In the last economic quarter, the UK economy stagnated 0% growth. At this stage in the economic cycle, you would usually expect a lower rate of inflation. - As demand in the economy falls there is downward pressure on prices causing lower inflation rates.
Inflation is increasing because of cost push factors. In particular the cost of living is rising because of
Higher oil prices - leading to higher petrol prices, and higher transport costs which affects all goods.
Higher food prices - caused by a combination of rising global demand and bottlenecks in supply.
Rising Energy prices - the price of natural gas is linked to the price of oil.
Rising commoditiy prices such as metals and minerals. Many blame rapid economic growth in India and China for this increased demand and higher prices
CPI Inflation is 4.7%, RPI is 5%.
Having said all that, I feel the prospects for inflation is that inflationary pressures will reduce in the coming year.
The slowing economy, rising unemployment and on going credit crunch will reduce demand pull inflation further
Global recession has already caused the price of oil to fall from its midsummer peak.
Evidence of food prices stabilising as supply bottlenecks overcome
The House of Representatives voted against the initial $700bn bailout. Though some bailout is likely to go through in a different form.
The Problem with the bailout was:
Buying worthless assets, won’t solve the causes of the credit crunch. It won’t solve the problem of home repossessions, falling house prices and the fact banks have made too many bad debts
There was a danger financial firms would use the bailout as a way to get rid of their worst assets and seek to make profit at the expense of the taxpayers
It will cause moral hazard. If you bailout firms who fail, it encourages risky behaviour in the future. The financial crisis is indicative that there is a fundamental disequilibrium in the markets.
The Government was getting a poor return. It was going to buy assets nobody wants to buy at prices well above market prices. If the government is going to bail out firms who lost money to incompetence, at the least they should get a stake in the company. This means the taxpayer has more chance of getting a fair return in the long term.
Having said all that. There is some economic justification for government intervention at this stage.
You could argue that the market value of these mortgage assets is undervalued. Panic has gripped money markets and no-one wants to lend to each other. Away from subprime mortgages there are some assets which will get a reasonable part of their cost back. Therefore, although the plan appears to cost $700bn, in actual fact it won’t because some assets will not be defaulted on. A government intervention would maintain some degree of calm and stability and prevent a market rout.
The problem is that we don’t know how much a crisis in the banking system would affect the real economy. Some people feel that if banks do go under, we could face a great depression not seen since the 1930s. Others argue, that this is actually unlikely, because we would be able to prevent a collapse in the money supply like in the 1930s.
The problem is who wants to risk a great depression?
Could you perhaps elaborate on that or point me to articles that discuss European debt?
National debt in EU countries is a real problem. Countries like Italy already have a national debt of over 100% of GDP, but, demographics mean that the ratio of retired people to workers is increasing making future debt likely to grow. Good article here in Times - EU debt
Is it certain that European countries will slip into a recession (by classical definition, and if so, who will and how deeply)?
I’m sure EU countries will slip into technical recession. How long will the EU recession last?
Depends on:
Extent of financial crisis spreading to EU banks
Depends how much EU house prices fall
Depends how much global economy slows down
The response of the ECB and whether lower rates would actually boost spending amongst EU consumers
Will the Euro continue its appreciation making it more difficult for EU exporters.
Gold looks like such a good investment at the moment.” How can you advise one to invest in Gold, and how can a person like myself start?
I think Gold is a good investment (though be wary of a speculative bubble in Gold). You could just buy shares in gold companies. Or I presume you could buy Gold stocks direcly. But, being an economist I have no money to invest, so actually, I don’t really know.
Readers Question: if production of food crops is increasing at a diminishing rate what factors of demand can reverse this trend.
If the production of food crops is increasing at a diminishing rate, then it is likely to increase the marginal cost of food production. If demand is rising faster than the supply of food then the market price will rise. Demand for food crops tends to be inelastic. Therefore, if price of food rises there will be only a small % fall in demand. Therefore, there could be an increase in revenue for farmers. This increase in revenue could give farmers an incentive to increase investment in agriculture. e.g. farming new land, using better technology to try and improve yields. Therefore, in the long run, the diminishing returns and higher prices may encourage greater supply.
However, that is only one possibility. For example, maybe there is no new land to farm. Maybe famers have exhausted productivity levels with use of chemical fertilisers / tractors e.t.c.
Also, if there are diminishing returns from increasing supply, but, not an increase in demand then prices won’t rise but fall. This may lead to lower revenues for farmers. Eventually some may go out of business (unless subsidised by government which often happens)
Readers Question: Should we worry about water running out?
In a way water is a renewable resource. From a global perspective, water is almost infinite in supply. However, there can be serious water shortages in local areas. This is becoming an increasing problem due to population growth and rapid economic growth.
Also, it is not just water, but, clean drinking water that is important.
In theory, if demand rises faster than supply, then the market price of water should rise and this will ration demand. This increase in the price of water should encourage local areas to ship water in or invest in desalination plants.
However, the market may not be able to respond to water shortages satisfactorily.
Water is an essential commodity for life. People expect to be able to consume water for free. However, the marginal cost of supplying extra water can be quite high. For political or social reasons governments may be reluctant to charge a market price for water to ration demand. However, this probably will need to change.
Water shortages are not easy to predict. With oil, the supply is fairly constant. If we run out, we at least can plan for it. However, water shortages have a habit of being unexpected. E.g. the draught in Spain and Australia was more severe than for a long time. In other words the market mechanism will respond too late. You need to invest in more water supplies a long time before having a draught period.
Demand continues to Grow.
The world’s population continues to rise, causing higher demand.
Global warming is causing increased demand for water for agriculture.
Economic growth also requires higher demand for water. People in rich countries use 10 times more water than poor countries.
Yet, the supply of drinking water is struggling to keep up.
“Two-fifths of the world’s people already face serious shortages, and water-borne diseases fill half its hospital beds.” - Why World’s taps are running dry at BBC
This is only part of the answer. There is no reason why the world cannot find a solution to water shortages. But, it is a problem which certainly requires intelligent intervention.
Readers Question: What are the types of unemployment?
Firstly, we can make a distinction between:
Supply side unemployment (the natural rate of unemployment). These are usually microeconomic imbalances in labour markets.
Demand side unemployment (Unemployment caused by lack of aggregate demand in the economy). In the coming recession, we can expect demand deficient unemployment (sometimes called cyclical unemployment) to increase significantly.
Amongst Supply side unemployment Different types include:
Frictional - when people are in between jobs.
Structural - Unemployment due to occupational or geographical immobilities. Often occurs after structural change in the economy. E.g. closure of mines, left many miners struggling to find suitable work.
Real Wage Unemployment. e.g. powerful trades unions bargaining for wages above the equilibrium. (this may be exacerbated by fall in aggregate demand)
Voluntary unemployment. Some debate exists over this form of unemployment. But, arguably high benefits may encourage some to stay on benefits rather than take low paid jobs.
Quite a few people have been asking about the economic effects of falling share prices.
I remember seeing one A Level question asking ‘ Discuss economic effects of a fall in share prices and a fall in house prices’ (15)
Falling share prices will
Reduce consumer wealth for those who own shares. Therefore, they may spend less
Reduce value of pension funds and reduce private pension income (if it is a prolonged fall in share prices)
Make it more difficult for companies to raise finance on the stock markets, leading to lower investment.
Falling share prices tend to reduce consumer confidence.
Therefore, these factors tend to reduce aggregate demand growth and lead to lower rates of economic growth.
However, bear in mind the impact may be limited
Not everyone owns shares.
People who own shares tend to be rich and can ‘afford to lose money’ on the stock market. Therefore, their consumption levels will not be affected at all.
Stock market crashes don’t always affect levels of economic growth. e.g. 1987 stock market crash didn’t reduce growth at all. (Partly because interest rates were cut sharply)
The impact of falling house prices would be much greater. More people own houses - it is the biggest form of wealth in the UK.
Also, falling share prices are often a reflection of bad economic news rather than the cause.
US National debt is currently, $9.7trillion. It is forecast to rise to, at least, $11.3tn (possibly more with financial bailout by the end of 2009. In the coming years, the National debt could become an ever increasing burden for the US economy. This is because:
Cyclical downturn reduces tax revenue and increases spending
Long term demographic trends which create additional demand on government spending, especially health care and pension commitments.
Financial bailout. There is much interest in the $700bn bail out; it will definitely worsen the National debt, if the government take responsibility of mopping up the bad loans from the banking system.
The Credit Crunch can be bewildering. (I’m glad the derivatives market is not on the A Level syllabus) I have to admit that 18 months ago, I had little idea about terms such as CDOs and ‘Credit Default Swaps’
Outside of Wall Street and the City, I’m sure most people had little idea either. Yet, despite being a mystery to the wider public, the Credit default swap market had (according to the International Swaps and Derivatives Association) ballooned to more than $45 trillion by mid-2007. If it is possible to put any meaningful perspective on this figure, Mongolia had a total GDP of $3.905 billion (2007 est.) The GDP of the UK, is a little over $1 trillion.
18 months ago, I would never have predicted so many high profile banking firms would have gone bankrupt or required bailouts from the government. The credit crunch has certainly been a shock to the global financial system.
