Predictions for Interest Rates UK

Readers Question: with economic scare, do you advise to invest? how do you predict inflation and interest rates will affect business?

In the UK, interest rates have only fallen slightly since the start of the global credit crisis. The Bank of England has reduced rates from 5.75% to 5.25%. The Bank is still worried about inflationary pressure (CPI inflation recently increased to 2.6%) Also the RPI rate suggests underlying inflation (the rate people actually face) is higher at over 4%

There is an increase in cost push inflation, due to factors such as: rising energy prices and rising food prices. This makes it difficult for the MPC to cut rates and still achieve the government’s inflation target of 2%

However, I still feel that interest rates will fall over the next 12 months. Falling house prices will definitely reduce consumer spending and this will reduce economic growth and therefore inflation. With low confidence and falling spending, the MPC might be able to cut rates to 4.75% or 4.5% by the beginning of 2009. If the housing market really starts to crash as some economists predict, we could even see interest rates fall to under 4%. However, at the moment I don’t think a housing crash is the most likely scenario

 Credit Crisis and Interest Rates

However, although the Bank may cut base rates, business may not see interest rates fall. This is because the commercial banks take advantage of the credit crunch to raise their own interest rates. Therefore, commercial lending rates may increase due to shortage of funds, even though the bank cuts the base rates.

Primary Products: Advantages and Disadvantages

Readers Question: What are the consequences for Ghana if it is dependent on primary products?

Definition of Primary products: Raw materials and resources used in the productive process. Examples include: metals, agricultural products and minerals.

Advantages of Producing Primary Products

  1. What Ghana will have a comparative advantage in producing
  2. Important source of export revenue
  3. Creates Jobs

Disadvantages of Relying on Primary Products

  1. Prices are Volatile due to inelastic demand. e.g a fall in price of primary product would lead to a fall in revenue.
  2. Limited resources. One day Ghana may run out of its primary products and the economy will be vulnerable to this lack of diversification
  3. Discourages investment in other aspects of the economy. Concentrating on primary products does not help the long term development of an economy because there is a lack of investment in other aspects such as education. Comparative advantage can change over time

Bank of England Inflation Target

Readers Question: What credit can the adoption of central bank independence take for the relative stability of the UK business cycle since 1997?

The MPC, Bank of England,  are responsible for setting interest rates and determining UK monetary policy. They seek to keep inflation close to the government’s target of CPI 2% +/-1 %

Since 1997, the UK has enjoyed a period of unbroken economic growth and low inflation. It appears that the UK has been able to avoid the ‘boom and bust‘ economic cycles that characterised the boost way period – most notably the Lawson boom of the late 80s and following recession.

The statistics on inflation and economic growth are impressive, especially when put in historical context. It is a good question to ask how much we can credit the independence of the Bank of England?

Why the MPC has helped keep inflation on target.

1. They are independent. They are not subject to political pressures. E.g. they are not tempted to cut interest rates just before an election. This used to be a problem for UK economy, with many experiences of boom and bust economic cycles.

2. Monetary Policy is pre-emptive. They try to prevent inflation before it occurs. They predict future inflation trends. If inflation looks to be increasing above the target of 2%+/-1 then they can increase interest rates to reduce consumer spending and keep inflation on track. Continue Reading →

Cost Benefit Analysis Education

Readers Question: Outline the technique of cost benefit analysis. How can it be applied to the assessment of investment in education projects and what are its strengths and weaknesses?

See: Procedure of CBA 

Potential Benefits of Education Spending

  • Increased Labour Productivity in the long run. i.e. more literate and numerate workforce should be more efficient enabling higher rates of economic growth
  • Decreased Unemployment. In a modern economy it is important workers have relevant skills. Structural unemployment is often caused by a lack of skills and training. Education aims to reduce structural unemployment, especially amongst young workers.
  • Higher wages for workers. More educated workforce can command higher salaries (see MRP model of wage determination)

Continue Reading →

Unit 5 Edexcel Economics

I want to know what topics to study for unit 5 Edexcel economics? Which are the important ones?

If you are doing unit 5A Labour Markets the most important topics are:

  • Determination of wages
  • Impact of Trades Unions / minimum wages on labour markets
  • Monopsony
  • Flexible Labour Markets
  • Government Intervention in Labour markets
  • Unemployment in labour markets Continue Reading →

Housing Spending and Urban Development

Readers Question: Will an extra $20 billion per year spent on housing have the same impact on the economy as an extra $20 billion spent on interstate highways?

It depends on the state of the economy.

At the moment, 2008, one of the biggest threats to the US economy is falling house prices. Data released for last month showed a record fall in house prices. Lower house prices are undermining consumer confidence and leading to lower consumer spending. This is one of the main causes of lower economic growth.

Falling house prices are being driven by two factors

  1. Rise in mortgage defaults
  2. Excess Supply.

Building more houses at this particular time would not help, it would exacerbate the glut in house prices and cause a further fall in prices. Therefore, this could cause further problems in the economy. Continue Reading →

The Cost of Economics Tuition

Readers Question: To pay you to teach me Economics through Cherwell Tutors will cost me about £45. If I instead advertise in the tutorial section at Daily Information I can probably get you (or equivalent) at £18.

Is this an example of market failure?

Well maybe £25 an hour. :)

It’s an interesting question.

There are various advantages for arranging tutorials through a well established college.

  • Time costs of arranging tutorials.
  • For more than one subject private reaching would be split up into different locations, increasing transport costs and time inconvenience.

However, for the one off lesson there are certain advantages of arranging a lesson privately. Primarily, the cost is roughly half. If there is a clear financial benefit why doesn’t it occur more often?

  • Poor information. I could advertise at Daily Info, but I  don’t have much incentive. The extra income is fairly low and there is the inconvenience of having to advertise and teach at home.
  • The main problem is that the market is too small and sporadic. There would be greater demand before exams, but, generally throughout the year demand would be too small to make it worthwhile a) tutor’s advertising b) prospective student searching Daily Info.
  • However, some tutors do advertise on Daily Info, so presumably there is a market for those who want to try. However, I would say the advantages of privately arranged lessons are greater for the buyer than the seller. Maybe tutors should charge a higher rate £30. At £30 there is a greater incentive to spend time marketing your services. But, would a £15 saving mean buyers would prefer to goto established colleges.

Is It Market Failure?

Not really, but there is a certain lack of information. Maybe an internet database could keep details of tutors services and this could make it easier to arrange tutorials. This would help overcome the limited information market failure.

Economic Impact of Beijing Olympics

Readers Question: Use the ideas and theories you have encountered in your study of the macroeconomic business environment to assess the possible impacts on China of holding the Olympic games in Beijing in 2008.

The Olympic Games will effect the Chinese economy in the following way.

Increase in Tourism. This is a short term effect but will help increase spending in the economy. It will come from the athletes, spectators and media who will travel to Beijin. It is argued the Olympics will also provide a long term boost in repeat tourism; this could be quite significant for China as the tourist industry is largely underdeveloped.

Increased Investment in Infrastructure. To prepare the economy for the Olympics, the Chinese authorities have attempted to improved infrastructure and transport links, these will have some effect in increasing the productive capacity. Continue Reading →

Oil Price Predictions

It is pretty difficult to predict the future price of oil. There are many factors at work and it is hard to isolate any particular economic fundamentals that will determine the future price. Nevertheless in response to a readers question I posted a few factors which might keep oil prices above $100 for the next 12 months.

Oil price predictions

Questions on Exchange Rates UK

1)  You say depreciation causes inflation for the three reasons you mention, but later, that in the long run, a higher rate of inflation will cause depreciation.  So my first question is how are these two phenomena linked?  Is ‘long run’ the key; i.e. it takes a prolonged high inflation to cause a devaluation,  but devaluation causes inflation sooner? How long does it take for those three reasons to really kick in?

It depends, there is no straight answer. The two phenomena may occur simultaneously. Also it is complicated by the fact that many factors affect the exchange rate apart from just inflation. (e.g. short term interest rates)

2)  My next question is that I’m aware that factors such as rising commodity prices can exert upward inflationary pressure,  but are there any other factors that affect the devaluation of a currency – or is it purely down to inflation?

Many factors can affect exchange rates. These include:

  • Interest Rates – lower interest rates cause less hot money flows and depreciation.
  • Expectations – If investors expect a currency to devalue they will sell less. Confidence and market expectations are important in determining exchange rate
  • Current account deficit. A large current account deficit may put downward pressure on exchange rates Continue Reading →