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Articles for the ‘Essentials of Economics 6e: Ch 11’ Category

A full employment target

Unemployment and employment are concepts that are often talked about in the media. Indeed, the 7% unemployment target referred to by the Governor of the Bank of England has been a constant feature of recent headlines. However, rather than targeting an unemployment rate of 7%, George Osborne has now called for ‘full employment’ and believes that tax and welfare changes are key to meeting this objective.

Reducing the unemployment rate is a key macroeconomic objective and the costs of unemployment are well-documented. There are obviously big costs to the individual and his/her family, including lower income, dependency, stress and potential health effects. There are also costs to the government: lower income tax revenues, potentially lower revenues from VAT through reduced consumer expenditure and the possibility of higher benefit payments. There are other more ‘economic’ costs, namely an inefficient use of resources. Unemployment represents a cost to the economy, as we are operating below full capacity and we therefore see a waste of resources. It is for this reason that ‘full employment’ is being targeted.

Traditional economic theory suggests that there is a trade-off between unemployment and inflation, illustrated by the well-known Phillips curve. In the past, governments have been willing to sacrifice unemployment for the purpose of reducing inflation. There have also been attempts to boost the economy and create jobs through increased borrowing. However, George Osborne has said:

Unemployment is never a price worth paying, but artificial jobs paid for with borrowed money doesn’t work either.

A figure representing full employment hasn’t been mentioned, so it remains unclear what level of unemployment would be acceptable, as despite the name ‘full employment’, this doesn’t mean that everyone has a job. There are several definitions of full employment, in both an economic and political context. In the period of reconstruction after the Second World War, William Beveridge, architect of the welfare state, defined full employment as where 3% of people would be unemployed.

In more recent times, other definitions have been given. In the era of monetarism in the 1970s, the term ‘natural rate of unemployment’ was used to define the unemployment rate to which economies tend in the long run – after inflationary expectations have adjusted. Keynesians use the term the ‘non-accelerating-inflation rate of unemployment (NAIRU)’, where unemployment is confined to equilibrium unemployment and where there is no excess or deficiency of aggregate demand. Both the natural rate and the NAIRU relate to the rate of unemployment at which the long-run Phillips curve is vertical.

In its Economic and Fiscal Outlook of March 2013, the Office for Budget Responsibility estimated the UK’s NAIRU to be 5.4%. George Osborne has not specified a particular rate. Rather, his speech refers to creating the ‘highest employment rate of any of the world’s leading economies’. He said the ambition was to make the UK:

…the best place in the world to create a job; to get a job; to keep a job; to be helped to look for another job if you lose one…A modern approach to full employment means backing business. It means cutting the tax on jobs and reforming welfare.

Therefore, while it appears that there is no target figure for unemployment, it seems that a new Conservative objective will be to focus on sustainable job creation and eliminate disequilibrium unemployment. This represents a move very much into Labour territory. Meeting the objective will be no easy task, given the past few years and such high levels of youth unemployment, as Labour were quick to point out, but the unemployment figures are certainly moving in the right direction. The following articles consider the objective of full employment.

Britain’s Osborne changes tone on economy with “full employment” target Reuters, William James (31/3/14)
George Osborne commits to ‘fight for full employment’ BBC News (including video) (1/4/14)
What does full employment mean? The Guardian (1/4/14)
What is full employment? The Telegraph, Peter Dominiczak (31/3/14)
’Jobs matter’, says George Osborne as he aims for full employment Independent, Andrew Grice (31/3/14)
Liam Bynre: Labour would aim for ‘full employment’ BBC News (17/5/13)
Osborne pledges full employment for UK Sky News (31/3/14)
Osborne commits to full employment as election looms Bloomberg, Svenja O’Donnell (31/3/14)
Whatever happened to full employment? BBC News, Tom de Castella and Caroline McClatchey (13/10/11)

Questions

  1. What is meant by full employment?
  2. Is it a good idea to target zero unemployment?
  3. Using a diagram, illustrate the difference between disequilibrium and equilibrium unemployment?
  4. How can full employment be achieved?
  5. What are the costs of unemployment?
  6. Use a diagram to illustrate the natural rate of unemployment and explain what it means in terms of the relationship between unemployment and inflation.
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A mini-stimulus for China

The growth of China over the past decade has been quite phenomenal, with figures recorded in double-digits. However, in the aftermath of the recession, growth has declined to around 7% – much higher than Western economies are used to, but significantly below the ‘norm’ for China. (Click here for a PowerPoint of the chart.)

The growth target for this year is 7.5%, but there appear to be some concerns about China’s ability to reach this figure and this has been emphasised by a recent Chinese policy.

A mini-stimulus package has been put in place, with the objective of meeting the 7.5% growth target. Government expenditure is a key component of aggregate demand and when other components of AD are lower than expected, boosting ‘G’ can be a solution. However, it’s not something that the Chinese government has had to do in recent years and the fact that this stimulus package has been put in place has brought doubts over China’s economic performance to the forefront , but has confirmed its commitment to growth. Mizuho economist, Shen Jianguang, said:

It’s very obvious that the leaders feel the need to stabilise growth…Overall, the 7.5 per cent growth target means that the government still cares a lot about economic growth.

Data suggest that growth in China is relatively weak and there are concerns that the growth target will be missed, hence the stimulus package. In the aftermath of the 2008 financial crisis, there was a large stimulus package in place in China. This latest investment by the government is in no way comparable to the size of the 2008 package, but instead will be on a smaller and more specific scale. Mark Williams of Capital Economics said:

It’s a bit of a rerun of what we saw last year – something less than a stimulus package and more of piecemeal measures to ensure they reach their growth target.

It is the construction of public housing and railways that will be the main areas of investment this time round. A sum of $120–180bn per year will be available for railway construction and $161bn for social housing, and tax breaks are being extended for small businesses.

The 2008 stimulus package saw debt increase to some 200% of GDP, which did cause growing concerns about the reliance on debt. However, this latest package will be financed through the issue of bonds, which is much more similar to how market economies finance spending.

The fact that the government has had to intervene with such a stimulus package is, however, causing growing concerns about the level of debt and the future of this fast growing economy, though the new method of financing is certainly seen as progress.

It should be noted that a decline in growth for China is not only concerning for China itself, but is also likely to have adverse consequences other countries. In the increasingly interdependent world that we live in, Western countries rely on foreign consumers purchasing their exports, and in recent years it has been Chinese consumers that have been a key component of demand. However, a decline in growth may also create some benefits – resources may not be used up as quickly and prices of raw materials and oil in particular may remain lower.

It is certainly too early for alarm bells, but the future of China’s growth is less certain than it was a decade ago. The following articles consider this issue.

China’s new mini-stimulus offers signs of worry and progress BBC News, Linda Yueh (3/4/14)
China puts railways and houses at hear of new stimulus measures The Guardian (3/4/14)
China unveils mini stimulus to to boost slowing economy The Telegraph (3/4/14)
China stimulus puts new focus on growth target Wall Street Journal, Bob Davis and Michael Arnold (3/4/14)
China embarks on ‘mini’ stimulus programme to kick-start economy Independent, Russell Lynch (3/4/14)
China takes first step to steady economic growth Reuters (2/4/14)
China unveils fresh stimulus The Autstralian (3/4/14)
China’s reformers can triumph again, if they follow the right route The Guardian, Joseph Stiglitz (2/4/14)

Questions

  1. How has Chinese growth reached double-digits? Which factors are responsible for such high growth?
  2. The BBC News article suggests that the stimulus package is cause for concerns but also shows progress. How can it do both?
  3. Using a diagram, illustrate how a stimulus package can boost economic growth.
  4. What are the advantages and disadvantages of high rates of growth for (a) China and (b) Western economies?
  5. Why does the method of financing growth matter?
  6. Railway and housing construction have been targeted to receive additional finance. Why do you think these sectors have been targeted?
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The MPC – looking for a remit (Part 2: new forward guidance)

With the publication of the February 2014 Inflation Report the Bank of England has adjusted its forward guidance to the markets.

As we saw in Part 1 of this blog, the economy should soon fall below the 7% unemployment threshold adopted in the original forward guidance issued last August. But the Bank feels that there is still too much slack in the economy to raise interest rates when unemployment does fall below 7%.

The Bank has thus issued a new vaguer form of forward guidance.

The MPC’s view is that the economy currently has spare capacity equivalent to about 1%–1½% of GDP, concentrated in the labour market. Around half of that slack reflects the difference between the current unemployment rate of 7.1% and an estimate of its
medium-term equilibrium rate of 6%–6½%. The remaining slack largely reflects a judgement that employees would like to work more hours than is currently the case. Companies appear to be operating at close to normal levels of capacity, although this is subject to some uncertainty.

The existence of spare capacity in the economy is both wasteful and increases the risk that inflation will undershoot the target in the medium term. Moreover, recent developments in inflation mean that the near-term trade-off between keeping inflation close to the target and supporting output and employment is more favourable than at the time the MPC announced its guidance last August: CPI inflation has fallen back to the 2% target more quickly than anticipated and, with domestic costs well contained, is expected to remain at, or a little below, the target for the next few years. The MPC therefore judges that there remains scope to absorb spare capacity further before raising Bank Rate.

Just what will determine the timing and pace of tightening? The Bank identifies three factors: the sustainability of the recovery; the extent to which supply responds to demand; and the evolution of cost and price pressures. But there is considerable uncertainty about all of these.

Thus although this updated forward guidance suggests that interest rates will not be raised for some time to come, even when unemployment falls below 7%, it is not at all clear when a rise in Bank Rate is likely to be, and then how quickly and by how much Bank Rate will be raised over subsequent months. Partly this is because of the inevitable uncertainty about future developments in the economy, but partly this is because it is not clear just how the MPC will interpret developments.

So is this new vaguer forward guidance helpful? The following articles address this question.

Articles
Bank of England Governor Carney’s statement on forward guidance Reuters (12/2/14)
Why has Mark Carney tweaked forward guidance? The Telegraph, Denise Roland (12/2/14)
Interest rates: Carney rips up ‘forward guidance’ policy Channel 4 News (12/2/14)
Forward guidance version 2: will the public believe it? The Guardian, Larry Elliott (12/2/14)
Mark Carney adjusts Bank interest rate policy BBC News (12/2/14)
Mark Carney’s almost promise on rates BBC News, Robert Peston (12/2/14)
Did the Bank of England’s Forward Guidance work? Independent, Ben Chu (2/2/14)
Forward Guidance 2.0: Is Carney just digging with a larger shovel? Market Watch, The Tell (12/2/14)
The U.K. Economy: Five Key Takeaways Wall Street Journal, Alen Mattich (12/2/14)

Bank of England pages
Inflation Report, February 2014 Bank of England (12/2/14)
Monetary Policy Bank of England
MPC Remit Letters Bank of England
Forward Guidance Bank of England

Questions

  1. Summarize the new forward guidance given by the Bank of England.
  2. Why is credibility an important requirement for policy?
  3. What data would you need to have in order to identify the degree of economic slack in the economy?
  4. Why is it difficult to obtain such data – at least in a reliable form?
  5. What is meant by the ‘output gap’? Would it be a good idea to target the output gap?
  6. Is it possible to target the rate of inflation and one or more other indicators at the same time? Explain.
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The MPC – looking for a remit (Part 1: the options)

Although the Monetary Policy Committee (MPC) of the Bank of England is independent in setting interest rates, until recently it still had to follow a precise remit set by the government. This was to target inflation of 2% (±1%), with interest rates set to meet this target in 24 months’ time. But things have changed since the new Governor, Mark Carney, took up office in July 2013. And now things are not so clear cut.

The Bank announced that it would keep Bank Rate at the current historically low level of 0.5% at least until unemployment had fallen to 7%, subject to various conditions. More generally, the Bank stated that:

The MPC intends at a minimum to maintain the present highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to price stability or financial stability.

This ‘forward guidance’ was designed to provide more information about future policy and thereby more certainty for businesses and households to plan.

But unemployment has fallen rapidly in recent months. It fell from a 7.7% average for the three months May to July 2013 to 7.1% for the latest available three months (September to November 2013). And yet there is still considerable slack in the economy.

It now, therefore, looks highly unlikely that the MPC will raise Bank Rate as soon as unemployment falls below 7%. This then raises the question of how useful the 7% target has been and whether, if anything, it has created further uncertainty about future MPC decisions.

The following still appears on the Bank of England website:

The MPC intends at a minimum to maintain the present highly stimulative stance of monetary policy until economic slack has been substantially reduced, provided this does not entail material risks to price stability or financial stability.

But this raises two questions: (a) how do you measure ‘economic slack’ and (b) what constitutes a substantial reduction?

So what should the Bank do now? What, if any, forward guidance should it offer to the markets? Will that forward guidance be credible? After all, credibility among businesses and households is an important condition for any policy stance. According to Larry Elliott in the first article below, there are five options.

Articles
Bank of England’s method of setting interest rates needs reviewing The Guardian, Larry Elliott (9/2/14)
Mark Carney set to adjust Bank interest rate policy BBC News (12/2/14)
Forward guidance: dead and alive BBC News, Robert Peston (11/2/14)
What “forward guidance” is, and how it (theoretically) works The Economist (11/2/14)
BOE’s forward guidance 2.0: Cheap talk, or big change? Market Watch (11/2/14)

Bank of England pages
Monetary Policy Bank of England
MPC Remit Letters Bank of England
Forward Guidance Bank of England

Questions

  1. What data would you need to have in order to identify the degree of economic slack in the economy?
  2. Why is it difficult to obtain such data – at least in a reliable form?
  3. Why might the issuing of the forward guidance last July have itself contributed to the fall in unemployment?
  4. Why is it difficult to obtain such data – at least in a reliable form?
  5. Why is credibility an important requirement for policy?
  6. Why may LFS unemployment be a poor guide to the degree of slack in the economy?
  7. Discuss the relative merits of each of the five policy options identified by Larry Elliott.
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Japan’s recovery

It is rising inflation that typically causes problems for countries, whether it is demand-pull or cost-push. However, one country that has not been subject to problems of rising prices is Japan. Instead, this economy has been suffering from the gloom of deflation for many years and many argue that this is worse than high inflation.

Falling prices are popular among consumers. If you see a product whose price has fallen from one day to the next, you can use your income to buy more goods. What’s the problem with this? The Japanese economy has experienced largely stagnant growth for two decades and a key cause has been falling prices. When the prices of goods begin to fall over and over again, people start to form expectations about the future direction of prices. If I expect the price of a good to fall next week, then why would I buy now, if I can buy the same good next week at a lower price? But, when next week arrives and the price has fallen as expected, why would I purchase the product, if I think that the price fall is set to continue? The problem of deflation is that with continuously falling prices, consumers stop spending. Aggregate demand therefore declines and economic growth all but disappears. This is the problem that the Japanese economy has been faced with for more than 20 years.

However, the latest data from Japan shows core consumer prices growing faster than expected in December 2013, compared to the previous year. This figure was above market forecasts and was the fastest rate of growth in the past 5 years. These data, together with those on unemployment have given the economy a much needed boost.

Recent government policy has been focused on boosts in government spending, with an aim of reducing the value of the currency (click here for a PowerPoint of the chart). Such policies will directly target aggregate demand and this in turn should help to generate an increase in national output and push up prices. If the price trend does begin to reverse, consumers will start to spend and again aggregate demand will be stimulated.

The future of the economy remains uncertain, though the same can be said of many Western economies. However, the signs are good for Japan and if the recovery of other economies continues and gathers pace, Japan’s export market will be a big contributor to recovery. The following articles consider the Japanese economy.

Japan inflation rises at fastest pace in over five years BBC News (31/1/14)
Benchmark Japan inflation rate hits 1.3% Financial Times, Jonathan Soble (31/1/14)
Japan’s inflation accelerates as Abe seeks wage gains Bloomberg, Chikako Mogi, Masahiro Hidaka and James Mayger (31/1/14)
Japan inflation quickens to over 5-year high, output rebounds Reuters, Leika Kihara and Stanley White (31/1/14)
Japaense inflation rises at fastest pace in over five years at 1.3% in December 2013 Independent, Russel Lynch (31/1/14)
Why Abenomics holds lessons for the West BBC News, Linda Yueh (18/12/13)

Questions

  1. Why is deflation a problem?
  2. Using an AD/AS diagram, illustrate the problem of expectations and how this contributes to stagnant growth.
  3. How will a lower currency help Japan?
  4. What is the likely effect of a sales tax being imposed?
  5. Does the fact that unemployment has declined support the fact that consumer prices are beginning to rise?
  6. What government policies would you recommend to a government faced with stagnant growth and falling prices?
  7. How important are expectations in creating the problem of deflation?
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Making economic sense of politicians’ statements

Politicians often make use of economic statistics to promote their point of view. A good example is a claim made by the UK Prime Minister on 23 January 2014. According to the latest statistics, he said, most British workers have seen their take-home pay rise in real terms. The Labour party countered this by arguing that incomes are not keeping up with prices.

So who is right? Studying economics and being familiar with analysing economic data should help you answer this question. Not surprisingly, the answer depends on just how you define the issue and what datasets you use.

The Prime Minister was referring to National Statistics’ Annual Survey of Hours and Earnings (ASHE). This shows that in April 2013 median gross weekly earnings for full-time employees were £517.5, up 2.25% from £506.10 in 2012, and mean gross weekly earnings for full-time employees were £620.30, up 2.06% from £607.80 in 2012 (see Table 1.1a in the dataset). CPI inflation over this period was 2.4%, representing a real fall in median gross weekly earnings of 0.15% and mean gross weekly earnings of 0.34%.

But when adjustments are made for increases in personal income tax allowances, then, according to the government, except for the richest 10% of the working population, people had an average increase in real take-home pay of 1.1%.

But does this paint the complete picture? Critics of the government’s claim that people are ‘better off’, make the following points.

First, the ASHE dataset is for the year ending April 2013. The ONS publishes other datasets that show that real wages have fallen faster since then. The Earnings and Working Hours datasets, published monthly, currently go up to November 2013. The chart shows real wages from January 2005 to November 2013 (with CPI = 100 in December 2013). You can see that the downward trend resumed after mid 2013. In the year to November 2013, nominal average weekly earnings rose by 0.9%, while CPI inflation was 2.1%. Thus real weekly earnings fell by 1.2% over the period (click here for a PowerPoint of the chart).

Second, there is the question of whether CPI or RPI inflation should be used in calculating real wages. RPI inflation was 2.9% (compared to CPI inflation of 2.4%) in the year to April 2013. The chart shows weekly earnings adjusted for both CPI and RPI.

Third, if, instead of looking at gross real wages, the effect of income tax and national insurance changes are taken into account, then benefit changes ought also to be taken into account. Some benefits, such as tax credits and child benefit were cut in the year to April 2013.

Fourth, looking at just one year (and not even the latest 12 months) gives a very partial picture. It is better to look at a longer period and see what the trends are. The chart shows the period from 2005. Real wages (CPI adjusted) are 8.0% lower than at the peak (at the beginning of 2009) and 5.0% lower than at the time of the election in 2010. The differences are even greater if RPI-adjusted wages are used.

But even if the claim that real incomes are rising is open to a number of objections, it may be that as the recovery begins to gather pace, real incomes will indeed begin to rise. But to assess whether this is so will require a careful analysis of the statistics when they become available.

Articles
UK pay rising in real terms, says coalition BBC News (24/1/14)
Are we really any better off than we were? BBC News, Brian Milligan (24/1/14)
Government take-home pay figures ‘perfectly sensible’ BBC Today Programme, Paul Johnson (24/1/14)
Take-Home Pay ‘Rising Faster Than Prices’ Sky News, Darren McCaffrey (25/1/14)
David Cameron hails the start of ‘recovery for all’ The Telegraph, Peter Dominiczak (23/1/14)
Is take-home pay improving? The answer is anything but simple The Guardian, Phillip Inman and Katie Allen (24/1/14)
Cameron’s ‘good news’ about rising incomes is misleading says Labour The Guardian, Rowena Mason (24/1/14)
The Tories’ claim that living standards have risen is nonsense on stilts New Statesman, George Eaton (24/1/14)
FactCheck: Conservative claims on rising living standards Channel 4 News, Patrick Worrall (25/1/14)
Living standards squeeze continues in UK, says IFS BBC News (31/1/14)
Richest have seen biggest cash income squeeze but poorest have faced higher inflation IFS Press Release (31/1/14)

Data
Average Weekly Earnings dataset ONS (22/1/14)
Annual Survey of Hours and Earnings, 2013 Provisional Results ONS (12/12/13)
Consumer Price Inflation, December 2013 ONS (14/1/14)
Inequality and Poverty Spreadsheet Institute for Fiscal Studies
An Examination of Falling Real Wages, 2010 to 2013 ONS (31/1/14)

Questions

  1. Why are mean weekly earnings higher than median weekly earnings?
  2. Explain the difference between RPI and CPI. Which is the more appropriate index for determining changes in real incomes?
  3. Find out what benefit changes have taken place over the past two years and how they have affected household incomes.
  4. How have gross weekly earnings changed for the different income groups? (The ASHE gives figures for decile groups.)
  5. Which is better for assessing changes in incomes: weekly earnings or hourly earnings?
  6. How would you define a change in living standards? What data would you need to be able to assess whether living standards have increased or decreased?
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Inflation back down to 2%

A recession is typically characterised by high unemployment, low or negative growth and low inflation, due to a lack of aggregate demand. However, since 2009, inflation levels in the UK have only added to the pressures facing the government and the Bank of England. Not only had there been a problem of lack of demand, but the inflation target was no longer being met.

Inflation had increased to above 5% – a figure we had not been accustomed to for many years. With interest rates at record lows with the aim of boosting aggregate demand, demand-pull inflation only added to cost-push pressures. However, data released by the ONS shows that inflation, as measured by the CPI, has now fallen back to its 2% target. Having been at 2.1% in November 2013, the figure for December 2013 fell by 0.1 percentage points.

The data for December include some of the energy price rises from the big six, but do not include the full extent of price decreases and discounting initiated by retailers in the lead up to Christmas. The key factors that have helped to keep prices down include some of the discounting throughout December and falling food prices, in particular bananas, grapes and meat.

With inflation back on target, pressures have been removed from the Bank of England to push up interest rates. Mark Carney has said that interest rates will remain at 0.5% until unemployment falls to 7%. With unemployment fast approaching this target, there has been speculation that interest rates would rise, but with inflation falling back on target, these pressures have been reduced. (Click here for a PowerPoint of the chart.) Referring to this, Jeremy Cook, the chief economist at World First said:

The lack of inflation will help stay their hand especially if the pace of job creation seen in the second half of last year also shows.

These thoughts were echoed by Rob Wood, the chief UK economist at Berenberg Bank:

Inflation is the BoE’s ‘get out of jail free’ card for this year … The lack of inflation pressure gives them room to delay a first hike until next year.

Many economists now believe that the CPI rate of inflation is likely to remain at or below the target, in particular if productivity growth improves. This belief is further enhanced by the fact that tax rates are stable, the pound is relatively strong and the previous upward pressure on commodity prices from China is now declining. Some economists believe that CPI inflation could fall to 1.5% this year and the Treasury has said that it is ‘another sign that the Government’s long-term economic plan is working’. The following articles consider this latest macroeconomic data.

UK inflation falls to Bank of England’s 2pc target in December The Telegraph, Szu Ping Chan (14/1/14)
UK inflation falls to 2% target rate in December BBC News (14/1/14)
Carney’s lucky streak continues as UK inflation slows to 2% Financial Times, Claire Jones (14/1/14)
UK inflation fall gives Bank of England a lift Wall Street Journal, Richard Barley(14/1/14)
Inflation falls to Bank of England target Reuters, William Schomberg and Ana Nicolaci da Costa (14/1/14)
Inflation hits Bank of England’s target of 2% in December Independent, John Paul Ford Rojas (14/1/14)

Questions

  1. What is the relationship between interest rates and aggregate demand?
  2. Which factors have led to the reduction in the rate of inflation?
  3. Why have the latest data on inflation rates reduced the pressure on the Bank of England to increase interest rates?
  4. Why do stable tax rates, a strong pound and reduced pressure from China on commodity prices suggest that the CPI measures of inflation is likely to remain at similarly low levels?
  5. Why has the RPI increased while the CPI has fallen?
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Taking an annual gaze into the crystal ball

As the old year gives way to the new, papers have been full of economic forecasts for the coming year. This year is no exception. The authors of the articles below give their predictions of what is to come for the global economy and, for the most part, their forecasts are relatively optimistic – but not entirely so. Despite a sunny outlook, there are various dark clouds on the horizon.

Most forecasters predict a higher rate of global economic growth in 2014 than in 2013 – and higher still in 2015. The IMF, in its October forecasts, predicted global growth of 3.6% in 2014 (up from 2.9% in 2013) and 4.0% in 2015.

Some countries will do much better than others, however. The USA, the UK, Germany and certain developing countries are forecast to grow more strongly. The eurozone as a whole, however, is likely to see little in the way of growth, as countries such as Greece, Spain, Portugal and Italy continue with austerity policies in an attempt to reduce their debt. Chinese growth has slowed, as the government seeks to rebalance the economy away from exports and investment in manufacturing towards consumption, and services in particular. It is still forecast to be 7.3% in 2014, however – well above the global average. Japanese growth has picked up in response to the three arrows of fiscal, monetary and supply-side policy. But this could well fade somewhat as the stimulus slows. The table shows IMF growth forecasts for selected countries and groups of countries to 2018.

Much will depend on what happens to monetary policy around the world. How quickly will monetary stimulus taper in the USA and in Japan? Will the ECB introduce more aggressively expansionary monetary policy? When will the Bank of England start raising interest rates?

Growth within countries is generally favouring those on higher incomes, with the gap between rich and poor set to continue widening over the coming years. The pay of top earners has continued to rise considerably faster than prices, while increasingly flexible labour markets and squeezed welfare budgets have seen a fall in living standards of many on low incomes. According to a Which? survey (reported in the Independent article below), in the UK:

Only three in ten expect their family’s situation to improve in the new year, while 60% said they are already dreading the arrival of their winter energy bill. The Which? survey also found that 13 million people could afford to pay for Christmas only by borrowing, with more than four in ten using credit cards, loans or overdrafts to fund their festive spending. A third of people (34%) also dipped into their savings, taking an average of £450 from their accounts.

If recovery is based on borrowing, with real incomes falling, or rising only very slowly, household debt levels are likely to increase. This has been stoked in the UK by the ‘Help to Buy‘ scheme, which has encouraged people to take on more debt and has fuelled the current house price boom. This could prove damaging in the long term, as any decline in confidence could lead to a fall in consumer expenditure once more as people seek to reduce their debts.

And what of the global banking system? Is it now sufficiently robust to weather a new crisis. Is borrowing growing too rapidly? Is bank lending becoming more reckless again? Are banks still too big to fail? Is China’s banking system sufficiently robust? These are questions considered in the articles below and, in particular, in the New York Times article by Gordon Brown, the former Prime Minister and Chancellor of the Exchequer.

Articles
Global economy: hopes and fears for 2014The Observer, Heather Stewart and Larry Elliott (29/12/13)
Looking ahead to 2014 BBC News, Linda Yueh (20/12/13)
Low hopes for a happy new financial year in 2014 Independent, Paul Gallagher (29/12/13)
Brisk UK economic growth seen in 2014 fuelled by spending – Reuters poll Reuters, Andy Bruce (12/12/13)
GLobal Economy: 2014 promises faster growth, but no leap forward Reuters, Andy Bruce (29/12/13)
My 2014 Economic Briefing Huffington Post, Tony Dolphin (27/12/13)
Three UK Economy Stories that will Dominate in 2014 International Business Times, Shane Croucher (27/12/13)
Who You Calling a BRIC? Bloomberg, Jim O’Neill (12/11/13)
Hope and Hurdles in 2014 Project Syndicate, Pingfan Hong (27/12/13)
On top of the world again The Economist (18/11/13)
Digging deeper The Economist (31/10/13)
BCC Economic Forecast: growth is gathering momentum, but recovery is not secure British Chambers of Commerce (12/13)
Eight predictions for 2014 Market Watch, David Marsh (30/12/13)
Stumbling Toward the Next Crash New York Times, Gordon Brown (18/12/13)
Central banks must show leadership to rejuvenate global economy The Guardian, Larry Elliott (1/1/14)
Global economy set to grow faster in 2014, with less risk of sudden shocks The Guardian, Nouriel Roubini (31/12/13)
A dismal new year for the global economy The Guardian, Joseph Stiglitz (8/1/14)

Forecasts and reports
World Economic Outlook (WEO) IMF (October 2013)
Economic Outlook OECD (November 2013)
Output, prices and jobs The Economist
Bank of England Inflation Report: Overview Bank of England (November 2013)

Questions

  1. What reasons are there to be cheerful about the global economic prospects for 2014 and 2015?
  2. Who will gain the most from economic growth in the UK and why?
  3. Why is the eurozone likely to grow so slowly, if at all?
  4. Are we stumbling towards another banking crisis, and if so, which can be done about it?
  5. Why has unemployment fallen in the UK despite falling living standards for most people?
  6. What is meant by ‘hysteresis’ in the context of unemployment? Is there a problem of hysteresis at the current time and, if so, what can be done about it?
  7. Explain whether the MINT economies are likely to be a major source of global economic growth in the coming year?
  8. Why is it so difficult to forecast the rate of economic growth over the next 12 months, let alone over a longer time period?
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Abenomics – one year on

It is one year since the election of Shinzo Abe in Japan. He immediately embarked on a radical economic policy to stimulate the Japanese economy, which had suffered from years of stagnation. There have been three parts (or three arrows) to his policy: fiscal policy and monetary policy to stimulate aggregate demand and supply-side policy to increase productivity.

As the previous post explains:

“The first arrow is monetary policy. The Bank of Japan has engaged in extensive quantitative easing through bond purchases in order to drive down the exchange rate (see A J-curve for Japan?), stimulate expenditure and increase the rate of inflation. A target inflation rate of 2% has been set by the Bank of Japan. Part of the problem for the Japanese economy over the years has been stagnant or falling prices. Japanese consumers have got used to waiting to spend in the hope of being able to buy at lower prices. Similarly, Japanese businesses have often delayed stock purchase. By committing to bond purchases of whatever amount is necessary to achieve the 2% inflation target, the central bank hopes to break this cycle and encourage people to buy now rather than later.

The second arrow is fiscal policy. Despite having the highest debt to GDP ratio in the developed world, Japan is embarking on a large-scale programme of infrastructure investment and other public works. The package is worth over $100bn. The expansionary fiscal policy is accompanied by a longer-term plan for fiscal consolidation as economic growth picks up. In the short term, Japan should have no difficulty in financing the higher deficit, given that most of the borrowing is internal and denominated in yen.

The third arrow is supply-side policy. On 5 June, Shinzo Abe unveiled a series of goals his government would like to achieve in order to boost capacity and productivity. These include increasing private-sector investment (both domestic and inward), infrastructure expenditure (both private and public), increasing farmland, encouraging more women to work by improving day-care facilities for children, and deregulation of both goods, capital and labour markets. The prime minister, however, did not give details of the measures that would be introduced to achieve these objectives. More details will be announced in mid-June.”

In the webcast and article below, Linda Yueh, the BBC’s Chief Business Correspondent, considers how effective the policies are proving and the challenges that remain.

Webcast
Has Abenomics fixed Japan’s economic fortunes? BBC News, Linda Yueh (16/12/13)

Articles
Why Abenomics holds lessons for the West BBC News, Linda Yueh (13/12/13)
Japanese business confidence hits six-year high, Tankan survey shows The Guardian (16/12/13)

Data
World Economic Outlook Database IMF (Oct 2013)
Bank of Japan Statistics Bank of Japan
Economic Outlook Annex Tables OECD
Country statistical profile: Japan 2013 OECD (15/11/13)

Questions

  1. Demonstrate on (a) an aggregate demand and supply diagram and (b) a Keynesian 45° line diagram the effects of the three arrows (assuming they are successful) in meeting their objectives.
  2. Why has Japan found it so hard to achieve economic growth over the past 20 years?
  3. How has the Japanese economy performed over the past 12 months?
  4. What lessons can be learnt by the UK and eurozone countries from Japan’s three arrows?
  5. Why is the second arrow problematic, given the size of Japan’s general government debt? Does the proportion of Japanese debt owed overseas affect the argument?
  6. In what ways do the three arrows (a) support each other; (b) conflict with each other?
  7. Why is the structure of the labour market in Japan acting as a break on economic growth? What policies are being, or could be, pursued to tackle these structural problems?
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Deflation danger in the eurozone

‘Deflation could be replacing debt as the main problem – and there’s nothing to suggest the ECB is up to the job.’ So begins the linked article below by Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley.

The good news in this is that worries about debt in eurozone countries are gradually receding. Indeed, this week Ireland officially ended its reliance on a bailout (of €67.5 billion) from the EU and IMF and regained financial sovereignty (see also).

The bad news is that this does not mark the end of austerity. Indeed, many eurozone countries could get stuck in a deflationary trap, with austerity policies continuing to depress aggregate demand. Eurozone inflation is less than 1% and falling. Broad money supply growth is now below that of the US dollar, the yen and sterling (see chart: click here for a PowerPoint).

The ECB has been far more cautious than central banks in other countries in acting to prevent recession and deflation. Unlike the USA, Japan and the UK, which have all engaged in extensive quantitative easing, the ECB had been reluctant to do so for fear of upsetting German opinion and taking the pressure off southern European countries to reform.

But as Eichengreen points out, the dangers of inaction could be much greater. What is more, quantitative easing is not the only option. The ECB could copy the UK approach of ‘funding for lending’ – not for housing, but for business.

Europe’s economic crisis could be mutating again The Guardian, Barry Eichengreen (10/12/13)

Questions

  1. What problems are created by falling prices?
  2. What effect would deflation have on debt and the difficulties in repaying that debt?
  3. What measures have already been adopted by the ECB to stimulate the eurozone economy? (Search previous articles on this site.)
  4. Why have such measures proved inadequate?
  5. What alternative policies are open to the ECB?
  6. What are the arguments for the ECB being given a higher inflation target (such as 3 or 4%)?
  7. What are the arguments for and against relaxing fiscal austerity in the eurozone at the current time?
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