March 3rd, 2010 — economics
Structural adjustment is a term used to describe the policies requested by the IMF in condition for financial aid when dealing with an economic crisis in. The policies are designed to tackle the root cause of the problem and provide a framework for long term development and long term growth. In practise they have had mixed results. Often criticised for creating painful changes in the economy which give as many costs as benefits. Recently, Structural adjustment policies have placed greater focus on poverty reduction, with countries encouraged to draw up Poverty Reduction Strategy Papers (PRSPs)
Structural adjustment tends to involve
Macro Economic – Structural Adjustment
- Policies to tackle Inflation (e.g. tightening of monetary or fiscal policy). In practise this may involve higher interest rates or higher taxes.
- Policies to deal with a budget deficit. Higher taxes, lower spending. Can be combined with the policy to reduce inflation.
- Removal of Tariff Barriers
- Abandoning Fixed Exchange Rates and allowing currency to float – In practise this involves a devaluation. This can help give exports greater competitiveness and help boost domestic demand. However, it increases the cost of imports and usually reduces living standards.
Micro Economic Structural Adjustment
On the micro economic side, policies are designed to increase competitiveness and productivity in the economy. These tend to involve ‘free market’ supply side policies such as:
- Privatisation – selling state owned assets to private sector
- Reducing red tape and bureaucracy
- Closing tax loopholes and reducing corruption
- Deregulation – Increasing competitiveness in economies
March 3rd, 2010 — economics
On my other blog I wrote a few articles about British Economic history. It was inspired by watching Andrew Marr’s entertaining – Modern British history. One of my first memories of the news was the coal miners strike. I lived in Yorkshire and in 1984 would have been 7 years old. I remember everyday the local news always carried pictures of these people huddled over outside fires and wondering what they were doing. The modern economic history of Britain is in many ways stranger than fiction.
Post War Economy
March 2nd, 2010 — economics
Joining the Euro is supposed to be an irreversible decision. But, individual countries could always pass individual acts of parliament to leave the Euro. However, leaving aside all the political issues, there are many economic stumbling blocks.
One problem is that countries generally would only consider leaving when there was a real economic crisis – but, it is during an economic crisis, when it would precisely be most difficult to leave.
I have covered this question in more detail at: Leaving the Euro.
But, essentially the problems of leaving the Euro include:
- Transaction costs of converting cash and machines.
- Difficulty of deciding exchange rate to leave at
- Difficulty of converting all contracts, mortgages, bank accounts from Euro to native currency.
- Possibility of capital flight in anticipation of Euro exit and subsequent devaluation
- Issues of loss of confidence in economy.
The greatest difficult of leaving the Euro, would come for those economies which are uncompetitive, trade deficits, large budget deficits and who need to devalue. (i.e. the likes of Greece, Spain, Italy).
The problem is that if Greece announced it was going to leave the Euro, investors and savers would withdraw from Greek banks to protect against devaluation.
A strong economy like Germany would find it easier to leave. A new D-Mark would appreciate so there would be no capital flight, in fact they would benefit from capital inflows.
This would enable the Euro to devalue and help it’s neighbours regain competitiveness.
Although the idea of Germany leaving the Euro sounds pure fantasy. The Euro economy is unbalanced.
Germany’s trade surplus is by far the largest in Europe, reaching 135.8 billion euros ($184.9 billion) in 2009, – Eurostat, the European Union’s statistics office.
The countries with the biggest trade deficits are also the ones with biggest economic problems: Britain, Spain, Greece and Portugal.
February 26th, 2010 — unemployment
Underemployment refers to a situation where there is a disequilibrium in the labour market causing labour to be under utilised. This can include:
- Workers working less hours than they would like
- Workers accepting jobs that don’t utilise their skills
According to the Office for National Statistics, there are 2.8 million workers in Britain who are working less hours than they would like (link). This could include people forced to work part time rather than full time. This figure of underemployment has increased during the recession because firms have sought to avoid paying redundancy by reducing working hours and therefore cost of labour.
Underemployment does not have as many costs as official unemployment. But, it does mean the underemployed have lower incomes and so will spend less.
Another type of underemployment occurs when workers end up with low skilled jobs that don’t utilise their qualifications. For example, a trained accountant who works in McDonalds is under using his skills.
If this kind of underemployment is widespread, it means the economy will be operating below its potential capacity.
Over Employment – Under Employment
Another market failure in the labour market is when firms employ workers even when there is no work for them to do. For example, firms may hang onto workers in winter for busy summer months. Some may call this underemployment, others may call it overemployment
Disguised Unemployment
Underemployment is similar to the concept of disguised unemployment.
Disguised unemployment looks at people who are not officially counted as unemployed but are either not working or working very inefficiently. e.g. disguised unemployment could count students not working in holidays who are not counted on official statistics.
February 23rd, 2010 — economics
Readers Question: Does it (financial crisis) have any possible positive effects for the future?
It is an opportunity to repair a broken financial system and put in safeguards to prevent future boom and busts.
For example, we could have policies which banks automatically hold more deposits during a boom to provide counter cyclical instruments.
Better Regulation. We can have regulation to avoid mortgage products which have a high likelyhood of default.
It is another reminder of the fallibility of the free market and the psychology of booms and busts. Though this interesting book – This time is different – 800 years of financial crisis. Suggests it won’t be the last time, irrational exuberance will lead to market crisis.
A combination of factors made this crisis severe. It certainly provides an opportunity for reform of financial system, but, it is often harder in practise than principle. Markets have an ability to get around regulation. They still have political power in influencing government legislation. Also, the negative effects of the crisis will be felt for a considerable time. – Where did all the money go – article in Telegraph suggests bank lending is likely to remain constrained for a considerable time
A new Era of Frugality? – Another potential benefit is that maybe consumers and society in general will be more thoughtful of the long term rather than short term consumption. A higher saving ratio may enable a higher investment rate and a more balanced economy. The UK and US economies were both geared towards consumer spending, partly financed through rising house prices. The recession may steer the economy in a different direction.
Better Macro economic policy. Policy makers are having to rethink the limitations of relying on a simple interest rate tool and 2% inflation target. Macro economics is more complicated than such a simplification.
February 22nd, 2010 — economics
Readers Question: Is the recession an urgent wake up call?
Yes, A few main issues arose.
1. Need for Better financial regulation. The primary cause of the recession was a credit crisis brought about by a raft of defaults on mortgages. This was worst in the US, where many subprime mortgages were sold to people who couldn’t pay back. If the mortgage industry had been properly regulated these kind of absurd mortgages could never have been lent.
The whole financial system was affected because global banks were buying these risky assets with little awareness of their toxic nature. There was a very poor awareness of risk.
See: Economic Lessons from Financial crisis of 2008-09
2. Bank Strategy. Many banks in the UK had pursued high risk growth. Traditional bank models were ignored as money was borrowed on money markets to lend mortgages. Bank reserve ratios fell on the assumption of continued growth. The banking system only survived due to extensive public support, placing a large burden on taxpayers.
See: Problem with Bank bonuses – the problem of the risk culture endemic in banking
Problem of Bank bailouts
What can we learn from financial crisis?
3. Boom and Bust in Asset Prices.
It was hoped controlling inflation would be sufficient to prevent a boom and bust. What this recession shows is how a bubble in asset prices (houses, and shares) can have a significant impact on macro economy.
Unfortunately, macro economics is much more complicated than just adjusting interest rates to keep inflation at 2%.
Related
- Is inflation really so bad?
What is optimal inflation rate
February 19th, 2010 — unemployment
Readers Question: explain benefits of increasing rate of unemployment BENEFIT FOR :UNEMPLOYED , society and any cost that may result from such policy.
Current Weekly Rates of Job Seekers Allowance in UK
- Under 24 £50.95
- Age 25 or over: £64.30
Source: Direct Gov
Note: Unemployed may be eligible for other benefits
In any economy there will be some frictional unemployment. It takes time for people to find a job suited to their skills. If you left university with a degree in mechanical engineering, it wouldn’t make sense to get the first job that came along. A good rate of unemployment benefit would enable you to take time in finding a job suited to your skills. A low rate may force you to get a job at McDonalds which would be an inefficient use of spending 4 years at university.
Another potential benefit of raising the job seekers allowance is that it would be an example of expansionary fiscal policy. An increase in unemployment benefit would lead to an increase in spending. (It would be more effective than say tax cuts for high earners. The mpc of the unemployed will be close to 100%. High earners may save tax cuts.)
One of the big mistakes of the Great Depression in the UK was that the government cut unemployment benefits (I think in 1931). The treasury were worried about rising levels of government borrowing so unemployment benefits were cut. Of course this reduced aggregate demand further and caused a deeper recession. (As well as increasing inequality)
Another benefit of raising job seekers allowance is that it would reduce income inequality. The poorest sections of society are generally on benefits such as job seekers allowance. Therefore, raising benefits would be effective in reducing poverty and inequality.
Disadvantage of Raising Unemployment Benefits.
The main problem of raising unemployment benefits is that higher benefits can create disincentives to work. There is an increased incentive to remain on benefits rather than work.However, note that the weekly rate of £65 is hardly going to be much of a disincentive from getting a job which pays NMW of £5.65 an hour.
Also, it requires higher taxes or more borrowing.
February 18th, 2010 — economics
As the old saying goes there are two certainties in life – death and taxation.
So why not combine the two and raise revenue from inherited wealth?
I have written on this topic before
But, I would like to make another case for why a ‘death’ tax meets the criteria of a ‘good’ tax
Principles of a Good Tax
- Effective in raising revenue
- Non Distortionary (efficient)
- Perceived as Fair – helping to promote greater equality
- Simple and Easy to Understand
Firstly a tax on inheritance doesn’t distort economic behaviour. Increasing income tax to 50% may discourage people from working in UK / working overtime. However, a tax on wealth, should make no difference to incentives to work during your lifetime. In this sense the tax is efficient and non-distortionary.
A tax on wealth, is one of the best ways to redistribute wealth inequality. Wealth inequality is greater than income inequality. A report by, World Institute for Development Economics Research at the UN University, suggests that 2% of population own 50% of global wealth (BBC). An inheritance tax is the best way to redistribute wealth and raise revenue. It is fairer than raising VAT which is paid disproportionally by people on low incomes.
There is popular opposition to inheritance tax, yet, the majority of inheritance tax is paid for by the wealthiest section of society. It is strange that a tax on bank profits would be so popular, but, an inheritance tax so unpopular.
It is easy to criticise taxes, but, we need to find ways of paying for an ageing population, and an expanding health care system.
Personally, I would much rather pay taxes when I’m dead and no longer need it, than pay taxes when I’m alive.
February 17th, 2010 — inflation
- Yesterday, the ONS reported a jump in CPI inflation to 3.5% for January (from 2.9% in December.
- RPIX – all items RPI excluding mortgage interest payments – was 4.6 per cent
- RPI was 3.7%
graph source: ONS
The record monthly increase in annual inflation is mainly due to the rise in VAT from 15% to 17.5%.
However, rising oil prices and transport prices have also contributed to inflationary pressures rising.
Usually, after a long recession, rising unemployment and increase in spare capacity, you would be expecting a fall in inflation.
- Last year, there was great concern about the threat of deflation. Indeed we could look upon these statistics as a vindication of economic policy – better to have a bit of inflation than have deflation. I would not be overly concerned by these statistics. I would certainly be more concerned if inflation was undershooting the target at this stage.
Indeed, there is a growing movement to change the government’s official inflation rate. For a long time, the somewhat arbitary figure of 2% was held up as the holy grail of inflation targetting.
However, 2% is not always the optimal inflation target. This is because
Inflation can spike due to temporary cost push factors. Inflation is influenced by volatile commodities like oil. Just before the recession, we had inflation of 5% – which discouraged Central Banks from cutting rates. But, this inflation was more of a temporary phenomena than evidence of excess demand in the economy. In other words Monetary policy needs to distinguish between temporary rises in inflation and a permanent rise in excess demand.
Higher Inflation Rate would give more Room for Manoeuvre. Some economists argue that a target of 2% gives Monetary policy too little room for maneouvre. E.g. during the current crisis, when inflation fell below the target, cuts in interest rates were ineffective in boosting demand. If we had a higher inflation target of 3%, we could have had higher nominal interest rates – leaving central banks more room for maneouvre and therefore less need to rely on large budget deficits.
fSee: Interview with Oliver Blanchard from the IMF
For example, in the US, unemployment is at 10% and looks set to remain high for the considerable future. Yet, some economists are already more concerned about the threat of inflation rising above 2%.
Low inflation is desirable for promoting economic stability and long term growth, but, what that low inflation rate is, needs careful examination and a degree of flexibility.
Related
The assumption that the optimal inflation rate is 2% could well be wrong and we would be better off with an inflation target of 3%
February 16th, 2010 — housing
To many people’s surprise, UK house prices have risen quite strongly in the past 12 months.
If we look at the experience of Japan, United States, Ireland or Spain, it seems the experience of Britain is unusual. Countries like Japan and the US had a boom and bust in house prices, similar to the UK. However, the fall in house prices has been more pronounced and longer lasting in other countries.
Given the weak state of the UK economy and financial sector, it is perhaps surprising house prices have recovered so strongly.
Several Factors would normally be lowering house prices
- House price to earnings ratios are still above long term averages.
- Unemployment is rising
- The economy is very slowly recovering from its deepest recession since the 1930s
- Banks are still reluctant to lend mortgages because of lack of finance.
Yet, despite these factors, figures from Rightmove suggested the annual rate of house price inflation was 6.1%. Prices rose 3.2% in the month to February alone. Rightmove measure asking prices, though other house price surveys such as Nationwide paint a similar picture.
There is every possibility that house prices could stop rising and start falling again – especially if the recession lengthens and there is significant job cuts in the public sector.
Yet, at the moment, the combination of – low interest rates and a relative shortage in supply is pushing house prices higher.
It is this shortage in supply that I feel is the main the reason for fact British house prices have stopped falling. In Spain, US and other countries, the boom in house prices, led to a boom in house building. Therefore, they have depressed demand and excess supply. – which hopefully all students would know is a recipe for falling prices.
In the UK, demand is still relatively weak, but, the excess supply is not there – a legacy of the UK’s strict planning regulations.
In the long term, what it suggests is UK house prices will remain expensive – meaning people who want to buy a house will have great difficulty saving for a deposit.
Related
