On the day, that the official unemployment figures fell to 7.8%, there was also news that more than 1,700 people applied for 8 positions at Costa Coffee in Nottingham. (Independent) The labour force survey suggests that here are currently 2.50 million unemployed people, down 14,000 on July to September 2012 and down 156,000 on a …
“It’s not the inflation they need to sort out, Mr Bootle, it’s the rising prices!”
Essentially, the wrong kind of inflation is cost-push inflation. This inflation is due to rising costs of production, such as rising energy prices, rising transport costs, imported inflation and rising food prices. This inflation causes a shift to the left of short run aggregate supply. A simple SRAS / AD diagram shows how this kind of inflation also causes a fall in real GDP.
The wrong kind of inflation
Cost push inflation, causing rising prices and falling real GDP. (note some textbooks may show SRAS as a straight-line, but the principle is the same)
This wrong kind of inflation leads to a fall in living standards. Since 2008, the UK has seen a fall in real wages. We have had the worst of both worlds – rising prices, but falling incomes (or at least stagnant incomes)
This bad type of inflation doesn’t cause a rise in wages. But, a fall in real wages. We may laugh at Mrs Bootle’s cleaner, but in a way she might be trying to say, inflation isn’t a problem, if money wages keep up. If money wages grow faster than inflation, then we can afford the rising prices. Our income has increased to meet the higher cost of living.
Iceland’s crisis was brutally severe. With a bloated current account deficit and bad debts, Iceland experienced a severe balance of payments crisis and banking losses. Iceland responded by:
Not guaranteeing all banking debt. Many large banks failed and were seized by the government
Allowing the currency to devalue by 50%.
Imposed capital controls to prevent the outflow of money.
This response is in contrast to countries like Spain and Ireland. In Ireland, the government implemented a very costly bank bailout – which in turn caused the Irish government to seek a bailout.
Yet, just five years after allowing banks to go under, Iceland is being rehabilitated into the international capital markets, with rating agencies upgrading Icelandic bonds from ‘junk’ status to BBB. (Guardian)
Iceland has succeeded in stabilising the macro economy, reducing the debt to GDP burden, and importantly has seen positive economic growth – helped by a substantial devaluation. The devaluation also helped to rebalance the economy and reduce the budget deficit.
The collapse of the bloated finance sector had another advantage. Iceland’s traditional exporters have now found they could employ graduates at reasonable salaries. Previously, graduates had been poached by banks with seemingly inexhaustible supplies of money. This has helped rebalancing the economy to the more ‘real’ sector.
After experiencing 10 quarters of negative growth, the Icelandic economy has grown for the past two years at an average of 2.5%. Unemployment has fallen to 5% and confidence is returning.
Readers Question Richard Drayton, the Professor of Imperial History at Kings College London, says in a letter to the London Review of Books: “What is clear is that in May 2010 the percentage of UK GDP which went to servicing debt, even after the impact of the 2008 crisis, was, at 2.5 per cent, at the lowest level enjoyed by any Conservative government since Lord Salisbury was at the Treasury in 1900.” http://www.lrb.co.uk/v35/n02/letters
Yes, as far as I can tell. Historical debt interest payments are not so easy to find. But, In 2010-11, debt interest payments were £44bn or 3% of GDP.
A few months ago I spent considerable time researching and found these statistics. The ONS said they don’t produce statistics. HM Treasury publish data, but it’s not easy to find – usually hidden away. More at Debt interest payments.
Historically, debt interest payments have been a higher % of GDP. In the late 1940s, debt interest payments reached close to 10% of GDP (though I can’t find a source for this, yet)
Why is it cheap to service debt despite rise in government borrowing?
The recent recession has seen a record fall in bond yields. Bond yields have fallen since start of crisis because
Graph showing falling import tariff rates in the US. Figures for 2011 includes estimates for tariff rates up to 2011. The key part of this years report is the fact that import tariff barriers have fallen considerably, meaning potential welfare gains of reducing import tariffs have fallen. US has one of lowest tariff rates, but …
For example, in France, the government spends 52% of GDP (National Output). In Switzerland, the government spends just 32%. In France the government takes a higher share of tax than in Switzerland. If France and Switzerland had equal levels of debt, then Switzerland would look more indebted, because the debt would be a higher % of tax revenue. French debt would look a smaller burden because the tax revenue is relatively larger.
However, this wouldn’t completely reflect the ability to repay the debt. For example, if Switzerland had a high level of debt to tax, it is in a better position to increase tax rates to raise more revenue if necessary. France by contrast already has high tax rates, and when France tries to increases tax rates it may create disincentives (like famous movie stars moving to Russia).
Also, you could argue that a lower tax country like Switzerland will encourage more private enterprise and a stronger economy. If a country was strangled by high taxes. It would see it’s debt to tax ratio fall, but the economy may weaken.
However, although it is best to measure government debt as a % of GDP, it is still useful to examine debt as a proportion of government tax take. For example, some developing economies struggle to raise tax revenue. A large proportion of GDP may be beyond the government. If the government can only collect 10% of GDP in tax revenue, this limits their ability to repay even modest levels of debt. It is definitely worth taking into account.
Welfare spending in the UK is a controversial topic. There is significant political and public concern at the growth of welfare spending in the past few decades. In particular, there is a fear that the growth of the welfare state is encouraging a ‘dependency culture’. But, how much has welfare spending actually increased by? Are we really a nation of scroungers or is the extent of welfare payments exaggerated? One important point to bear in mind is that in a recession, we expect welfare spending to increase. That is really the whole point of the welfare state – to provide a minimum income during a period of temporary unemployment.
Welfare spending includes benefits the government pay to those out of work or on low incomes. It includes:
Job seekers allowance – unemployment benefit
Income support
Housing benefit
Child Benefit
Winter fuel allowance (1)
Growth in Nominal Welfare Spending
Since 2001, welfare spending has increased from £57bn t0 £115bn. However, the government are planning to stabilise welfare spending at £115bn through limiting entitlement and the increase in the amount paid. The government may argue without firm action now, the trend would see continued unaffordable increases in welfare.
Welfare Payments in Real Terms
If we look at welfare payments in real terms (adjusted for inflation), we see the growth is less spectacular. Nevertheless, even adjusted for inflation, the welfare bill has increased by £34bn since 2001.
Interesting post by David Blanchflower about the best form of economic stimulus – Here’s a way to end the slump (Useful for any economic student wishing to understand marginal propensity to consume – mpc)
An economic stimulus in 1936 increased demand for model T Fords
A fiscal stimulus could involve a tax cut or government spending increase. This should increase overall aggregate demand, and boost economic growth.
A monetary stimulus could involve interest rate cut or policy of quantitative easing.
But, if we decide to pursue fiscal stimulus – How do we make sure this has the biggest effect on increasing overall aggregate demand? Who is the best group of people to give it to?
For example, If you cut the higher rate of marginal income tax 50p to 40p for incomes over £100,000 – then this tax cuts is most likely to be saved. This is because people with salaries of over £100,000 are not in great need of buying essential items. They probably have most items they need. If they gain an extra increase in income, a large proportion will just be saved. They may buy one or two extra luxuries, but comparatively, they will have a low marginal propensity to consume. Therefore, the effect of the fiscal stimulus will be largely dissipated. You could argue that a low income tax may have a supply side incentive, but at 50%, it is debatable how significant this will be.
If you cut capital gains tax, it would benefit a relatively small percentage of wealthy firms and individuals. Again, you would expect a relatively low marginal propensity to consume. There may be some extra investment. But, in the current climate, you would expect business to be risk-averse. It’s hard to see businessmen rushing to invest because of lower capital gains tax.
Quantitative easing is a form of monetary policy which has given extra cash reserves to banks. Yet, this has had a very limited stimulus effect. Basically, banks have been saying thanks very much for the cash, we will use it to improve our bank reserves, but not to engage in a risky investment.
What about if we gave it to those on a very low income. For example, low paid workers, who have seen a 10% real pay decrease in the past few years? or increase unemployment benefits? Here, you would expect a higher marginal propensity to consume. The problem is that increasing benefits to the unemployed is not going to gain you too much political kudos.
In 1936, the US government gave a stimulus to a group of low-income people – military veterans from the First World War. The US Congress authorised $1.8bn to 3.2 million war veterans (2.1% of GDP) = (to put stimulus into perspective – 2.1% of GDP is equal to £30bn in UK). The money was financed from a bigger government deficit.
Joshua Hausman from UC Berkeley argues that the bonus added 2.5 to 3 percentage points to 1936 GDP growth and lowered the unemployment rate by 1.3 to 1.5 percentage points. Contemporary newspaper accounts reported that veterans were keen to spend this extra money. Many used the $550 + payment to buy their first-ever car. Fortunately, the price of the cheapest Ford car was $500.
