Readers Question: What is the importance of economics?

Economics is concerned with the optimal distribution of resources in society. The subject involves

• Understanding what happens in markets and the macroeconomy.
• Examining statistics about the state of the economy and explaining their significance
• Understanding different policy options and evaluating their likely outcomes.

Examples of the importance of economics

1. Dealing with a shortage of raw materials. Economics provides a mechanism for looking at possible consequences as we run short of raw materials such as gas and oil. See also: Effects of a world without oil.
2. How to distribute resources in society. To what extent should we redistribute income in society? Is inequality necessary to create economic incentives or does inequality create unnecessary economic and social problems?
3. To what extent should the government intervene in the economy? A critical divide in economics is the extent to which the government should intervene in the economy. Free market economists, like Hayek and Friedman, argue for limited government intervention and free markets. Other economists, like Stiglitz or Krugman, argue government intervention can overcome inequality and the underprovision of public goods. For example – should the government provide health care free at the point of use or is it more efficient to encourage private health care? See also: To what extent should the government intervene in the economy?
4. The principle of opportunity cost. Politicians win elections by promising more spending and cutting taxes. This is because lower taxes and more spending is what voters want to hear. However, an economist will be aware that everything has an opportunity cost. Spend more on subsidising free university education, and it means higher taxes and lower spending elsewhere. Giving students £4,000 a year to spend at university may be a noble ideal. But, is it the best use of public money? Are there better uses of money, such as spending on primary education? See: Opportunity Cost

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When reading economic articles in the past few years, you may frequently come across the reference to the ‘zero lower bound’ or ZLB.

What is the Zero Lower Bound rate?

In short – when interest rates can’t fall any further below 0%

Examples of ZLB

1. UK interest rates were cut to 0.5% in March 2009 and have stayed there until 2013
2. In Dec 2008, the US, the Federal Reserve cut interest rates to between 0% and 0.25%. Interest rates stayed at 0% as unemployment rose from 7.3% to 10% at the end of 2009. Between Dec 2008 and 2013, the US has been at this zero lower bound of monetary policy.
3. In April 2020, interest rates cut to zero in US, Europe and UK in response to Corona recession.

ZLB explained

• The main tool of conventional monetary policy is interest rates, set by the Central Bank. If inflation is low and economic growth negative, the Central Bank will cut interest rates to stimulate demand and higher economic growth. (see effect of lower interest rates)
• However, there may come a point when interest rates have fallen to zero and therefore, they can’t fall any further.
• This is the zero lower bound rate – interest rates have fallen as far as they can.
• Note: it is considered not practical to have negative nominal interest rates. No one would lend money at a negative interest rate – you would be better off just holding cash.
• This means the Central Bank can no longer use interest rates to stimulate the economy. People often term this a liquidity trap.

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