Do Free Markets cause Recession?

Readers Question: Consider the view that leaving the economy to private enterprise and the market system is more likely to lead to recessions and instability than to sustained economic growth.

Without government intervention, I believe the economic cycle would be more volatile.

  • Booms and busts will be more common see: The economics of Herding and irrational behaviour
  • Economies can get stuck in recessions, where resources are under utilised and it can take a long time for the economy to recover. See: Keynes general theory.
  • The finance sector does need regulating. The experience of the current credit crunch suggests that banks are not good at self regulation; it would have been better to have stricter regulation of lending and this would have avoided many bad debts.

See: How long do recessions last?

However, government intervention is not always successful:

Also, it is argued by classical economists that economies will automatically recover after a fall in short term output. But, the experience of the great depression shows that a lack of government intervention can cause problems.

Sterling Weakens against the Pound

I wrote a quick essay on the Reasons for the falling value of the Pound

Some are predicting we might see parity between the Euro and Pound in the next few months. That would be bad news for UK tourists travelling to America. However, I think it is unlikely the pound will fall that low – unless the housing price falls turns into a housing slump.

Apologies for getting behind with readers questions

Why Do Foreigners Hold US Dollars?

Readers Question: Why do foreigners often hold U.S. dollars? How does the holding of dollars by foreigners affect the welfare of American?

The Dollar still is the world’s reserve currency. With about 67% of the world’s currency reserves held in dollars.

The reason foreigners often hold US dollars

  • Historically, it has been seen as a safe, secure and strong currency.
  • Because most other people hold currency in dollars, people may think there is strength in numbers
  • Most commodities priced in US dollars. Most commodities such as oil and gold are priced in US dollars, so this gives an additional reason to hold currency in US dollars, minimising transaction costs of getting dollars to buy commodities.
  • China buys US Dollar assets to keep its currency undervalued. By keeping dollar undervalue, it makes Chinese exports more competitive and helps to boost export demand. See: Chinese currency manipulation
  • Problems in Eurozone have made US more attractive than many Euro bonds.

See: Why the US Dollar may lose its place as the world’s reserve currency.

How does the holding of dollars by foreigners affect the welfare of American? – will answer soon.

Who Benefits from a Recession?

Readers Question: Identify and explain economic variables that may be affected positively by the economic slowdown.

Does anyone benefit from a recession?

Some people who may do well in a period of a slowdown in economic growth

  • Companies dealing with bankruptcies and IVF
  • Companies dealing with debt problems
  • It is said bookmakers and publicans do well in a recession because people like to ‘drown their sorrows’ with small gambles and getting drunk. (this may be just an old wives tale though :) )
  • Pawnbrokers and people who pay cash for goods
  • Firms selling inferior goods. (goods where demand rises when income falls) e.g. value goods, second hand stores e.t.c.
  • Greater efficiency – enabling economy to more productive in long term
  • Economists and analysts – get to talk about recession and how to get out of it

Related articles

How Much Does a Current account deficit affect a Country?

Readers Question: A huge current account deficit can seriously affect the economic well being of any country, big or small. Discuss this statement and offer some policy advises to the governments in countries which suffer from this.

Please see: Does a current account deficit matter?

I would add that some countries are better able to finance a current account deficit. E.g. the US could run a current account deficit because Chinese investors were willing to buy US assets. US debt was bought at a relatively low interest rates because of the dollar’s status as the reserve currency.

Some countries like the UK, may be an attractive destination for long term investment (Capital inflows) and this makes a current account deficit easier to finance. So it does depend on the size of the country and also the confidence people have in investing their. E.g. a developing economy may find it more difficult to attract capital flows.

 

 Policies to Reduce Current account deficit

Visiting New York to Spend some Dollars

Tomorrow, Monday, I am flying to New York, US. There might be a delay in answering some questions, but, I hope to be back quite soon.

I will be taking lots of dollars to take advantage of the discrepency in the dollar / sterling exchange rate.

Economists, often say there should be no ‘free money on the table’. But, buying a new Mac laptop in the US, could save me £500 due to the weakness of the dollar. I guess someone has to do well out of the declining dollar…

Increasing Labour Market Flexibility and Information

Readers Question: Assess the effectiveness of government policies to increase labour market flexibility in the UK.

It is difficult for the government to effectively increase labour market flexibility. However, this essay offers a few policies and evaluation of how successful they have been 

Policies Include:

  1. Subsidised childcare provision – increase incentive for women to work.
  2. Increased spending on education and training
  3. Reducing power of trades unions and minimum wages
  4. Making it easier to hire and fire workers.
  5. New Deal

It is argued that the UK labour market has become more flexible than European counterparts such as France, Germany and Spain. Economists argue that this increased labour market flexibility is a reason why UK unemployment is lower and that the government can make a difference

Should we increase the value of the state pension?

Readers Question: Evaluate the view that the most effective way to reduce poverty is to increase significantly the state pension.

Pensioners account for a growing % of the population; therefore inequality and poverty amongst pensioners is becoming a significant cause of relative poverty in the UK.

For several years, the state pension has been index linked. This means increased in line with inflation. However, this increase means it has fallen behind average wages and therefore relative poverty between pensioners and workers has increased. Increasing the state pension is a guaranteed way to reduce relative poverty between pensioners and those in work.

Minimum Income Guarantee. Rather than increase the state pension, the government have relied on using means tested benefits to increase the incomes of old people.  This means pensioners who rely only on state pensioners can receive a top up benefit. This is cheaper than increasing the universal state pension. However, it has a significant disadvantages. Relying on means tested pensions to reduce poverty creates a disincentive for people to save for a private pension. Therefore, in the long run, it may encourage people to be dependent on state benefits. Continue Reading →

Hyperinflation and the Declining Dollar

In this essay I looked at why the Dollar may soon be losing its status as the world’s reserve currency. There are actually quite a few arguments against this occurring; but, this essay focuses mainly on why the dollar is weak and why this may lead to the Euro replacing the dollar as the world’s reserve currency.

A fascinating piece of economic history is the hyperinflation of Germany in 1923. I first encountered the hyperinflation whilst studying GCSE history. There are many examples of how inflation can ruin an economy. Stories like people taking a wheelbarrow full of money to buy a loaf of bread. They left the wheel barrow unattended and when they returned the money was still there but, the wheel barrow taken. This essay looks at some of the causes and costs of hyperinflation.

Interestingly the German government of the fledgling Weimar republic were more concerned about unemployment than inflation.

Recommended Book 

  • Economic NaturalistWhy Economics explains almost everything – is a good read about the application of Economics to everyday life

Negative Mortgage Equity Withdrawal

Readers Question: During 1995 – 1997 in the UK, mortgage equity withdrawal was negative. What does a negative mew value show? and why was there a negative value during this period in the UK?

Mortgage equity withdrawal occurs when people borrow money against the value of their house.
A common way to withdraw equity is to re-mortgage your house. This is especially common when house prices are rising because the house is worth more than the initial mortgage. Mortgage equity withdrawal is thus a way to increase borrowing secured against your rising house value.

Net Mortgage Equity Withdrawal is a way to measure the total amount that people borrow against their house, but, don’t use to invest in housing. i.e. people re-mortgaging to buy a car e.t.c

However, in addition to withdrawing your equity through re-mortgaging. Consumers also inject money through buying houses and improving the condition of existing houses.

A negative value of MEW means that the value of housing stock is increasing faster than the amount of equity taken out by homeowners.

In 1995, we see the following statistics:

(A) Withdrawal by Mortgages £ million 11,519
(B) Other Equity Withdrawals £ million 17,434

(C) Equity Injected through House Purchase £ million 11,721
(D) Financial Equity Injected £ million 13,045
(E) Dwelling Improvement Investment £ million 10,573

(F) Net Equity Withdrawal £ million -6,386
Source Council of Mortgage Lenders CML pdf
Continue Reading →

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