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Articles for the ‘Essentials of Economics 6e: Ch 14’ Category

What to do about slowing global growth?

First the IMF in its World Economic Outlook, then the European Commission in its Economic Forecasts (see also) and now the OECD in its Economic Outlook (see also) – all three organisations in the latest issues of their 6-monthly publications are predicting slower global economic growth than they did 6 months previously. This applies both to the current year and to 2016. The OECD’s forecast for global growth this year is now 2.9%, down from the 3.7% it was forecasting a year ago. Its latest growth forecast for 2016 is 3.3%, down from the 3.9% it was forecasting a year ago.

Various reasons are given for the gloomier outlook. These include: a dramatic slowdown in global trade growth; slowing economic growth in China and fears over structural weaknesses in China; falling commodity prices (linked to slowing demand but also as a result of increased supply); austerity policies as governments attempt to deal with the hangover of debt from the financial crisis of 2007/8; low investment leading to low rates of productivity growth despite technological progress; and general fears about low growth leading to low spending as people become more cautious about their future incomes.

The slowdown in trade growth (forecast to be just 2% in 2015) is perhaps the most worrying for future global growth. As Angel Gurría, OECD Secretary-General, states in his remarks at the launch of the latest OECD Economic Outlook:

‘Global trade, which was already growing slowly over the past few years, appears to have stagnated and even declined since late 2014, with the weakness centering increasingly on emerging markets, particularly China. This is deeply concerning as robust trade and global growth go hand in hand. In 2015 global trade is expected to grow by a disappointing 2%. Over the past five decades there have been only five other years in which trade growth has been 2% or less, all of which coincided with a marked downturn of global growth.’

So what policies should governments pursue to stimulate economic growth? According to Angel Gurría:

‘Short-term demand needs to be supported and structural reforms to be pursued with greater ambition than is currently the case. Three specific actions are key:

•  First, we need to resist and turn back rising protectionism. Trade strengthens competition and investment and revs up the “diffusion machine” – the spread of new technologies throughout the economy – which will ultimately lift productivity.
•  Second, we need to step up structural reform efforts, which have weakened in recent years. And here, I mean the whole range of structural reforms – education, innovation, competition, labour and product market regulation, R&D, taxes, etc.
•  Third, there is scope to adjust public spending towards investment. If done collectively by all countries, if the sector and projects chosen have high multipliers, and if combined with serious structural reforms, stronger public investment can give a boost to growth and employment and not increase the relative debt burden.’

On this third point, the OECD Economic Outlook argues that ‘the rationale for such investments is that they could help to push economies onto a higher growth path than might otherwise be the case, at a time when private investment growth remains modest.’

Collective action to increase public investment can be expected to boost the initial domestic multiplier effects from the stimulus, since private investment and exports in each economy will benefit from stronger demand in other economies. …the multiplier effects from an investment-led stimulus are likely to be a little larger than from other forms of fiscal stimulus, since the former also has small, but positive, supply-side effects.

In other words, the OECD is calling for a relaxation of austerity policies, with public investment being used to provide a stimulus to growth. The higher growth will then lead to increased potential output, as well as actual output, and an increase in tax revenues.

These policy recommendations are very much in line with those of the IMF.

Videos and Webcasts
OECD warns of global trade slowdown, trims growth outlook again Reuters (9/11/15)
OECD returns to revisionism with growth downgrade Euronews, Robert Hackwill (9/11/15)
OECD: Weak China Import Growth Leads Trade Slowdown Bloomberg, Catherine L Mann, OECD Chief Economist (9/11/15)
OECD Economic Outlook: Moving forward in difficult times OECD PowerPoint presentation, Catherine L Mann, OECD Chief Economist (9/11/15)
Press Conference OECD, Angel Gurría and Álvaro Pereira (9/11/15)

OECD cuts world growth forecast Financial Times, Ferdinando Giugliano (9/11/15)
OECD rings alarm bell over threat of global growth recession thanks to China slowdown Independent, Ben Chu (10/11/15)
OECD cuts global growth forecasts amid ‘deep concern’ over slowdown BBC News (9/11/15)
OECD fears slowdown in global trade amid China woes The Guardian, Katie Allen (9/11/15)
The global economy is slowing down. But is it recession – or protectionism? The Observer, Heather Stewart and Fergus Ryan (14/11/15)
Global growth is struggling, but it is not all bad news The Telegraph, Andrew Sentance (13/11/15)

OECD Publications
Economic Outlook Annex Tables OCED (9/11/15)
Press Release: Emerging market slowdown and drop in trade clouding global outlook OCED (9/11/15)
Data handout for press OECD (9/11/15)
OECD Economic Outlook, Chapter 3: Lifting Investment for Higher Sustainable Growth OCED (9/11/15)
OECD Economic Outlook: Full Report OECD (9/11/15)


  1. Is a slowdown in international trade a cause of slower economic growth or simply an indicator of slower economic growth? Examine the causal connections between trade and growth.
  2. How worried should we be about disappointing growth in the global economy?
  3. What determines the size of the multiplier effects of an increase in public investment?
  4. Why are the multiplier effects of an increase in public-sector investment likely to be larger in the USA and Japan than in the UK, the eurozone and Canada?
  5. How can monetary policy be supportive of fiscal policy to stimulate economic growth?
  6. Under what circumstances would public-sector investment (a) stimulate and (b) crowd out private-sector investment?
  7. How would a Keynesian economist respond to the recommendations of the OECD?
  8. How would a neoclassical/neoliberal economist respond to the recommendations?
  9. Are the OECD’s recommendations in line with the Japanese government’s ‘three arrows‘?
  10. What structural reforms are recommended by the OECD? Are these ‘market orientated’ or ‘interventionist’ reforms, or both? Explain.
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The best news in the world: but just how good is it?

According to a an article in The Guardian, The best news in the world, by the president of the World Bank, Jim Yong Kim, there has been a dramatic fall in global poverty over the past two decades. The number of people in extreme poverty is projected to fall this year to below 10% of global population for the first time. This has been made possible, he claims, by unprecedented economic growth, especially in China.

But this raises three questions.

The first is whether, in the face of falling growth rates, progress in poverty reduction can be maintained.

The second is whether the World Bank is measuring extreme poverty in the right way. It is now defined as living on less than US$1.90 a day in 2011 prices – until a few weeks ago is was $1.25 in 2005 prices. As a result of this rebasing, global poverty falls from 14.5% of the world’s population (or 1011 million people) under the old method to 14.2% (or 987 million) under the new.

The third question is whether countries can improve their data collection so that a truer estimate of poverty can be made.

As far as the first question is concerned, Kim states that to stimulate growth, ‘every dollar of public spending should be scrutinised for impact. Every effort must be made to improve productivity.’ What is more, three things must happen:

Economic growth must lift all people. It must be inclusive.
Investment in human beings is crucial – especially investing in their health and education. Malnourished and poorly educated children will never reach their full potential and countries, in turn, will fall short of their economic and social aspirations.
We must ensure that we can provide safety nets that prevent people from falling back into poverty because of poor health, economic shocks, or natural disasters.

As far as the second question is concerned, there are many who argue that $1.90 per day is far too low a measure of the extreme poverty threshold. It is a purchasing-power parity measure and is equivalent to what $1.90 would buy in the USA in 2011. But, according to the Jason Hickel article linked below, ‘the US Department of Agriculture calculates that in 2011 the very minimum necessary to buy sufficient food was $5.04 per day. And that’s not taking account of other requirements for survival, such as shelter and clothing.’ Peter Edward of Newcastle University, claims Hickell, ‘calculates that in order to achieve normal human life expectancy of just over 70 years, people need roughly 2.7 to 3.9 times the existing poverty line.’

But even if living on below $1.90 a day is defined as extreme poverty, it is important not to see the problem of poverty as having been solved for people who manage to achieve an income slightly above that level.

The third question is how to improve data. There is a paucity and unreliability of data in many developing countries. According to Kim:

Our report adds that data is sparse and inconsistent across the region and globally. Some 29 countries around the world had no poverty data from 2002 to 2011, so they could not track their progress. Another 28 had just one survey that collected poverty data during that time.

This is a situation that must change to improve the world’s ability to tackle poverty. In fact, we can’t accomplish our goal if we do not have enough information to know whether people are actually lifting themselves out of poverty. For that we need to address huge data gaps. We need robust data.

The best news in the world: we have made real progress towards ending extreme poverty The Guardian, Jim Yong Kim (3/11/15)
Could you live on $1.90 a day? That’s the international poverty line The Guardian, Jason Hickel (1/11/15)
Making international trade work for the world’s poorest The Guardian, Jim Yong Kim and Roberto Azevêdo (30/6/15)
Global Poverty Will Hit New Low This Year, World Bank Says Huffington Post, Lydia O’Connor (23/10/15)
The international poverty line has just been raised to $1.90 a day, but global poverty is basically unchanged. How is that even possible? World Bank blogs, Francisco Ferreira, Dean Mitchell Jolliffe and Espen Beer Prydz (4/10/2015)
Why Didn’t the World Bank Make Reducing Inequality One of Its Goals? World Bank blogs, Jaime Saavedra-Chanduvi (23/9/13)
$1.90 Per Day: What Does it Say? Institute for New Economic Thinking, Rahul ​Lahoti and Sanjay Reddy (6/10/15)

Reports and papers
The Role of Trade in Ending Poverty WTO and World Bank (2015)
Poverty in a Rising Africa World Bank (1/10/15)
Ending extreme poverty and sharing prosperity: progress and policies World Bank, Marcio Cruz, James Foster, Bryce Quillin and Philip Schellekens (October 2015)


  1. Explain how the World Bank calculates the extreme poverty line.
  2. Why, if the line has risen from $1.25 per day to $1.90 per day, has the number of people recorded as being in extreme poverty fallen as a result?
  3. Why has the number of people in extreme poverty been rising over the years and yet the percentage of people in extreme poverty been falling?
  4. What policies can be adopted to tackle poverty? Discuss their practicality?
  5. Are reduced poverty and increased economic growth consistent policy goals? (See the blog post Inequality and economic growth.)
  6. What are the inadequacies of using income per day (albeit in ppp terms) as a measure of the degree of poverty? What other indicators of poverty could be used and how suitable would they be?
  7. How could international trade be made to work for the world’s poorest?
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ECB signals further monetary easing

Mario Draghi, the ECB President, has indicated that the ECB is prepared to engage in further monetary stimulus. This is because of continuing weaknesses in the global economy and in particular in emerging markets.

Although the ECB at its meeting in Malta on 22 October decided to keep both interest rates and asset purchases (€60 billion per month) at current levels, Mario Draghi stated at the press conference that, at its next meeting on December 3rd, the ECB would be prepared to cut interest rates and re-examine the size, composition and duration of its quantitative easing programme. He stopped short, however, of saying that interest rates would definitely be cut or quantitative easing definitely increased. He said the following:

“The Governing Council has been closely monitoring incoming information since our meeting in early September. While euro area domestic demand remains resilient, concerns over growth prospects in emerging markets and possible repercussions for the economy from developments in financial and commodity markets continue to signal downside risks to the outlook for growth and inflation. Most notably, the strength and persistence of the factors that are currently slowing the return of inflation to levels below, but close to, 2% in the medium term require thorough analysis.

In this context, the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting, when the new Eurosystem staff macroeconomic projections will be available. The Governing Council is willing and able to act by using all the instruments available within its mandate if warranted in order to maintain an appropriate degree of monetary accommodation.”

Mario Draghi also argued that monetary policy should be supported by fiscal policy and structural policies (mirroring Japan’s three arrows). Structural policies should include actions to improve the business environment, including the provision of an adequate public infrastructure. This is vital to “increase productive investment, boost job creation and raise productivity”.

As far as fiscal policies are concerned, these “should support the economic recovery, while remaining in compliance with the EU’s fiscal rules”. In other words, fiscal policy should be expansionary, while staying within the limits set by the Stability and Growth Pact.

His words had immediate effects in markets. Eurozone government bond yields dropped to record lows and the euro depreciated 3% against the US dollar over the following 24 hours.

ECB Press Conference on YouTube, Mario Draghi (22/10/15)
Draghi reloads bazooka FT Markets, Ferdinando Guigliano (22/10/15)

Mario Draghi: ECB prepared to cut interest rates and expand QE The Guardian, Heather Stewart (22/10/15)
Draghi signals ECB ready to extend QE Financial Times, Claire Jones and Elaine Moore (22/10/15)
Dovish Mario Draghi sends bond yields to new lows Financial Times, Katie Martin (23/10/15)
What Draghi Said on QE, Policy Outlook, Global Risks and Inflation Bloomberg, Deborah Hyde (22/10/15)
ECB set to ‘re-examine’ stimulus policy at next meeting BBC News (22/10/15)
The global economy warrants a big dose of caution The Guardian, Larry Elliott (25/10/15)

ECB Press Conference
Introductory statement to the press conference (with Q&A) ECB, Mario Draghi (President of the ECB), Vítor Constâncio (Vice-President of the ECB) (22/10/15)


  1. Why is the ECB considering further expansionary monetary policy?
  2. What monetary measures can a central bank use to stimulate aggregate demand?
  3. Explain the effects of Mario Draghi’s announcement on bond and foreign exchange markets.
  4. What are the objectives of ECB monetary policy according to the its mandate?
  5. Should the ECB consider using quantitative easing to provide direct funding for infrastructure projects?
  6. What constraints does the EU’s Stability and Growth Pact impose on eurozone countries?
  7. What are the arguments for and against (a) the Bank of England and (b) the US Federal Reserve engaging in further QE?
  8. If the ECB does engage in an expanded QE programme, what will determine its effectiveness?
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China in facts and figures

The second largest economy in the world, with a record expansion to its current economic status: China. With a phenomenal population, massive migration to the cities and incredible infrastructure development, China has fast become a key economic player, with environmental and pollution problems to match.

The price of China’s economic development may be too high for some people. Increases in incomes, growth and employment may be good news, but is the cost too high? Do economic growth and progress mean poor health and if so, is this a price worth paying

Another big topic within China is the impact on inequality. With growth accelerating in urban areas, population movement from the rural to the urban has been a common feature across China, but this has also created greater inequality. This population movement has separated families and played a role in creating barriers of access to health and education.

The following article from the BBC considers a range of indicators within China and you may also want to review some earlier blog postings on the Sloman News Site which analyse the Chinese economy.

Cement and pig consumption reveal China’s huge changes BBC News (21/9/15)


  1. What are the key drivers of China’s development?
  2. What are the costs and benefits of rural-urban migration?
  3. To what extent do you think there may be a trade-off between quality and quantity when it comes to infrastructure projects? Or is Chinese labour simply more efficient relative to countries such as the UK?
  4. How should we measure economic development? If access to education and health care is limited in the more rural areas, but widely available in the larger cities, does this suggest a country that is developing?
  5. What are the main externalities that China must tackle? Are they domestic issues or global ones? What about the solutions?
  6. If a key driver of Chinese growth and development is government investment in infrastructure projects, is this true and sustainable growth or do you think it might slowly disappear if the government doesn’t continue to invest?
  7. Do you think the relative success of China can be replicated in other emerging nations and in particular in nations within Africa?
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UK trade: not all doom and gloom

The UK’s balance on trade continues to be sharply in deficit. At the same time, both manufacturing and overall production are still well below their pre-crisis levels. What is more, with a sterling exchange rate that has appreciated substantially over recent months, UK exports are at an increasing price disadvantage. The hoped-for re-balancing of the economy from debt-financed consumption to investment and exports has not occurred. Investment in the UK remains low relative to that in other major economies (see).

But other developments in the global economy are working in the UK’s favour.

Manufacturing globally is becoming more capital intensive, which reduces the comparative advantage of developing countries with low labour costs.

At the same time, the dividing line between manufacturing and services is becoming more blurred. Manufacturers in developing countries may still produce parts, such as chips or engines, but the design, marketing and sales of the products may take place in developed countries, such as the UK. Indeed, as products become more sophisticated, an increasing amount of value added may occur in developed countries.

The UK may be particularly well-placed in this regard. It can provide many high-end services in IT, business support and financial services to international manufacturers. It may have a comparative advantage in idea-intensive production.

Finally with a higher exchange rate, the UK’s terms of trade have been improving. The downside is that it makes UK exports more expensive in foreign currency terms, but it also makes commodity prices cheaper, which have already fallen in dollar terms, and also the prices of imported component parts. This helps offset the effect of the appreciation of the exchange rate on exports.

The following article by Jeremy Warner considers whether, despite its poor performance in traditional manufacturing, the UK might have hit an economic ‘sweet spot’ in its trade position.

Unbalanced but lucky, Britain hits an economic sweet spot The Telegraph, Jeremy Warner (8/9/15)

UK Trade (Excel file) ONS (9/9/15)
(See, for example, Worksheet 1. You can search for longer series using Google advanced search, putting in the ‘site or domaine’ box and searching for a particular series, using the series identifier found at the top of each column in the Excel file, such as BOKI for balance on trade in goods.)
Exchange rate data Bank of England Statistical Interactive Database


  1. Explain the difference between the balance on trade, the balance on trade in goods and the balance of payments on current account.
  2. Why has the UK not experienced a re-balancing of the economy as hope for by the Chancellor of the Exchequer, amongst others?
  3. What is meant by the ‘terms of trade’?
  4. What would cause an ‘improvement’ in the terms of trade?
  5. Are the UK’s terms of trade likely to move in the UK’s favour in the coming months? Explain.
  6. What current factors are mitigating against a recovery of UK manufacturing exports?
  7. Is de-industrialisation necessarily a ‘bad thing’?
  8. Does the development of new capital-intensive technologies in manufacturing mean that the UK could become a net exporter of manufactures? Explain why or why not.
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A Chinese Trilemma

China has a key role in the global economy. Recording double digit growth for a number of years and posting impressive export figures, China’s has been an economy on an upward trajectory. But its growth has been slowing and this might spell trouble for the global economy, as was discussed in the following blog. For many, China is the pendulum and the direction it moves in will have a big influence on many other countries.

There are some suggestions that China’s rapid growth has been somewhat artificial, in particular following the financial crisis, where we saw massive investment by state-owner enterprises, banks and local government. This has led to a severe imbalance within the Chinese economy, with high levels of debt. One of the key factors that has enabled China to grow so quickly has been strong exports. China has typically had a large current account surplus, often balanced by large current account deficits in many Western countries.

The exchange rate is a key component in keeping strong export growth and the devaluation of the Chinese currency in August (see What a devalued yuan means to the rest of the world) is perhaps a suggestion that export growth in China is lower than desired. Devaluing the currency will boost the competitiveness of Chinese exports and this in turn may lead to a growth in the current account surplus, which had fallen quite significantly from around 10% to 2%.

The problem is that China is currently imbalanced and this is likely to create problems around the world. With globalisation, the free movement of capital and people, deflation in the West and falling world asset prices, the situation in China is crucial. Although you will find many articles about China and blogs on this site about its devaluation, its growth and policy, the BBC News article below considers the conflicts that exist between three key economic objectives:

1. currency stability
2. the free movement of capital
3. independent monetary policy

and the need for some international co-operation and co-ordination to enable China’s economy to return to internal and external balance.

China’s impossible trinity BBC News, Duncan Weldon (8/9/15)


  1. What is meant by internal balance?
  2. What is external balance?
  3. Would you suggest that China is suffering from an imbalanced economy? If so, which type of imbalance and why is this a problem for China and for the world economy?
  4. The article refers to the trilemma. Why can an country not achieve all 3 parts of the trilemma? You should explain why each combination of 2 aspects is possible, but why the third is problematic.
  5. Use a diagram to explain why a fall in the exchange rate will boost the competitiveness of exports and why this can create economic growth.
  6. Why is a devalued Chinese currency bad news for the rest of the world?
  7. How could international co-operation and co-ordination help China?
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A chill wind from the east

The mood has changed in international markets. Investors are becoming more pessimistic about recovery in the world economy and of the likely direction of share prices. Concern has centred on the Chinese economy. Forecasts are for slower Chinese growth (but still around 5 to 7 per cent) and worries centre on the impact of this on the demand for other countries’ exports.

The Chinese stock market has been undergoing turmoil over the past few weeks, and this has added to jitters on other stock markets around the world. Between the 5th and 24th of August, the FTSE 100 fell by 12.6%, from 6752 to 5898; the German DAX fell by 17.1% from 11,636 to 9648 and the US DOW Jones by 10.7% from 17,546 to 15,666. Although markets have recovered somewhat since, they are very volatile and well below their peaks earlier this year.

But are investors right to be worried? Will a ‘contagion’ spread from China to the rest of the world, and especially to its major suppliers of raw materials, such as Australia, and manufactured exports, such as the USA and Germany? Will other south-east Asian countries continue to slow? Will worries lead to continued falls in stock markets as pessimism becomes more entrenched? Will this then impact on the real economy and lead then to even further falls in share prices and further falls in aggregate demand?

Or will the mood of pessimism evaporate as the Chinese economy continues to grow, albeit at a slightly slower rate? Indeed, will the Chinese authorities introduce further stimulus measures (see the News items What a devalued yuan means to the rest of the world and The Shanghai Stock Exchange: a burst bubble?), such as significant quantitative easing (QE)? Has the current slowing in China been caused, at least in part, by a lack of expansion of the monetary base – an issue that the Chinese central bank may well address?

Will other central banks, such as the Fed and the Bank of England, delay interest rate rises? Will the huge QE programme by the ECB, which is scheduled to continue at €60 billion until at least September 2016, give a significant boost to recovery in Europe and beyond?

The following articles explore these questions.

The Guardian view on China’s meltdown: the end of a flawed globalisation The Guardian, Editorial (1/9/15)
Central banks can do nothing more to insulate us from the Asian winter The Guardian, Business leader (6/9/15)
Where are Asia’s economies heading BBC News, Karishma Vaswani (4/9/15)
How China’s cash injections add up to quantitative squeezing The Economist (7/9/14)
Nouriel Roubini dismisses China scare as false alarm, stuns with optimism The Telegraph, Ambrose Evans-Pritchard (4/9/15)
Markets Are Too Pessimistic About Chinese Growth Bloomberg, Nouriel Roubini (4/9/15)

World Economic Outlook databases IMF: see, for example, data on China, including GDP growth forecasts.
Market Data Yahoo: see, for example, FTSE 100 data.


  1. How do open-market operations work? Why may QE be described as an extreme form of open-market operations?
  2. Examine whether or not the Chinese authorities have been engaging in monetary expansion or monetary tightening.
  3. Is an expansion of the monetary base necessary for there to be a growth in broad money?
  4. Why might the process of globalisation over the past 20 or so years be described a ‘flawed’?
  5. Why have Chinese stock markets been so volatile in recent weeks? How seriously should investors elsewhere take the large falls in share prices on the Chinese markets?
  6. Would it be fair to describe the Chinese economy as ‘unstable, unbalanced, uncoordinated and unsustainable’?
  7. What is the outlook over the next couple of years for Asian economies? Explain.
  8. For what reasons might stock markets have overshot in a downward direction?
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What a devalued yuan means to the rest of the world

On August 11th, China devalued its currency, the yuan, by 1.9%. The next day it devalued it by a further 1.6% and on the next day by a further 1.1%. Even though the total devaluation was relatively small, especially given a much bigger revaluation over the previous three years (see chart below), traders in world markets greeted the news with considerable pessimism. Stock markets around the world fell. For example, the US Dow Jones was down by 1.1%, the FTSE 100 was down by 2.5% and the German DAX by 5.8%.

There are three major concerns of investors about the devaluation. The first is that a weaker yuan will make other countries’ exports more expensive in China, thereby making it harder to export to China. At the same time Chinese imports into the rest of the world will be cheaper, thereby making it harder for domestic producers to compete with Chinese imports.

The second is that cheaper Chinese imports will put downward pressure on prices at a time when inflation rates in the major economies are already below target rates. The fear of deflation has not gone away and this further deflationary twist will intensify such fears and possibly dampen demand.

The third is that the devaluation is taken as a sign that the Chinese authorities are worried about a slowing Chinese economy and are using the devaluation to boost Chinese exports. The rapidly expanding Chinese economy has been one of the major motors of the global economy in recent years and hence a slowing Chinese economy is cause for serious concern at a time when the global economy is still only very slowly recovering from the shock of the financial crisis of 2007–8

But just how worried should the rest of the world be about the falling yuan? And will it continue to fall, or could this be seen as a ‘one-off’ correction? What effect will it have on the macroeconomic policies of the USA, the eurozone and other major countries/regions? The following articles analyse Chinese policy towards its currency and the implications for the rest of the world.

China weakens yuan for a third straight day on Thursday CNBC, Nyshka Chandran (13/8/15)
Markets reel as investors fear worst of Chinese slowdown is yet to come The Telegraph, Peter Spence (12/8/15)
China cannot risk the global chaos of currency devaluation The Telegraph, Ambrose Evans-Pritchard (12/8/15)
Beware a China crisis that could crash down on us all The Telegraph, Liam Halligan (15/8/15)
The curious case of China’s currency The Economist, Buttonwood’s notebook (11/8/15)
China’s yuan currency falls for a second day BBC News (12/8/15)
China slowdown forces devaluation BBC News, Robert Peston (11/8/15)
What the yuan devaluation means around the world BBC News, Lerato Mbele, Daniel Gallas and Yogita Limaye (12/8/15)
China allows yuan currency to drop for third day BBC News, various reporters (13/8/15)
The Guardian view on global currencies: it’s the economy, stupid The Guardian, Editorial (14/8/15)
China’s currency gambit and Labour’s debate about quantitative easing: old and new ways to cope with economic crisis The Guardian, Paul Mason (16/8/15)


  1. By what percentages have the nominal and real yuan exchange rate indices appreciated since the beginning of 2011? Use data from the Bank for International Settlements.
  2. Explain the difference between nominal and real exchange rate indices.
  3. Compare the changes in the yuan exchange rate indices with that of the yuan/dollar exchange rate (see Bank of England Interactive Database). Explain the difference.
  4. How is the yuan exchange rate with other currencies determined?
  5. How have the Chinese authorities engineered a devaluation of the yuan? To what extent could it be described as a ‘depreciation’ rather than a ‘devaluation’?
  6. Why have world stock markets reacted so negatively to the devaluation?
  7. Why, in global terms, is the devaluation described as deflationary?
  8. How much should the rest of the world be worried by the devaluation of the yuan?
  9. Explain the statement by Robert Peston that ‘Beijing has done the monetary tightening that arguably the US economy needs’.
  10. Comment on the following statement by Stephen King of HSBC (see the second Telegraph article below): ‘The world economy is sailing across the ocean without any lifeboats to use in case of emergency.’
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A deus ex machina at last?

It was argued in an earlier blog on the Greek debt crisis that a deus ex machina was needed to find a resolution to the impasse between Greece and its creditors. The most likely candidate for such as role was the IMF.

Three days before the Greek referendum on whether or not to accept the Troika’s proposals, the IMF has stepped onto the stage. To the undoubted surprise of the other two partners in the Troika (the European Commission and the ECB), the IMF argues that Greece’s debts are unsustainable and that much more is needed than a mere bailout (which simply rolls over the debt).

According to the IMF, Greece needs €52bn of extra funds between October 2015 and December 2018, large-scale debt relief, a 20-year grace period before making any debt repayments and then debt repayments spread over the following 20 years. In return, Greece should commit to supply-side reforms to cut out waste, reduce bureaucracy, improve tax collection methods and generally improve the efficiency of the economic system.

It would also have to agree to the previously proposed primary budget surplus (i.e. the budget surplus excluding debt repayments) of 1 per cent of GDP this year, rising to 3.5 per cent in 2018.

So it this what commentators have been waiting for? What will be the reaction of the Greeks and the other two partners in the Troika? We shall see.

IMF says Greece needs extra €50bn in funds and debt relief The Guardian. Phillip Inman, Larry Elliott and Alberto Nardelli (2/7/15)
IMF: 3rd Greek bailout would cost €52bn. Or more? Financial Times, Peter Spiegel (2/7/15)
IMF: Greece needs to reform for sustainable debt, financing needs rising CNBC, Everett Rosenfeld (2/7/15)
The IMF has made an obvious point about Greece’s huge debt. Here’s why it still matters Quartz, Jason Karaian (3/7/15)
Greece: when is it time to forgive debt? The Conversation, Jagjit Chadha (2/7/15)

IMF Analysis
Greece: Preliminary Draft Debt Sustainability Analysis IMF (2/7/15)
Preliminary Debt Sustainability Analysis for Greece IMF (25/6/15)


  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. What are the proposals of the IMF? What effect will they have on the Greek economy if accepted?
  4. How would the IMF proposals affect aggregate demand (a) directly; (b) compared with the proposals previously on the table that Greece rejected on 26 June?
  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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A high-risk game of thrones

The negotiations between Greece and the ‘troika’ of creditors (the IMF, the European Commission and the ECB) have seen many twists and turns before breaking down on 26 June. Throughout, both sides have sought to give as little as possible while seeking a compromise. Both sides have claimed that their position is reasonable, even though a gulf has remained between them.

What has been playing out is a high-stakes game, where the optimum outcome for each side is quite different.

Greece seeks bailout terms that would allow it to achieve a smaller primary budget surplus (but still a surplus in the midst of a deep recession). The surplus would be achieved largely through tax rises on the wealthy rather than further cuts that would hit the poor hard. It is also seeking a substantial amount of debt forgiveness to make servicing the remaining debt possible.

The troika is seeking a larger budget surplus than the Greeks are willing to contemplate. This, it maintains, should be achieved largely through additional cuts in government expenditure, including further reductions in pensions and in public-sector wages.

Both sides used threats and promises as the negotiations became more and more acrimonious.

The troika threatened to withhold the final €7.2bn of the bailout necessary to pay the €1.6bn due to the IMF on 30 June, unless the Greeks accepted the terms of the austerity package put to them. The Greek Prime Minister, Alexis Tsipras, in rejecting the proposals, called a referendum on the package. This threatens the stability of the eurozone as a No vote, if it led to a Greek exit from the eurozone, could undermine confidence in monetary union. After all, if Greece could be forced out, other countries facing severe difficulties might also be forced out at some point in the future. Once a country leaves the eurozone, the monetary union becomes more like a system of pegged exchange rates. And pegged exchange rates are open to destabilising speculation at times of economic divergence.

A Greek exit from the euro (dubbed ‘Grexit’) is seen as undesirable by most Greeks and by most politicians in the rest of Europe. The optimum for both sides collectively would be a compromise, which saw more modest cuts by Greece and the eurozone remaining intact. By both sides seeking to maximise their own position, the Nash equilibrium is certainly not the best outcome.

But as long as the troika believes that the Greeks are likely to vote Yes to the proposed bailout terms, it still hopes to get the outcome that is best from its point of view – an outcome that would probably involve regime change. And as long as the Greek government hopes that a No vote will force the troika to think again and come back with less austere proposals, it still hopes to get the outcome that is best from its point of view. But the outcome of this game of ‘chicken’ could well be Grexit and a Nash equilibrium that neither side wants.

But while the endgame is being played out by politicians, people in Greece are suffering. Policies of severely depressing aggregate demand to turn a large budget deficit into a primary budget surplus have led to the economy shrinking by 26%, overall unemployment of 27% and youth unemployment of over 60%. The Greeks truly believe themselves to be stuck between a rock and a hard place.

The following articles look at the nature of the ‘game’ being played and at the effects on the Greek economy, both of the proposed austerity package proposed by the troika and Grexit. They also look at the knock-on effects for the eurozone, the EU and the global economy.

Can game theory explain the Greek debt crisis? BBC News Magazine, Marcus Miller (26/6/15)
Against the Grain: What Yanis Varoufakis can learn from a real game theory master – Nicola Sturgeon City A.M., Paul Ormerod (24/6/15)
John Nash’s Game Theory and Greece Bloomberg, Mohamed A. El-Erian (29/5/15)
The Greek crisis: that 1931 moment The Economist, Buttonwood column (23/6/15)
How game theory explains Grexit and may also predict Greek poll outcome The Conversation, Partha Gangopadhyay (1/7/15)
Greece debt crisis: Tsipras may resign if Greeks vote yes BBC News (30/6/15)
Greek debt crisis: Is Grexit inevitable? BBC News. Paul Kirby (29/6/15)
Existential threat to euro from Greek exit BBC News, Robert Peston (29/6/15)
How I would vote in the Greek referendum The Guardian, Joseph Stiglitz (29/6/15)
Greece in chaos: will Syriza’s last desperate gamble pay off? The Guardian, Paul Mason (29/6/15)
What happens if Greece defaults on its International Monetary Fund loans? The Telegraph, Mehreen Khan (30/6/15)
For Greece’s international creditors, regime change is the ultimate goal The Telegraph, Jeremy Warner (29/6/15)
Europe has suffered a reputational catastrophe in Greece The Telegraph, Ambrose Evans-Pritchard (2/7/15)


  1. What is meant by a primary budget surplus?
  2. What was the troika’s proposal on the table on the 26 June that was rejected by the Greek government?
  3. What was the Greek government’s proposal that was rejected by the troika?
  4. Explain the decision trees outlined in the first BBC article below.
  5. In terms of game theory, what form of game is being played?
  6. Are the negotiations between the Greek government and the troika a prisoners’ dilemma game? Explain why or why not.
  7. Does the game being played between the SNP and the Conservative government in the UK offer any useful lessons to both sides in the negotiations over Greece’s possible bailout and its terms?
  8. Does a No vote in the referendum on 5 July imply that Greece must leave the euro? Explain.
  9. What would be the effects of further austerity measures on aggregate demand? What benefits to the Greek economy could be achieved from such measures?
  10. Why may pegged exchange rates be regarded as the worst of both worlds – a single currency in a monetary union and floating exchange rates?
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