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Articles for the ‘Essentials of Economics 6e: Ch 12’ Category

Wanted: a Deus ex Machina for Greece

With talks ongoing about resolving the Greek debt crisis, it is clear that there is no agreement that will satisfy both sides – the Greek government and the troika of lenders (the IMF, the ECB and the European Commission). Their current negotiating positions are irreconcilable. What is needed is something more fundamental to provide a long-term solution. What is needed is a ‘deus ex machina‘.

A deus ex machina, which is Latin for ‘god from a machine’, was a device used in Greek tragedy to solve an impossible situation. A god would appear from above, lowered by a crane, or from below through a trap door, and would put everything right. The tragedy would then be given a happy ending.

So what possible happy ending could be brought to the current Greek tragedy and who could be the deus ex machina?

The negotiations between Greece and the troika currently centre on extending credit by €7.2bn when existing debts come up for repayment. There are repayments currently due to the IMF, or by the end of June, of €1.5bn and more in July, September and December (another €3.2bn). There are also €6.7bn of Greek bonds held by the ECB, as part of the 2010 bailout programme, that are due for repayment in July and August. Without the €7.2 billion bailout, Greece will be unable to meet these debt repayments, which also include Treasury bills.

But the troika will only release the funds in return for harsh austerity measures, which involve further cuts to pensions and public expenditure. Greece would be required to run a substantial budget surplus for many years.

Greece could refuse, but then it would end up defaulting on debt and be forced out of the euro. The result would probably be a substantial depreciation of a newly restored drachma, rising inflation and many Greeks suffering even greater hardship – at least for a period of time.

So what is the possible deus ex machina? If you’re looking for a ‘god’ then it is best, perhaps, to look beyond the current actors. Perhaps the Americans could play the role in finding a solution to the impasse. Perhaps a small group of independent experts or politicians, or both, could find one. In either case, the politics of the situation would have to be addressed as well as the economics and finance.

And what would be the ‘fix’ to satisfy both sides? Ultimately, this has to allow Greek debt to be sustainable without further depressing demand and undermining the fabric of Greek society. This would almost certainly have to involve a large measure of debt forgiveness (i.e. debts being written off). It also has to avoid creating a moral hazard, whereby if the Greeks are seen as being ‘let off lightly’, this might encourage other indebted eurozone countries to be less willing to reduce their debts and make demands for forgiveness too.

Ultimately, the issue is a political one, not an economic one. This will require clever negotiation and, if there is a deus ex machina, clever mediation too.

Greek PM Tsipras warns lenders bailout plans ‘not realistic’ BBC News, Jim Reynolds (5/6/25)
Greece defers IMF payment until end of June BBC News, Chris Morris (5/6/15)
Greek debt talks: Empty shops and divided societies BBC News, Chris Morris (10/6/15)
Potential Grexit effects Deutsche Welle (13/6/15)

It’s time to end the pretence: Greece will never fully repay its bailout loan The Guardian, Andrew Farlow (9/6/15)
Greek exit would trigger eurozone collapse, says Alexis Tsipras The Guardian, Phillip Inman, Helena Smith and Graeme Wearden (9/6/15)
The eurozone was a dream of unity. Now Europe has turned upon itself The Guardian, Business leader (14/6/15)
Greece bailout talks: an intractable crisis with three possible outcomes The Guardian, Larry Elliott (2/6/15)
Greece needs an economic defibrillator and a debt write-off Financial Times letters, Ray Kinsella (25/3/15)
Greece’s new debt restructuring plan Times of Change, Peter Spiegel (5/6/15)
Eurozone still in denial about Greece BBC News, Robert Peston (3/6/15)
Greece bailout talks – the main actors in a modern-day epic The Guardian, Phillip Inman, Ian Traynor and Helena Smith (9/6/15)
Greece isn’t any old troubled debtor BBC News, Robert Peston (15/6/15)
Greece in default if debt deadline missed, says Lagarde BBC News (18/6/15)
Burden of debt to IMF and European neighbours proves too much for Greece The Guardian, Heather Stewart (17/6/15)

Ending the Greek Crisis: Debt Management and Investment led Growth Greek government


  1. To which organisations is Greece indebted? What form to the debts take?
  2. To what extent is Greece’s current debt burden the result of design faults of the euro?
  3. Would it be possible to restructure debts in ways that make it easier for Greece to service them?
  4. Should Greece be treated by the IMF the same way it treated the highly indebted poor countries (HIPCs) and granted substantial debt relief?
  5. What would be the effects of Greek exit from the euro (a) for Greece; (b) for other eurozone countries?
  6. What bargaining chips can Greece deploy in the negotiations?
  7. Explain what is meant by ‘moral hazard’. Where in possible outcomes to the negotiations may there be moral hazard?
  8. What has been the impact of Greek austerity measures on the distribution of income and wealth in Greece?
  9. What are the practicalities of pursuing supply-side policies in Greece without further dampening aggregate demand?
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No instruments left to play

Let’s say that the world slides back into recession, or at least, the eurozone, the USA and other major economies. This is not unthinkable, given the determination of many countries to reduce public-sector deficits and debt, concerns about slowing growth in China and other major developing countries, and worries about various geo-political developments, such as conflict in the Middle East and the possible exit of Greece from the euro and the shock waves this might send. If it happened, what could governments and central banks do to stimulate aggregate demand? The problem is, according to the linked articles below, the world has largely run out of policy instruments.

In normal times, the main policy instruments for stimulating aggregate demand are cuts in interest rates (monetary policy) and increases in government expenditure and/or tax cuts (fiscal policy). But with interest rates currently at virtually zero, there is little scope for further cuts. And with governments attempting to ‘repair’ their balance sheets by cutting deficits, there is little appetite for increasing deficits again.

It is possible that central banks could engage in further quantitative easing. Indeed, the ECB is only just starting its large QE programme, involving monthly bond purchases of €60bn until at least September 2016 (totalling €1.14tr at that point). But QE leads to market distortions, such as increased asset prices (e.g. share and house prices), made higher and more unstable by speculation. By providing ‘cheap money’, it also encourages potentially risky investments.

The articles below considers the dilemma and looks at six possible options for policy makers suggested by Stephen King, chief economist at HSBC. But are they realistic? Read the articles and then consider the questions.

Financial crisis fixes leave policymakers short of ammo for next recession The Guardian, Larry Elliott (31/5/15)
How to get the economy working for us Guardian Letters, Mary Mellor; Colin Hines; Martin London; William Dixon and David Wilson (2/6/15)
HSBC’s Stephen King Outlines “Economic Nightmare” ValueWalk (14/5/15)
HSBC: Central Banks Are Running Low on Ammunition Bloomberg, Julie Verhage (13/5/15)
If the US economy is signalling an iceberg, bad news: we’re out of lifeboats The Guardian, Nils Pratley (13/5/15)
Policy makers lack the firepower to fight another US recession Financial Times, Stephen King (18/5/15)
The new surrealism Global Economics Quarterly, Stephen King (Q2, 2015)


  1. What are the risks to global recovery?
  2. Why has recovery from the 2008/9 recession been slower than that from previous recessions?
  3. What are the traditional instruments for combatting a recession?
  4. Why might central banks be wary of engaging in further rounds of quantitative easing?
  5. What is meant by ‘helicopter money’? Would this be a better solution to a recession than quantitative easing?
  6. Go through the other five policy options identified by Stephen King and discuss the suitability of each one.
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Eurozone: positive inflation

The eurozone has been suffering from deflation: that is, negative inflation. But, the latest data show an increase in the rate of inflation in April from 0% to 0.3%. This is still a very low rate, with a return to deflation remaining a possibility (though perhaps unlikely); but certainly an improvement.

The eurozone economy has been stagnant for some time but the actions of the European Central Bank (ECB) finally appear to be working. Prices across the eurozone have risen, including services up by 1.3%, food and drink up by 1.2% and energy prices, albeit still falling, but at a slower rate. All of this has helped to push the annual inflation rate above 0%. For many, this increase was bigger than expected. Howard Archer, Chief European Economist at HIS Global Insight said:

“Renewed dips into deflation for the eurozone are looking increasingly unlikely with the risks diluted by a firming in oil prices from their January lows, the weakness of the euro and improved eurozone economic activity.”

Economic policy in the eurozone has focused on stimulating the economy, with interest rates remaining low and a €1.1 trillion bond-buying programme by the ECB. But, why is deflation such a concern? We know that one of the main macroeconomic objectives of a nation is low and stable inflation. If prices are low (or even falling) is it really as bad as economists and policy-makers suggest?

The problem of deflation occurs when people expect prices to continue falling and thus delay spending on durables, hoping to get the products cheaper later on. As such, consumption falls and this puts downward pressure on aggregate demand. This decision by consumers to put off spending will cause aggregate demand to shift to the left, thus pushing national income down, creating higher unemployment and adding to problems of economic stagnation. If this expectation continues, then so will the inward shifts in AD. In the eurozone, this has been a key problem, but it now appears that aggregate demand has stopped falling and is now slowly recovering, together with the economy.

It is important to note how interdependent all aspects of an economy are. The euro responded as news of better inflation data emerged, together with expectations of a Greek deal being reached. Enrique Diaz-Alvarez, chief risk officer at Ebury said:

“The move [rise in euro] got going with the big upside surprise in eurozone inflation data — especially core inflation, which bounced up from 0.6 per cent to 0.9 per cent. This is exactly what the ECB wants to see, as it is proof that QE is having the desired effect and removes the threat of deflation in the eurozone from the foreseeable future.”

One of the key factors that has kept inflation down in the eurozone (and also the UK) is falling oil prices. It is for this reason that many have been suggesting that this type of deflation is not bad deflation. With oil prices recovering, the general price level will also recover and so economies will follow suit. The following articles consider the fortunes of the eurozone.

Eurozone inflation shouldn’t shift ECB’s QE focus Wall Street Journal, Richard Barley (2/6/15)
Eurozone deflation threat recedes Financial Times, Claire Jones (2/6/15)
Eurozone inflation rate rises to 0.3% in May BBC News (2/6/15)
Eurozone back to inflation as May prices beat forecast Reuters, Jan Strupczewski (2/6/15)
Boost for ECB as Eurozone prices turn positive in May Guardian, Phillip Inman (2/6/15)
Eurozone inflation higher than expected due to quantitative easing International Business Times, Bauke Schram (2/6/15)
Euro lifted by Greek deal hopes and firmer inflation data Financial Times, Roger Blitz and Michael Hunter (2/6/15)


  1. What is the difference between the 0.3% and 0.9% figures quoted for inflation in the eurozone?
  2. What is deflation and why is it such a concern?
  3. Illustrate the impact of falling consumer demand in an AD/AS diagram.
  4. How has the ECB’s QE policy helped to tackle the problem of deflation? Do you think that this programme needs to continue or now the economy has begun to improve, should the programme end?
  5. To what extent is the economic stagnation in the eurozone a cause for concern to countries such as the UK and USA? Explain your answer.
  6. Why has the euro risen, following news of this positive inflation data?
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Tackling the UK’s poor productivity

As we saw in the blog post The UK’s poor productivity record, the UK’s productivity, as measured by output per hour worked, has grown much slower than in other major developed countries since the financial crisis. In fact, output per hour is lower now than in 2008. In France and Germany it is around 3 per higher than in 2008; in Japan it is nearly 6% higher; in the USA it is over 8% higher; and in Ireland it is 12% higher.

The chart below shows international comparisons of labour productivity from 2000 to 2014. (Click here for a PowerPoint of the chart.)

And it is not just labour productivity that has fallen in the UK. Total factor productivity of labour and capital combined has also fallen. This reflects the fall in business investment after the financial crisis and, more recently, meeting the demand for extra output by employing more labour rather than by investing in extra capital.

In his first major speech since the election, the Chancellor of the Exchequer, George Osborne, told the CBI that the government was intent on tackling the problem of low and stagnant productivity. This would require investment in infrastructure, such as high-speed rail, better roads, superfast broadband and a new runway in the south east. It would require investment in education, training and research; it would involve cutting red tape for business; it would require making it easier for both parents in a family to work by cutting the cost of childcare. The details of the government’s policies would be made clear in the soon-to-be published Productivity Plan.

But how much difference can the government make? Are there intractable problems that will prove virtually impossible to overcome? How much, indeed, can a government do, however much it would like to? The articles explore the issues.

Will George Osborne’s productivity plan help make Britain a world-beater? The Guardian, Larry Elliott (24/5/15)
UK productivity has stayed stubbornly low for years. Dare we hope for better? The Guardian (24/5/15)
Joseph Stiglitz: ‘GDP per capita in the UK is lower than it was before the crisis. That is not a success’ The Observer, Anthony Andrew (24/5/15)
Osborne says low productivity key economic challenge BBC News (20/5/15)
Solving the productivity puzzle BBC News, Duncan Weldon (20/4/15)
Osborne faces up to productivity challenge BBC News, Robert Peston (20/5/15)
Osborne makes priority of boosting UK productivity Financial Times, George Parker (20/5/15)
The Bank of England is living in cloud-cuckoo land on wages Independent, David Blanchflower (18/5/14)
Cameron’s Plan Hasn’t Cracked Productivity Slump Flagged by BOE Bloomberg, Jill Ward (14/5/15)
To solve Britain’s productivity puzzle, try asking the workers The Conversation, Stephen Wood (29/6/15)

Inflation Report: Chapter 3, Output and Supply Bank of England (May 2015)


  1. Define (a) labour productivity; (b) capital productivity; (c) total factor productivity.
  2. Why has the UK experienced lower productivity than other developed countries?
  3. Why may the UK’s lower unemployment than other countries in the post-recession period be the direct consequence of lower productivity growth?
  4. For what reasons might it be difficult for the government to achieve a significant increase in UK productivity?
  5. How might demand-side policy negatively impact on the supply-side policies that the government might adopt to increase productivity?
  6. How might the period up to and beyond the referendum in the UK on continuing EU membership impact on productivity?
  7. How might poor productivity be tackled?
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US interest rates and growth

The US economy has been performing relatively well, but as with the UK economy, growth in the first quarter of 2015 has slowed. In the US, it has slowed to 0.2%, which is below expectations and said to be due to ‘transitory factors’. In response, the Federal Reserve has kept interest rates at a record low, within the band 0.0% to 0.25%.

The USA appears relatively unconcerned about the slower growth it is experiencing and expects growth to recover in the next quarter. The Fed said:

“Growth in household spending declined; households’ real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high. Business fixed investment softened, the recovery in the housing sector remained slow, and exports declined.”

Nothing has been said as to when interest rates may rise and with this unexpected slowing of the economy, further delays are likely. An investment Manager from Aberdeen Asset Management said:

“The removal of the Fed’s time dependent forward guidance could be significant. It means that any meeting from now on could be the one when they announce that magic first rate rise.”

Low rates will provide optimal conditions for stimulating growth. A key instrument of monetary policy, interest rates affect many of the components of aggregate demand. Lower interest rates reduce the cost of borrowing, reduce the return on savings and hence encourage consumption. They can also reduce mortgage repayments and have a role in reducing the exchange rate. All of these factors are crucial for any economic stimulus.

Analysts are not expecting rates to rise in the June meeting and so attention has now turned to September as the likely time when interest rates will increase and finally reward savers. Any earlier increase in rates could spell trouble for economic growth and similar arguments can be made in the UK and across the eurozone. The following articles consider the US economy.

Federal Reserve keeps interest rates at record low BBC News, Kim Gittleson (29/4/15)
Shock stalling of US economy hits chances of early Fed rate rise The Guardian, Larry Elliott (29/4/15)
US Fed leave interest rates unchanged after poor GDP figures Independent, Andrew Dewson (30/4/15)
Fed could give clues on first interest rate hike USA Today, Paul Davidson (28/4/15)
Fed’s downgrade of economic outlook signals longer rate hike wait Reuters, Michael Flaherty and Howard Schneider (29/4/15)
Five things that stopped the Fed raising rates The Telegraph, Peter Spence (29/4/15)


  1. By outlining the key components of aggregate demand, explain the mechanisms by which interest rates will affect each component.
  2. How can inflation rates be affected by interest rates?
  3. Why could it be helpful for the Fed not to provide any forward guidance?
  4. What are the key factors behind the slowdown of growth in the USA? Do you agree that they are transitory factors?
  5. Who would be helped and harmed by a rate rise?
  6. Consider the main macroeconomic objectives and in each case, with respect to the current situation in the USA, explain whether economic theory would suggest that interest rates should (a) fall , (b) remain as they are, or (c) rise.
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Deficit plans: clear or vague?

In their manifestos, the parties standing for the UK general election on May 7th state their plans for fiscal policy and, more specifically, for reducing public-sector net borrowing and public-sector net debt. The degree of detail in the plans varies, especially with regards to where cuts will be made, but there are nevertheless some very clear differences between the parties.

The Institute for Fiscal Studies has examined the public finance plans of the Conservatives, Labour, Liberal Democrats and SNP and has published a briefing note (see link below) and an accompanying press release. It accuses all four parties’ plans of being short on detail over specific cuts (especially the Conservatives), and over borrowing requirements (especially Labour):

None of these parties has provided anything like full details of their fiscal plans for each year of the coming parliament, leaving the electorate somewhat in the dark as to both the scale and composition of likely spending cuts and tax increases. In our analysis we have used the information provided in each manifesto, plus in some cases some necessary assumptions, to shed light on the four parties’ plans.

But despite the lack of detail, the IFS claims that there are big differences in the parties’ plans. These are illustrated in the following three charts from the IFS Briefing Note.

According to Carl Emmerson, IFS deputy director:

“There are genuinely big differences between the main parties’ fiscal plans. The electorate has a real choice, although it can at best see only the broad outlines of that choice. Conservative plans involve a significantly larger reduction in borrowing and debt than Labour plans. But they are predicated on substantial and almost entirely unspecified spending cuts and tax increases. While Labour has been considerably less clear about its overall fiscal ambitions its stated position appears to be consistent with little in the way of further spending cuts after this year”.

So what would be the implications of the plans of the various parties for fiscal policy and what, in turn, would be the implications for economic growth and investment? The various videos and articles look at the briefing note and at what is missing from the parties’ plans.

Voters ‘in the dark’ over budgets BBC News, Robert Peston (23/4/15)
Election 2015: Main parties respond to IFS deficit claims BBC News, James Landale (23/4/15)
Election 2015: ‘Not enough detail’ on deficit cut plans, says IFS BBC News, Paul Johnson (23/4/15)
IFS: Electorate ‘left in the dark’ by political parties ITV News, Chris Ship (23/4/15)
Voters Left In Dark Over Spending Cuts, Says IFS Sky News (23/4/15)
Post-election austerity: parties’ plans compared Institute for Fiscal Studies, Press Briefing (23/5/15)

IFS: election choice is stark Economia, Oliver Griffin (23/4/15)
Election 2015: Voters ‘left in the dark’, says IFS BBC News (23/4/15)
The huge choice for voters BBC News, Robert Peston (23/4/15)
IFS manifesto analysis: fantasy island of Tory deficit reduction plan The Guardian, Larry Elliott (23/4/15)
Tories have £30bn black hole in spending plans, says IFS The Guardian, Heather Stewart (23/4/15)
Ed Miliband will leave Britain an extra £90bn in debt, IFS finds The Telegraph, Steven Swinford (23/4/15)
IFS despairs as it finds no party’s imaginary numbers add up The Guardian, John Crace (23/4/15)
Reality Check: Why should we trust the IFS? BBC News, Sebastian Chrispin (23/4/15)
IFS: Households can expect lower incomes, whoever wins the election BBC News, Brian Milligan (28/4/15)

Briefing Notes
Post-election Austerity: Parties’ Plans Compared Institute for Fiscal Studies, Briefing Note BN170, Rowena Crawford, Carl Emmerson, Soumaya Keynes and Gemma Tetlow (April 15)
Taxes and Benefits: The Parties’ Plans Institute for Fiscal Studies, Briefing Notw BN 172, Stuart Adam, James Browne, Carl Emmerson, Andrew Hood, Paul Johnson, Robert Joyce, Helen Miller, David Phillips, Thomas Pope and Barra Roantree (April 2015)


  1. What detail is missing about cuts in the Conservative plans?
  2. What detail is missing in the Labour plans on borrowing requirements?
  3. How do (a) the Liberal Democrat plans and (b) the SNP plans differ from Conservative and Labour plans?
  4. Find out the public finances plans of (a) the Green Party; (b) UKIP; and (c) Plaid Cymru. How different are these plans from those of other parties?
  5. Define ‘austerity’.
  6. How would a tightening of fiscal policy affect economic growth (a) in the short term; (b) in the long term?
  7. How would an expansion of the economy affect the budget balance through automatic fiscal stabilisers?
  8. What is meant by the structural deficit? How could this be reduced?
  9. Would the structural deficit be affected by austerity policies and the resulting size of the output gap, or is it independent of such policies? Explain.
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Scotland: Fiscal Autonomy?

Scottish voters will be crucial in the upcoming election, with the SNP poised to take many of Labour’s seats north of the border. The future of Scotland will depend on which party comes to power and what decisions are made with regards to its finances.

Nicola Sturgeon wants government spending and taxation powers transferred to the Scottish Parliament, but would this mean spending cuts and tax rises for the Scottish people? Ed Miliband, Labour’s leader has been vocal in pointing out what this might mean, with cuts to pensions or raising taxes. However, given that it is Labour that is facing the biggest threat from the SNP, it is perhaps hardly surprising.

However, as the first video below shows, there would be an estimated £7.6bn deficit in Scotland, according to the IFS if spending and taxing was to be transferred here. This is because the tax revenues raised in Scotland are lower per person and spending per person is higher than across the whole of the UK. Oil prices are extremely low at present and hence this is reducing tax revenues. When the oil price does rise, revenues will increase and so if the split in finances was to occur this would reduce that deficit somewhat, but it would still leave a rather large hole in Scotland’s finances. The following videos and articles consider the SNP’s plans.

SNP fiscal autonomy plan: What would it do to Scotland’s finances? BBC News, Robert Peston (10/4/15)
Labour attacks SNP’s ‘devastating’ economic plans BBC News (10/4/15)

Ed Miliband attacks SNP plan for Scottish fiscal autonomy The Guardian, Severin Carrell (10/4/15)
Ed Miliband wars pensions will be cut under SNP plans The Telegraph, Auslan Cramb (10/4/15)
SNP fails to account for billions in welfare and pensions pledge, says IFS The Guardian, Severin Carrell (10/4/15)


  1. What is a budget deficit?
  2. What does fiscal autonomy for Scotland actually mean?
  3. The IFS suggests that there will be a large deficit in Scottish finances if they gain autonomy. How could this gap be reduced?
  4. Why has Labour claimed that tax rises would occur under the SNP’s plans? What could this mean for Scottish growth?
  5. Why do lower oil prices reduce tax revenues for Scotland?
  6. If Scotland had control over its finances, it could influence where government spending goes. Which industries would you invest in if you were in charge?
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The UK’s poor productivity record

Real GDP depends on two things: output per hour worked and the number of hours worked. On the surface, the UK economy is currently doing relatively well, with growth in 2014 of 2.8%. After several years of poor economic growth following the financial crisis of 2007/8, growth of 2.8% represents a return to the long-run average for the 20 years prior to the crisis.

But growth since 2010 has been entirely due to an increase in hours worked. On the one hand, this is good, as it has meant an increase in employment. In this respect, the UK is doing better than other major economies. But productivity has not grown and on this front, the UK is doing worse than other countries.

The first chart shows UK output per hour worked (click here for a PowerPoint). It is based on figures released by the ONS on 1 April 2015. Average annual growth in output per hour worked was 2.3% from 2000 to 2008. Since then, productivity growth has stalled and output per hour is now lower than at the peak in 2008.

The green line projects from 2008 what output per hour would have been if its growth had remained at 2.3%. It shows that by the end of 2014 output per hour would have been nearly 18% higher if productivity growth had been maintained.

The second chart compares UK productivity growth with other countries (click here for a PowerPoint). Up to 2008, UK productivity was rising slightly faster than in the other five countries illustrated. Since then, it has performed worse than the other five countries, especially since 2011.

Productivity growth increases potential GDP. It also increases actual GDP if the productivity increase is not offset by a fall in hours worked. A rise in hours worked without a rise in productivity, however, even though it results in an increase in actual output, does not increase potential output. If real GDP growth is to be sustained over the long term, there must be an increase in productivity and not just in hours worked.

The articles below examines this poor productivity performance and looks at reasons why it has been so bad.

UK’s sluggish productivity worsened in late 2014 – ONS Reuters (1/4/15)
UK productivity growth is weakest since second world war, says ONS The Guardian, Larry Elliott (1/4/15)
UK productivity weakness worsening, says ONS Financial Times, Chris Giles (1/4/15)
Is the UK’s sluggish productivity a problem? Financial Times comment (1/4/15)
UK manufacturing hits eight-month high but productivity slump raises fears over sustainability of economic recovery This is Money, Camilla Canocchi (1/4/15)
Weak UK productivity unprecedented, ONS says BBC News (1/4/15)
Weep for falling productivity Robert Peston (1/4/15)
UK’s Falling Productivity Prevented A Massive Rise In Unemployment Forbes, Tim Worstall (2/4/15)

Labour Productivity, Q4 2014 ONS (1/4/15)
AMECO database European Commission, Economic and Financial Affairs


  1. How can productivity be measured? What are the advantages and disadvantages of using specific measures?
  2. Draw a diagram to show the effects on equilibrium national income of (a) a productivity increase, but offset by a fall in the number of hours worked; (b) a productivity increase with hours worked remaining the same; (c) a rise in hours worked with no increase in productivity. Assume that actual output depends on aggregate demand.
  3. Is poor productivity growth good for employment? Explain.
  4. Why is productivity in the UK lower now than in 2008?
  5. What policies can be pursued to increase productivity in the UK?
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Interpreting economic data at election time

The UK general election is on May 7. In the campaign during the run-up to the election the economy will be a major issue. All parties will use economic data to claim that the economy has performed well or badly and that the prospects are good or bad. As economics students you will, no doubt, be asked to comment on these claims by your friends. So where can you get analysis of the data that is not biased towards one party or another?

One source is the Institute for Fiscal Studies. It is respected by politicians of all parties as an impartial presenter and analyser of economic data. In fact, it is fiercely independent. But at election time, when often quite dramatic claims are made by politicians, the IFS often comments on whether the data support such claims.

An example occurred when David Cameron claimed that if Labour were elected, working families would face a £3028 tax rise to fund the party’s spending commitments. The IFS said that the claim was misleading as, even on the Conservatives’ assumptions, it was was based on the cumulative increase over five years, not the annual increase, and was not per household but only per working household. The IFS also said that the Conservatives’ assumptions were wrong and not in accordance with the Charter for Budget Responsibility, with which the Labour party agreed.

Expect the IFS to criticise more claims as the election campaign progresses: not just by the Conservative party but by the other parties too. After all, the IFS is not partisan and is prepared to challenge false economic claims from whatever party. Expect also that the political parties will cherry pick whatever statements by the IFS seen to favour them or criticise their opponents.

You can also expect political bias in the newspapers that report the campaigns. Even when they present facts, how they present them and which facts they choose to include and which to ignore will be a reflection of their political bias. So even newspaper reporting of what the IFS says is likely to be selective and nuanced!

Why IFS boss Paul Johnson counts in this tightest of general elections The Guardian, Larry Elliott (30/3/15)
David Cameron’s claim that Labour would raise taxes by £3,000 is ‘not sensible’, says the IFS Independent, Jon Stone (30/3/15)
‘tax rise’ is shot down by IFS The Guardian, Patrick Wintour (30/3/15)
We will borrow more if we win the election, Labour admits The Telegraph, Christopher Hope (29/3/15)
Chancellor accused of U-turn on austerity: Top economist says £20bn fiscal boost lurking in Budget is ‘remarkable reversal’ This is Money, Hugo Duncan (19/3/15)


  1. Distinguish between positive and normative statements. How might politicians blur the distinction in their claims and counter-claims?
  2. Identify three series of macroeconomic data from at least two independent organisations. For what reasons might the data be (a) unreliable; (b) used by political parties to mislead the electorate?
  3. In what ways can political parties use economic data to their own advantage without falsifying the data?
  4. How may public-sector deficit and debt statistics be interpreted in ways to suit (a) the current government’s case that the public finances have been well managed; (b) the opposition case that the public finances have been badly managed?
  5. Use data to analyse an economic claim by each of at least three political parties and the extent to which the claims are accurate.
  6. The above links are to articles from four UK national newspapers: The Guardian, the Independent, The Telegraph and the Daily Mail (This is Money). Identify political bias in the reporting in each of the articles.
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The six year anniversary

In March 2009, interest rates in the UK fell to a record low of 0.5%. At the time, it is unlikely that anyone expected that we would still be talking about such low interest rates 6 years later. There has been no movement in the UK rate of interest over the past 6 years and many believe that we are unlikely to see an increase before 2016 or late 2015 at the earliest. With inflation at 0.3%, there is ‘little reason to raise the cost of borrowing’.

The cut in interest rates back in 2009 was in response to the financial crisis and recession. A key instrument of monetary policy, interest rates affect many of the components of aggregate demand. Lower interest rates reduce the cost of borrowing, reduce the return on savings and hence encourage consumption. They can also reduce mortgage repayments and have a role in reducing the exchange rate. All of these factors are crucial for any economic stimulus. As the recovery in the UK took hold, discussions started to focus on when (and not if) interest rates would increase. As the 6 year anniversary occurs, with the MPC keeping rates at 0.5% for March, this question has once again been raised.

Interest rates are used to target inflation and the target in the UK is 2% +/- 1%. With inflation at 0.3% and some predicting that it will turn negative, thanks to such a large fall in oil prices, perhaps the most likely change in interest rates is that they will fall further. A senior Economic Adviser to the EY Item Club commented:

“While the risks of an earlier rate rise have probably increased lately, we still think it most likely that the Bank will wait until February 2016, by which time inflation will be back above 1% and heading towards the 2% target.”

This was echoed by the Chief Economist at the British Chambers of Commerce, who said:

“The strengthening pound against the euro is already posing challenges for many UK exporters and higher interest rates would only make matters worse…Given this background, business confidence will be strengthened if the Monetary Policy Committee (MPC) clearly states that interest rates are likely to stay on hold until at least early 2016.”

Some might question the logic of keeping interest rates so low, given that unemployment is falling and the economy is growing. In such cases, we would normally expect interest rates to increase, especially given how low they are and the fact that it has been 6 years since they went down. However, with oil prices down, inflation has fallen and wage growth does remain relatively weak. Furthermore, there are still some areas within the UK that are still in the recovery process.

The strength of the economy relative to Europe is also putting upward pressure on the pound, which will adversely affect the competitiveness of UK exports. These factors together mean that retaining interest rates at 0.5% received unanimous support amongst the MPC. The only disagreement was on the future direction of interest rates. It is this disagreement that is perhaps what is causing problems, as confirmation of what will happen to interest rates over the rest of 2015 would give greater certainty to an economy. The following articles consider this anniversary.

UK interest rates mark six-year anniversary at record low The Guardian, Angela Monaghan (5/3/15)
UK interest rates mark six years at record low of 0.5% BBC News (5/3/15)
Bank of England keeps interest rates on hold Financial Times, Emily Cadman (5/3/15)
Carney facing seven-year itch as BOE holds rates Bloomberg, Jennifer Ryan (5/3/15)
Bank of England rates have now been on hold six years. Here’s how it has affected you The Telegraph, Szu Ping Chan (5/3/15)
Bank of England keeps rates on hold, six years after crisis cut Reuters (5/3/15)
Bank of England keeps key rate at record low Wall Street Journal, Jason Douglas (5/3/15)


  1. By outlining the key components of aggregate demand, explain the mechanisms by which interest rates will affect each component.
  2. How can inflation rates be affected by interest rates?
  3. Why is there a debate amongst the MPC as to the future direction of interest rates?
  4. The Chief Economist at the British Chambers of Commerce has said that the strengthening pound is creating problems in the UK and higher interest rates would make matters worse. Why is this?
  5. Who would be helped and harmed by a rate rise?
  6. Consider the main macroeconomic objectives and in each case explain whether economic theory would suggest that interest rates should (a) fall , (b) remain at 0.5% or (c) rise.
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