay.

This is why the government can pay for it out of general taxation. This forces everyone to pay.

This contrasts to a private good, where the benefits accrue to a certain individual and there are market incentives to pay for it.

The Greatest Risk to an Economy – Inflation?

Readers Question: To what extent do you agree that “the greatest risk to the economy is not inflation, but over-investment

To be honest, the idea of over-investment has never struck me as being the biggest risk to an economy.

Over-investment may refer to excessive growth in an economy, such as China is experiencing at the moment. It is possible that the main problem of over investment is that inflation will occur. e.g. China is currently expanding very rapidly causing a boom and rise in inflationary pressures. Another problem of the Chinese situation is that a lot of the investment is based on bad loans. The banking sector have a poor record of lending to viable business options. Therefore, the banking sector is risking being left with bad debts related to the increase investment. Continue Reading →

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