Economics help blog – Page 165

Economic reasons for long school vacations

18 November 201711 June 2014 by Tejvan Pettinger

Readers Questions: I want to know the economic reason behind:

Summer/Winter vacations in school?
or: Why we have summer/winter vacations in school.

This is an interesting question, especially as I have just finished teaching for the year and begun the long summer holidays myself.

Oxford students on their way to their last exam in May. Oxford only have 24 weeks of teaching per year.

Possible economic reasons

Non-monetary benefit for teachers. Generally, teachers pay is relatively low for the standard of their qualifications. Teachers with good degrees could probably choose a career with higher monetary benefits (and less stress) if they moved to the city or something like that. Most teachers are paid by the government, so pay is not dependent on market forces, but government’s tight budgets. Giving teachers a six week summer vacation could be seen as a non-monetary benefit to compensate for the relatively lower pay. I’ve heard some teachers say the long summer holidays are one of the best perks of the job. I’m sure if the summer holidays were just one week, there would be an even bigger rush to leave the profession, and the government would have to raise salaries to attract teachers. The government wouldn’t want to have to increase teachers pay, so it’s easier to leave the long holidays.

Education has little short term productivity. Education is not like a factory producing cars. A car factory couldn’t afford to have a six week summer break because output would immediately fall, and average costs rise (less output, less economies of scale). However, education is very different. If students take long holidays, there is going to be little change in long-term productivity of the economy. In the short term, there will be no change in the productivity of the economy. Education does not directly increase GDP. Therefore, long school holidays do not directly reduce real output.

More productive use of time. You could argue that long summer holidays are a useful opportunity for students to work in temporary summer jobs – helping the tourism industry. Summer holidays also enable teachers to work marking examination papers (I did this for a few years before I could take it no longer)

Diminishing returns from teaching longer hours. If we switched from 6 week to 2 week summer holiday – would we really get a more productive and highly educated workforce? I doubt it. Students are hard to teach by the end of May, let alone trying to teach them into mid August. Teaching students for long hours has diminishing returns. Increase the number of school weeks by 10%, may only give a 1% increase in the standards of education.

Therefore, extending the school year would have little benefit to the economy in terms of improved education standards and higher productivity.

House Price Inflation – Pros and Cons

10 September 20219 June 2014 by Tejvan Pettinger

Readers Question: Why is house price inflation considered good while other forms of inflation are considered bad? Or are all forms of inflation bad for the economy?

House price inflation has a mixed impact on the economy depending upon the extent and timing of the rise in house prices.

This graph shows house price inflation in the UK since 1981. It shows the volatility of house price inflation in the UK.

Benefits of Moderate House Price Inflation

A rise in house prices increases the wealth of householders. This can lead to increased consumer spending. Householders can take equity withdrawal from the increased value of their house.
House price inflation doesn’t reduce the value of savings like ordinary inflation. For homeowners, wealth actually increases.
House price inflation doesn’t indicate the economy is at full capacity and overheating, it just reflects demand is greater than supply in this particular market.

Problems of House Price Inflation

Rising house prices are good for homeowners, but it can reduce living standards for those who don’t have a house. In the UK house price inflation has made homes unaffordable for many first time buyers – see: House price to income ratios. Rising house prices have also had an impact on increasing rents. House prices inflation, in the UK, has increased inter generational inequality; those buying houses in the 1970s and 80s have done very well, but young people facing a very difficult housing market.

House Price Inflation and Boom and Busts

The most serious problem of house price inflation is that in booms, the rise in house prices often prove to be unsustainable. In the 1980s, rising house prices contributed to an economic boom – rising consumer spending and rapid economic growth. However, this economic growth and rise in house prices both proved unsustainable. When interest rates were increased to reduce inflation, it caused a collapse in house prices. This fall in house prices left many with negative equity. The subsequent fall in house prices was a factor in contributing to the recession of 1991. Volatility in house price inflation has a big impact on economic instability. Similarly falling house prices post 2008 (as a consequence of the overheating in house prices) has been a big drag on the US and European economies.

Napoleon, eggs and capturing consumer surplus

18 November 20179 June 2014 by Tejvan Pettinger

On campaign in the early 1800s, Napoleon approached a hostelry on the slopes of Col du Pin Bouchain near Roanne. (BTW: the Col du Pin Bouchain at 759m was the first mountain ever used in the Tour de France in the 1903 edition.) Napoleon was shocked at the price of eggs, and so he asked …

Should we worry about a trade deficit?

1 February 20206 June 2014 by Tejvan Pettinger

A trade deficit implies the value of imports of goods is greater than exports. (M>X) The trade deficit is an important component of the current account on the balance of payments. Sometimes people use a trade deficit and a current account interchangeably, but in the UK this is not correct. The current account also includes …

Bond Spreads

10 February 20202 June 2014 by Tejvan Pettinger

Readers Question: How do bond spreads affect the value of the Dollar or Euro?

A bond yield refers to the interest payment that you receive from holding the bond yield. If the yield is 4%, you can expect £4 a year from a £100 bond.

A bond spread refers to the differences in bond yields. For example, it could mean the spread between different government 10 year bond yields. In the US bond yields may be 2%, whereas in the Eurozone, bond yields may be 4%.

There could be many different reasons for this bond spread (difference) But, if markets are concerned that one country is at risk of debt default or liquidity shortages, investors may be unwilling to hold those bonds and therefore bond yields go up to try and attract investors. (See inverse relationship between bond price and bond yield)

EU bond Yields — A time when Italian and Spanish bonds had a large bond spread over UK and German.

If investors are nervous about holding Eurozone bonds, due to fears of illiquidity, then international investors will be demanding less Euros – they would prefer to hold dollars and buy US bonds. Therefore, in this case, we would expect to see an appreciation in the US dollar and a fall in the Euro.

If you look at government bond yields (FT) – Greece has a high bond yield 6%. If Greece had its own currency, you would expect the Greek Drachma to fall.

Argentina has had periods of high bond yields because investors are nervous about holding Argentinian debt due to fears of a debt default. This corresponded with a fall in the Argentinian currency.

However, high bond yields are not necessarily a reflection that markets are nervous about the state of government finances. Bond yields can rise when markets are optimistic about future economic growth. See: Factors affecting bond yields

However, it is worth bearing in mind, many other factors determine exchange rates, apart from bond spreads, such as:

Higher interest rates can attract hot money flows. If people are confident of a country and they see high interest rates, they may move their currency to benefit from better interest rates.
Relative inflation rates. If inflation is relatively low in a country, then demand for the currency will be higher in the long-term as their goods will become more competitive.
See: Factors influencing exchange rate

Narrowing of bond yields on Eurozone

The ECB decision to purchase bonds and intervene in the market (since 2012) to provide liquidity has calmed investors and lead to lower bond yields amongst members of the Eurozone

The great Europe debate

18 November 201728 May 2014 by Tejvan Pettinger

The rise of UKIP and Euro-scepticism in the UK inspired me to have another look at an old blog post – Benefits of the European Union.

I’ve spent the past four years criticising the economic policy of the EU, and more specifically the ECB. There are may good reasons to be dissappointed at the EU in recent years. But there is always a danger that people can lose any sense of perspective and see the EU only as an unmitigated bureaucratic disaster more reminiscent of the Soviet Union than a modern progressive block of countries, who have made substantial progress in the past couple of decades.

Researching the benefits of the European Union was a reminder to myself that despite all the problems of the EU, it is not quite as bad as some politicians would like to make out. If nothing else – there is nowhere else in the world I would rather live than within the EU, where there is the rule of law, respect for human rights and decent living standards.

The European Union can count many significant achievements of the past few decades.

Reduction of tariff and non-tariff barriers have led to increased trade and, despite problems of recent years, real prosperity for most of the population.
Promoting human rights and helping Europe to become continent of peace, rather than the near perpetual conflict which marred the first half of the Twentieth Century.
Harmonisation of rules and regulations has helped simplify trade and commerce, and enabled the free movement of people.

Yes, despite many impressive achievements, the EU do seem in danger of throwing away, or at least diminishing many of these hard won gains. I don’t see the problem as regulation on bendy bananas (which are usually false or exaggerated for effect by Daily Trash newspapers – who seem to latch onto anti-EU headline with a glee previously reserved for stories about Princess Diana). The real problem the EU faces is economic stagnation, mass unemployment and the alienation of a whole young generation.

What makes it doubly sad is that it didn’t have to be like this.

The biggest problem facing the EU is one of economic policy. The Single Currency was a bridge too far. The EU is simply not an optimal currency area. The limitations of the Single Currency have been magnified by an attempt to deal with deflationary pressure through a combination of misplaced austerity and the dogma of suffering. What makes it worse is that countries who have suffered the most economically, have the feeling that their economic suffering has been imposed from the outside. And this just isn’t political rhetoric, that’s how a single monetary policy works. It’s the worst combination – economic stagnation caused by policies outside your country. With the toxic mix of unemployment and outside influence, it is hardly surprising that political extremism is on the rise.

Source: ECB

The ECB may claim that in the coming months they may do more to combat the threat of deflation and low growth. Now the ECB is willing to effectively act as lender of resort, bond yields have fallen. The Euro may hold together. But, that doesn’t change the fact Europe has been failing for the past five years. The crisis was never about bond yields or EU debt. When bond yields on government debt rise to 12%, this doesn’t cause social alienation and a surge in political extremism. The social and political alienation is caused by mass unemployment and a sense of powerlessness.

UK’s Target for Economic Growth

13 March 201826 May 2014 by Tejvan Pettinger

Readers Question: What is the UK’s target for economic growth? Economic growth is the annual % increase in national output (Real GDP) The UK doesn’t have an explicit target for economic growth (for example, we have an inflation target of CPI 2%+/-1.) However, the government will aim to achieve economic growth close to the …

Policies to ease pressure on the housing market

18 November 201720 May 2014 by Tejvan Pettinger

Readers Question: What policies could be used to ease pressure on housing market?

Firstly, the main pressure in the UK housing market is the persistent and continued above inflation price increases. Back in 2004, Kate Barker’s report into housing market trends found that the UK would need to build 250,000 houses to reduce the house price inflation rate to 1.1%. But, since 2004, the UK housing market has fallen short of this target. In the middle of the recession, the number of home starts fell to just over 100,000. (Housing supply)

The Home Builders Federation claim to catch up, we would need to increase home building to 320,000 a year – something not seen in the UK since the 1950s.

Policies to ease pressure on housing market

1. New Garden cities The building of new cities, in the mode of Milton Keynes, can enable a significant increase in homes. Currently there are plans for a new city in Ebbsfleet, Kent on the high speed railway line to London.

However, from planning to completion this will take a long time. It also means building on greenbelt land, which is likely to raise objections.

2. Government subsidy / council homes. Additional government spending to subsidise the building of ‘social’ housing could help increase supply. In the past decades, council housing has fallen out of vogue as the government have sought to sell off council housing and cut back on the building of council housing. But, it was council houses which provided a significant boost to the UK’s housing stock in the post war period.

Clement Attlee’s post-war Labour government built more than a million homes, 80% of which were council houses. In recent years, local authority building of new houses has virtually ceased. It is notable that since local authorities ceased to build homes, the UK housing shortage has become more acute. Housing associations have never been able to replace the large numbers built by local authorities.

It would require a change in political commitment and the willingness to spend extra money. Also, since the Thatcher era, the notion of council housing has gained a form of social stigma. However, it could make a big difference to the number of homes built.

3. Greater flexibility in planning. Planning restrictions are quite strict in the UK. Loosening the number of restrictions and making it easier for builders will make supply more elastic. This could involve reducing the amount of protected greenbelt land. It could also involve streamlining the regulations home-builders have to meet.

However, this could lead to significant local objections as people protest about the increased building, congestion and loss of green fields. One other solution would be to provide grants for turning derelict brown field sites into new homes.

4. Incentives for local authorities

Home building is a local issue. Local authorities have to deal with opposition to home building, so there is often local political pressure to stop house building. However greater financial incentives, such as allowing the council to keep council tax receipts from new housing developments, could give them a greater motivation to allow home building.

5. Introduction of a Planning-gain Supplement scheme

At the moment, building new houses tends to give the greatest benefit to landowners. Local residents feel they just lose out – depressed house prices, loss of unique village e.t.c. One solution is to make sure local residents near new housing schemes gain some compensation in return for accepting more houses. For example, a new housing development could be accompanied with a bypass or better public transport links. This is interesting from an economic perspective as it is seeking to provide a pareto improvement (one where everyone benefits).

The difficulty is that in the real world, it can be difficult to ensure people are compensated. Some local residents may feel there is nothing to compensate for the loss of a beautiful view. People may also exaggerate how much they lose from a new housing scheme.

6. Government’s Help to to buy

The government’s help to buy scheme is controversial because it is seeking to ease the problem through helping homeowners borrow more money. Critics argue this merely fuels demand and keeps prices artificially high.

However, to some extent, the Help to Buy scheme has provided some incentive for private builders to increase supply. In particular the first part of the scheme which offers buyers an interest-free loan worth up to 20% of the value of a new-build home. This increased demand for new build homes, encourages house builders because they are more confident there will be demand for the new homes.