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

Oil prices continue to fall

Over the past three months oil prices have been falling. From the beginning of September to the end of November Brent Crude has fallen by 30.8%: from $101.2 to a four-year low of $70.0 per barrel (see chart below: click here for a PowerPoint). The fall in price has been the result of changes in demand and supply.

As the eurozone, Japan, South America and other parts of the world have struggled to recover, so the demand for oil has been depressed. But supply has continued to expand as the USA and Canada have increased shale oil production through fracking. As far as OPEC is concerned, rather than cutting production, it decided at a meeting on 27 November to maintain the current target of 30 million barrels a day.

The videos and articles linked below look at these demand and supply factors and what is likely to happen to oil prices over the coming months.

They also look at the winners and losers. Although falling prices are likely in general to benefit oil importing countries and harm oil exporting ones, it is not as simple as that. The lower prices could help boost recovery and that could help to halt the oil price fall and be of benefit to the oil exporting countries. But if prices stay low for long enough, this could lower inflation and even cause deflation (in the sense of falling prices) in many countries. This, in turn, could dampen demand (see the blog post, Deflation danger). This is a particular problem in Japan and the eurozone. Major oil importing developing countries, such as China and India, however, should see a boost to growth from the lower oil prices.

Some oil exporting countries will be harder hit than others. Russia, in particular, has been badly affected, especially as it is also suffering from the economic sanctions imposed by Western governments in response to the situation in Ukraine. The rouble has fallen by some 32% this year against the US dollar and nearly 23% in the past three months alone.

Then there are the environmental effects. Cheaper oil puts less pressure on companies and governments to invest in renewable sources of energy. And then there are the direct effects on the environment of fracking itself – something increasingly being debated in the UK as well as in the USA and Canada.

Videos
Oil price at four-year low as Opec meets BBC News, Mark Lobel (27/11/14)
Opec losing control of oil prices due to US fracking BBC News, Nigel Cassidy (4/12/13)
How the price of oil is set – video explainer The Telegraph, Oliver Duggan (28/11/14)
How Oil’s Price Plunge Impacts Wall Street Bloomberg TV, Richard Mallinson (28/11/14)
Oil Prices Plummet: The Impact on Russia’s Economy Bloomberg TV, Martin Lindstrom (28/11/14)

Articles
Oil prices plunge after Opec meeting BBC News (28/11/14)
Crude oil prices extend losses Financial Times, Dave Shellock (28/11/14)
Oil price plunges after Opec split keeps output steady The Guardian, Terry Macalister and Graeme Wearden (27/11/14)
Falling oil prices: Who are the winners and losers? BBC News, Tim Bowler (17/10/14)Hooray for cheap oil BBC News, Robert Peston (1/12/14)
Russian Recession Risk at Record as Oil Price Saps Economy Bloomberg, Andre Tartar and Anna Andrianova (28/11/14)
Rouble falls as oil price hits five-year low BBC News (1/12/14)

Data
Brent Spot Price US Energy Information Administration (select daily, weekly, monthly or annual: can be downloaded to Excel)
Spot exchange rate of Russian rouble against the dollar Bank of England

Questions

  1. Use a diagram to illustrate the effects of changes in the demand and supply of oil on oil prices.
  2. How does the price elasticity of demand and supply of oil affect the magnitude of these price changes?
  3. Explain whether (a) the demand for and (b) the supply of oil are likely to be relatively elastic or relatively inelastic? How are these elasticities likely to change over time?
  4. Distinguish between the spot price and forward prices of oil? If the three-month forward price is below the spot price, what are the implications of this?
  5. Analyse who gains and who loses from the recent price falls.
  6. What are the effects of a falling rouble on the Russian economy?
  7. What are likely to be the effects of further falls in oil prices on the eurozone economy?
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Japan’s arrows missing their target

Since coming to office two years ago, Shinzo Abe’s government has been determined to revive the Japanese economy. The policy has involved ‘three arrows‘: expansionary fiscal policy, expansionary monetary policy and supply-side reforms. But figures just out show that the Japanese economy is back in recession. The economy shrank by 0.4% in quarter 3, having shrunk by 1.9% in quarter 2.

This has come as a huge disappointment for Mr Abe, who has staked his political reputation on escaping from deflation and achieving sustained economic growth. In response, he has called a general election to put a revised economic plan to the electorate.

The main cause of the reversal into recession has been an increase in the sales tax on all goods, which has dampened spending. The tax rise, planned by the previous government, was to help reduce the deficit and start tackling the huge public-sector debt, which, at over 230% of GDP, is by far the highest in the developed world. Another rise in sales tax is due in October 2015 – from 8% to 10%. Mr Abe hopes to cancel the rise and it is this that he may put to the electorate.

So what is the outlook for Japan? Will quarter 4 show economic growth, or will pessimism have set in? Will the Bank of Japan introduce even more quantitative easing, or will it wait for the latest increase in QE to take effect (see the blog post, All eased out: at least for the USA and UK)?

The following articles look at the implications of the latest news, both for Japan and globally, and at the options for the government and central bank.

Articles
Japanese economy falls into surprise recession Independent, Maria Tadeo (17/11/14)
Japan’s economy makes surprise fall into recession BBC News (17/11/14)
Coming to a crunch: Time is running out for Abenomics The Economist (20/11/14)
Japan’s economy: Delay the second consumption tax hike The Economist (17/11/14)
Defying Expectations, Japan’s Economy Falls Into Recession New York Times, Jonathan Soble (16/11/14)
Japan shocks as economy slips into recession CNBC, Li Anne Wong (17/11/14)
Japan Unexpectedly Enters Recession as Abe Weighs Tax: Economy Bloomberg, Keiko Ujikane and Toru Fujioka (17/11/14)
The world should be wary: Japan’s economic woes are contagious The Guardian, Larry Elliott (17/11/14)
Why is Japan heading to the polls? BBC News (18/11/14)

Previous news items on this site
A new economic road for Japan? (January 2013)
A J-curve for Japan? (May 2013)
Japan’s three arrows (June 2013)
Abenomics – one year on (December 2013)
Japan’s recovery (January 2014)
Japan’s CPI: An Update (May 2014)
All eased out: at least for the USA and UK (November 2014)

Data
Quarterly Estimates of GDP Japanese Cabinet Office
Japan and the IMF IMF Country Reports
Economic Outlook Annex Tables OECD

Questions

  1. Give details of the Japanese government’s three arrows.
  2. Discuss the pros and cons of the rise in the sales tax. Is it possible for the rise in the sales tax to increase the size of the public-sector deficit?
  3. What have been the effects of Japanese government policies on (a) prices of goods and services; (b) living standards; (c) asset prices?
  4. Who have been the gainers and losers of the policies?
  5. How is the Japanese situation likely to effect the value of the yen? How is this, in turn, likely to affect its trading partners? Could this set off a chain reaction?
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Gloomy assessments of the global economic outlook

In two posts recently, we considered the pessimistic views of Robert Peston about the prospects for the global economy (see Cloudy skies ahead? and The end of growth in the West?). In this post we consider the views of Christine Lagarde, Managing Director of the International Monetary Fund, and Lord Adair Turner, the former head of the Financial Services Authority (FSA) (which was replaced in 2013 by the Financial Conduct Authority and the Prudential Regulation Authority).

Christine Lagarde was addressing an audience at Georgetown University in Washington DC. The first four links below are to webcasts of the full speech and subsequent interviews about the speech. She gives a more gloomy assessment of the global economy than six months ago, especially the eurozone economy and several emerging economies, such as China. There are short- to medium-term dangers for the world economy from political conflicts, such as that between Russia and the West over Ukraine. But there are long-term dangers too. These come from the effects of subdued private investment and low infrastructure spending by governments.

Her views are backed up by the six-monthly World Economic Outlook, published by the IMF on 7 October. There are links below to two webcasts from the IMF discussing the report and the accompanying datasets.

In the final webcast link below, Lord Turner argues that there is a “real danger of a simultaneous slowdown producing a big setback to growth expectations.” He is particularly worried about China, which is experiencing an asset price bubble and slowing economic growth. Other emerging economies too are suffering from slowing growth. This poses real problems for developed countries, such as Germany, which are heavily reliant on their export sector.

Webcasts
The Challenges Facing the Global Economy: New Momentum to Overcome a New Mediocre IMF Videos, Christine Lagarde (full speech) (2/10/14)
Christine Lagarde downbeat on global economy BBC News Canada, Christine Lagarde interviewed by Katy Kay (2/10/14)
IMF’s Lagarde on Global Economy, Central Banks Bloomberg TV, Christine Lagarde interviewed by Tom Keene (2/10/14)
Lagarde: Global economy weaker than envisioned 6 months ago, IMF to cut growth outlook CNBC (2/10/14)
IMF Says Uneven Global Growth Disappoints IMF Videos, Olivier Blanchard (7/10/14)
Time Is Right for an Infrastructure Push IMF Videos, Abdul Ablad (30/9/14)
China slowdown poses ‘biggest risk to global economy’ The Telegraph, Adair Turner (4/10/14)

Articles
Global Growth Disappoints, Pace of Recovery Uneven and Country-Specific IMF Survey Magazine (7/10/14)
Global economy risks becoming stuck in low growth trap The Telegraph, Szu Ping Chan (2/10/14)
American Exceptionalism Thrives Amid Struggling Global Economy Bloomberg, Rich Miller and Simon Kennedy (4/10/14)
World Bank cuts China growth forecast for next three years BBC News (6/10/14)
Beware a Chinese slowdown The Guardian, Kenneth Rogoff (6/10/14)
IMF says economic growth may never return to pre-crisis levels The Guardian, Larry Elliott (7/10/14)
IMF goes back to the future with gloomy talk of secular stagnation The Guardian, Larry Elliott (7/10/14)

Data
World Economic Outlook Database IMF (7/10/14)
World Economic Outlook IMF (October 2014)

Questions

  1. What are the particular ‘headwinds’ facing the global economy?
  2. Why is the outlook for the global economy more pessimistic now than six months ago?
  3. Why are increasing levels of debt and asset price rises a threat to Chinese economic growth?
  4. Why may China be more able to deal with high levels of debt than many other countries?
  5. In what ways are commodity prices an indicator of the confidence of investors about future economic growth?
  6. What are the determinants of long-term economic growth? Why are potential economic growth rates lower today than in the 2000s?
  7. How might governments today boost long-term economic growth?
  8. What are the arguments for and against governments engaging in large-scale public investment in infrastructure projects? What would be the supply-side and demand-side effects of such policies?
  9. If confidence is a major determinant of investment, how might bodies such as the IMF boost confidence?
  10. Why does the IMF caution against over-aggressive attempts to reduce budget deficits?
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Big Mac wages

At least once a year The Economist publishes its ‘hamburger standard’ exchange rates for currencies. It is a light-hearted attempt to see if currencies are exchanging at their purchasing-power parity rates. The test is the price at which a ‘Big Mac’ McDonald’s hamburger sells in different countries!

According to this simplified version of the purchasing-power parity theory, exchange rates should adjust so that a Big Mac costs the same in dollars everywhere (see Economics 8th edition Box 25.4).

These Big Mac exchange rates can be used to compare various prices and incomes between countries. The article linked below from The Guardian compares minimum wages between European countries in Big Mac terms.

There are 25 countries across Europe which have minimum wages. A clear pattern of minimum wage rates can be seen: although actual exchange rates understate the purchasing power of incomes in poorer European countries compared to richer ones, minimum wages, even in purchasing-power standard terms, are still higher in the richer countries.

Luxembourg’s minimum wage buys you just about three Big Macs in an hour, while most of northern Europe (and France) between 2–2.5 Big Macs. Moving south, the minimum wage nets about one Big Mac an hour. As we progress east, it begins to cost more than an hour of work on the minimum wage in order to afford a Big Mac.

Of course, there are other factors determining the dollar price of a Big Mac other than the failure of exchange rates to reflect purchasing-power parities. Nevertheless, using the Big Mac index in this way does give a useful preliminary snap shot of differences in what minimum wages can buy in different countries.

Articles
Comparing the minimum wage across Europe using the price of a Big Mac The Guardian datablog, Alberto Nardelli (25/9/14)
Minimum wage statistics Eurostat (Sept/14)

Data
Earnings Database Eurostat

Questions

  1. What is meant by ‘purchasing-power parity exchange rates’?
  2. Why may actual exchange rates not accurately reflect the purchasing power of currencies within countries?
  3. Using the link to Eurostat article above, compare Big Mac minimum wages with (a) actual minimum wages and (b) minimum wages expressed in purchasing-power standard terms.
  4. Using the links to the Eurostat article and Eurostat data, describe how the proportion of employees earning minimum wages varies across European countries. What factors determine this proportion?
  5. Using the same links, describe how the monthly minimum wage as a proportion of average monthly earnings varies across European countries. Explain these differences.
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Plus ça change, plus c’est la même chose

The French economy is flatlining. It has just recorded the second quarter of zero economic growth, with growth averaging just 0.02% over the past 12 months. What is more, the budget deficit is rising, not falling. In April this year, the French finance minister said that the deficit would fall from 4.3% in 2013 to 3.8% in 2014 and to the eurozone ceiling of 3% in 2015. He is now predicting that it will rise this year to 4.4% and not reach the 3% target until 2017.

The deficit is rising because a flatlining economy is not generating sufficient tax revenues. What is more, expenditure on unemployment benefits and other social protection is rising as unemployment has risen, now standing at a record 10.3%.

And it is not just the current economic situation that is poor; the outlook is poor too. The confidence of French companies is low and falling, and investment plans are muted. President Hollande has pledged to cut payroll taxes to help firms, but so far this has not encouraged firms to invest more.

So what can the French government do? And what can the EU as a whole do to help revive not just the French economy but most of the rest of the eurozone, which is also suffering from zero, or near zero, growth?

There are two quite different sets of remedies being proposed.

The first comes from the German government and increasingly from the French government too. This is to stick to the austerity plans: to get the deficit down; to reduce the size of government in order to prevent crowding out; and to institute market-orientated supply-side policies that are business friendly, such as reducing business regulation. Business leaders in France, who generally back this approach, have called for reducing the number of public holidays and scrapping the maximum 35-hour working week. They are also seeking reduced business taxes, financed by reducing various benefits.

Increasingly President Hollande is moving towards a more business-friendly set of policies. Under his government’s ‘Responsibility Pact’, a €40 billion package of tax breaks for business will be financed through €50 billion of cuts in public spending. To carry through these policies he has appointed an ex-investment banker, Emmanuel Macron, as economy minister. He replaces Arnaud Montebourg, who roundly criticised government austerity policy and called for policies to boost aggregate demand.

This brings us to the alternative set of remedies. These focus on stimulating aggregate demand through greater infrastructure investment and cutting taxes more generally (not just for business). The central argument is that growth must come first and that this will then generate the tax revenues and reductions in unemployment that will then allow the deficit to be brought down. Only when economic growth is firmly established should measures be taken to cut government expenditure in an attempt to reduce the structural deficit.

There are also compromise policies being proposed from the centre. These include measures to stimulate aggregate demand, mainly through tax cuts, accompanied by supply-side policies, whether market orientated or interventionist.

As Europe continues to struggle to achieve recovery, so the debate is getting harsher. Monetary policy alone may not be sufficient to bring recovery. Although the ECB has taken a number of measures to stimulate demand, so far they have been to little avail. As long as business confidence remains low, making increased liquidity available to banks at interest rates close to zero will not make banks more willing to lend to business, or businesses more willing to borrow. Calls for an end, or at least a temporary halt, to austerity are thus getting louder. At the same time, calls for sticking to austerity and tackling excessive government spending are also getting louder.

Articles
Hollande entrusts French economy to ex-banker Macron Reuters, Ingrid Melander and Jean-Baptiste Vey (26/8/14)
France’s new Minister of the Economy Emmanuel Macron described by left-wingers as a ‘copy-and-paste Tony Blair’ Independent, John Lichfield (28/8/14)
Merkel praises France’s economic reform plans after Berlin talks with PM Valls Deutsche Welle (22/9/14)
French economy flat-lines as business activity falters Reuters, Leigh Thomas (23/9/14)
French public finances: Rétropédalage The Economist (13/9/14)
French employer group urges ‘shock therapy’ for economy Reuters (24/9/14)
Last chance to save France: loosen 35-hour week and cut public holidays, say bosses The Telegraph (24/9/14)
‘Sick’ France’s economy is stricken by unemployment ‘fever’ The Telegraph (17/9/14)
France’s economics ills worsen but all remedies appear unpalatable The Observer, Larry Elliott and Anne Penketh (31/8/14)
The Fall of France The New York Times, Paul Krugman (28/8/14)
Why Europe is terrified of deflation Salon, Paul Ames (20/9/14)
Europe’s Greater Depression is worse than the 1930s The Washington Post, Matt O’Brien (14/8/14)
Worse than the 1930s: Europe’s recession is really a depression The Washington Post, Matt O’Brien (20/8/14)
Eurozone business growth slows in September, PMI survey finds BBC News (23/9/14)
Europe must ‘boost demand’ to revive economy, US warns BBC News (21/9/14)
Valls says France would never ask Germany to solve its problems Reuters, Annika Breidthardt and Michelle Martin (23/9/14)
The euro-zone economy: Asset-backed indolence The Economist (11/9/14)

Data
Annual macro-economic database (AMECO) Economic and Financial Affairs DG, European Commission
Business and Consumer Surveys Times Series Economic and Financial Affairs DG, European Commission
StatExtracts OECD
Statistics database European Central Bank

Questions

  1. What types of supply-side reforms would be consistent with the German government’s vision of solving Europe’s low growth problem?
  2. How could a Keynesian policy of reflation be consistent with getting France’s deficit down to the 3% of GDP limit as specified in the Stability and Growth Pact (see)?
  3. What is meant by (a) financial crowding out and (b) resource crowding out? Would reflationary fiscal policy in France lead to either form of crowding out? How would it be affected by the monetary stance of the ECB?
  4. Give examples of market-orientated and interventionist supply-side policies.
  5. What is meant by the terms ‘cyclical budget deficit’ and ‘structural budget deficit’. Could demand-side policy affect the structural deficit?
  6. Using the European Commission’s Business and Consumer Surveys find our what has happened to business and consumer confidence in France over the past few months.
  7. How important is business and consumer confidence in determining economic growth in (a) the short term and (b) the long term?
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The effects of Scottish independence: a question of known unknowns?

Economic journalists, commentators and politicians have been examining the possible economic effects of a Yes vote in the Scottish independence referendum on 18 September. For an economist, there are two main categories of difficulty in examining the consequences. The first is the positive question of what precisely will be the consequences. The second is the normative question of whether the likely effects will be desirable or undesirable and how much so.

The first question is largely one of ‘known unknowns’. This rather strange term was used in 2002 by Donald Rumsfeld, US Secretary of Defense, in the context of intelligence about Iraq. The problem is a general one about forecasting the future. We may know the types of thing that are likely happen, but the magnitude of the outcome cannot be precisely known because there are so many unknowable things that can influence it.

Here are some known issues of Scottish independence, but with unknown consequences (at least in precisely quantifiable terms). The list is certainly not exhaustive and you could probably add more questions yourself to the list.

Will independence result in lower or higher economic growth in the short and long term?
Will there be a currency union, with Scotland and the rest of the UK sharing the pound and a central bank? Or will Scotland merely use the pound outside a currency union? Would it prefer to have its own currency or join the euro over the longer term?
What will happen to the sterling exchange rate with the dollar, the euro and various other countries?
How will businesses react? Will independence encourage greater inward investment in Scotland or will there be a net capital outflow? And either way, what will be the magnitude of the effect?
How will assets, such as oil, be shared between Scotland and the rest of the UK? And how will national debt be apportioned?
How big will the transition costs be of moving to an independent Scotland?
How will independence impact on Scottish trade (a) with countries outside the UK and (b) with the rest of the UK?
What will happen about Scotland’s membership of the EU? Will other EU countries, such as Spain (because of its concerns about independence movements in Catalonia and the Basque country), attempt to block Scotland remaining in or rejoining the EU?
What will happen to tax rates in Scotland, with the new Scottish government free to set its own tax rates?
What will be the consequences for Scottish pensions and the Scottish pensions industry?
What will happen to the distribution of income in Scotland? How might Scottish governments behave in terms of income redistribution and what will be its consequences on output and growth?

Of course, just because the effects cannot be known with certainty, attempts are constantly being made to quantify the outcomes in the light of the best information available at the time. These are refined as circumstances change and newer data become available.

But forecasts also depend on the assumptions made about the post-referendum decisions of politicians in Scotland, the rest of the UK and in major trading partner countries. It also depends on assumptions about the reactions of businesses. Not surprisingly, both sides of the debate make assumptions favourable to their own case.

Then there is the second category of question. Even if you could quantify the effects, just how desirable would they be? The issue here is one of the weightings given to the various costs and benefits. How would you weight distributional consequences, given that some people will gain or lose more than others? What social discount rate would you apply to future costs and benefits?

Then there are the normative and largely unquantifiable costs and benefits. How would you assess the desirability of political consequences, such as greater independence in decision-making or the break-up of a union dating back over 300 years? But these questions about nationhood are crucial issues for many of the voters.

Articles
Scottish Independence would have Broad Impact on UK Economy NBC News, Catherine Boyle (9/9/14)
Scottish independence: the economic implications The Guardian, Angela Monaghan (7/9/14)
Scottish vote: Experts warn of potential economic impact BBC News, Matthew Wall (9/9/14)
The economics of Scottish independence: A messy divorce The Economist (21/2/14)
Dispute over economic impact of Scottish independence Financial Times, Mure Dickie, Jonathan Guthrie and John Aglionby (28/5/14)
10 economic benefits for a wealthier independent Scotland Michael Gray (6/3/14)
Scottish independence, UK dependency New Economics Foundation (NEF), James Meadway (4/9/14)
Scottish Jobs and the World Economy Scottish Economy Watch, Brian Ashcroft (25/8/14)
Scottish yes vote: what happens to the pound in your pocket? Channel 4 News (9/9/14)
What price Scottish independence? BBC News, Robert Peston (12/9/14)
What price Scottish independence? BBC News, Robert Peston (7/9/14)
Economists can’t tell Scots how to vote BBC News, Robert Peston (16/9/14)

Books and Reports
The Economic Consequences of Scottish Independence Scottish Economic Society and Helmut Schmidt Universität, David Bell, David Eiser and Klaus B Beckmann (eds) (August 2014)
The potential implications of independence for businesses in Scotland Oxford Economics, Weir (April 2014)

Questions

  1. What is a currency union? What implications would there be for Scotland being in a currency union with the rest of the UK?
  2. If you could measure the effects of independence over the next ten years, would you treat £1m of benefits or costs occurring in ten years’ time the same as £1m of benefits and costs occurring next year? Explain.
  3. Is it inevitable that events occurring in the future will at best be known unknowns?
  4. If you make a statement that something will occur in the future and you turn out to be wrong, was your statement a positive one or a normative one?
  5. What would be the likely effects of Scottish independence on the current account of the balance of payments (a) for Scotland; (b) for the rest if the UK?
  6. How does inequality in Scotland compare with that in the rest of the UK and in other countries? Why might Scottish independence lead to a reduction in inequality? (See the chapter on inequality in the book above edited by David Bell, David Eiser and Klaus B Beckmann.)
  7. One of the problems in assessing the arguments for a Yes vote is uncertainty over what would happen if there was a majority voting No. What might happen in terms of further devolution in the case of a No vote?
  8. Why is there uncertainty over the amount of national debt that would exist in Scotland if it became independent?
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Eurozone becalmed in the doldrums

The eurozone recorded 0.0% growth in the second quarter of 2014. While the UK and USA are now experiencing relatively buoyant economic growth, the eurozone as a whole is stagnating. Some of the 18 eurozone countries, it is true, are now growing, including Spain, Portugal, Ireland and the Netherlands. But the German and Italian economies contracted in the three months to the end of June, while France experienced zero growth.

This will put growing pressure on the ECB to introduce quantitative easing (QE) through the direct purchase of government bonds or other assets. Although this has been a key policy of many central banks, including the Bank of England, the Fed and the Bank of Japan, up to now the ECB has focused mainly on providing cheap funds to banks to encourage them to lend and keeping interest rates very low.

In June, the ECB did announce that it would explore the possibility of QE. It would also introduce €400 billion worth of targeted long-term lending to banks (targeted longer-term refinancing operations (TLTROs)), and would cease sterilising the extra liquidity injected through the Securities Markets Programme, which involved the purchase of existing bonds on the secondary market.

These plans and their implications are examined in the blog post, The ECB: tackling the threat of deflation.

But even if it does eventually introduce QE, this is unlikely before 2015. However, the first €200 billion of TLTROs will be introduced in September and the remaining €200 billion in December. The ECB hopes that these measures in the pipeline will give a sufficient stimulus to rekindle economic growth. But increasingly there are calls for something more dramatic to be done to prevent the eurozone as a whole slipping back into recession.

Articles
Eurozone economy grinds to halt even before Russia sanctions bite Reuters, Michelle Martin and Martin Santa (14/8/14)
ECB under pressure to boost growth, analysts say BBC News (14/8/14)
Eurozone growth at zero as Germany slumps, France stagnates Deutsche Welle (14/8/14)
Eurozone crisis: The grim economic reality BBC News, Gavin Hewitt (14/8/14)
Eurozone growth splutters to a halt as crisis enters new phase The Guardian, Larry Elliott (14/8/14)
Eurozone can learn from George Osborne and Bank of England stimulus The Guardian, Larry Elliott (14/8/14)
Broken Europe: economic growth grinds to a standstill The Telegraph, Szu Ping Chan (14/8/14)
One-in-three chance the ECB conducts quantitative easing next year – Reuters Poll Reuters, Sumanta Dey (13/8/14)
Eurozone’s Unravelling Recovery: What’s Going Wrong Across Troubled Currency Bloc International Business Times, Finbarr Bermingham (14/8/14)
France calls on ECB to act as eurozone growth grinds to a halt The Guardian, Larry Elliott (14/8/14)
That sinking feeling (again) The Economist (30/8/14)

Data
GDP stable in the euro area and up by 0.2% in the EU28 eurostat euroindicators (14/8/14)
Statistics Pocket Book ECB
European Economy: links to data sources Economics Network
Euro area economic and financial data ECB

Questions

  1. Explain how quantitative easing works.
  2. Why has the ECB been reluctant to introduce QE?
  3. What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the Securities Markets Programme? Why did it cease doing this in June?
  4. How have events in Ukraine and political reactions to them influenced the eurozone economy?
  5. Should QE be ‘fast tracked’? Would there be any dangers in this?
  6. What is the ‘Funding for Lending’ scheme in the UK? Is the planned introduction of TLTROs similar to Funding for Lending?
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The ECB: tackling the threat of deflation

The spectre of deflation haunts the eurozone economy. Inflation in the 12 months to May 2014 was 0.5%, down from 0.7% to April and well below the target of 2% (see). Price deflation can result in deflation of the whole economy. With the prospect of falling prices, many consumers put off spending, hoping to buy things later at a lower price. This delay in spending deflates aggregate demand and can result in a decline in growth or even negative growth: hardly a welcome prospect as the eurozone still struggles to recover from the long period of recession or sluggish growth that followed the 2007–8 financial crisis.

The ECB is well aware of the problem. Its President, Mario Draghi, has stated on several occasions that the central bank will do whatever it takes to ward off deflation and stimulate recovery. At its monthly meeting on 5 June, the ECB Council acted. It took the following measures (see Mario Draghi’s press conference and the press release):

• The main refinancing rate it charges banks on reverse repos (when using open-market operations) was cut from 0.25% to 0.15%.
• The rate it pays banks for depositing money in the ECB was cut from 0% to –0.1%. In other words, banks would be charged for ‘parking’ money with the ECB rather than lending it.
• It will provide targeted lending to banks (targeted longer-term refinancing operations (TLTROs)), initially of 7% of the total amount of each banks’ loans to the non-financial private sector within the eurozone. This will be provided in two equal amounts, in September and December 2014. These extra loans will be for bank lending to businesses and households (other than for house purchase). The total amount will be some €400 billion. Substantial additional lending will be made available quarterly from March 2016 to June 2016.
• It will make preparations for an asset purchase scheme. Unlike that in the UK, which involves the purchase of government bonds, this will involve the purchase of assets which involve claims on private-sector (non-financial) institutions. Depending on financing arrangements, this could amount to quantitative easing.
• It will suspend sterilising the extra liquidity that has been injected under the Securities Markets Programme (operated from May 2010 to September 2012), which involved purchasing eurozone countries’ existing bonds on the secondary market. In other words it will stop preventing the securities that have been purchased from increasing money supply. This therefore, for the first time, represents a genuine form of quantitative easing.

The question is whether the measures will be enough to stimulate the eurozone economy, prevent deflation and bring inflation back to around 2%. The measures are potentially significant, especially the prospect of quantitative easing – a policy pursued by other main central banks, such as the Fed, the Bank of England and the Bank of Japan. A lot depends on what the ECB does over the coming months.

The following articles consider the ECB’s policy. The first ones were published before the announcement and look at alternatives open to the ECB. The others look at the actual decisions and assess how successful they are likely to be.

Articles published before the announcement
Mario Draghi faces moment of truth as man with power to steady eurozone The Observer, Larry Elliott (1/6/14)
What the ECB will do in June? Draghi spells it out The Economist (26/5/14)
Draghi as Committed as a Central Banker Gets, as Economists Await ECB Stimulus Bloomberg, Alessandro Speciale and Andre Tartar (19/5/14)
ECB’s credit and credibility test BBC News, Robert Peston (2/6/14)
90 ECB decamps to debate monetary fixes Financial Times, Claire Jones (25/5/14)

Speech
Monetary policy in a prolonged period of low inflation ECB, Mario Draghi (26/5/14)

Articles published after the announcement
ECB launches €400bn scheme, seeks to force bank lending Irish Independent (5/6/14)
The ECB’s toolbox BBC News, Linda Yueh (5/6/14)
ECB’s justified action will help but is no panacea for eurozone deflationary ills The Guardian, Larry Elliott (5/6/14)
Why Negative Rates Won’t Work In The Eurozone Forbes, Frances Coppola (4/6/14)
Germany’s fear of QE is what’s stopping us from cracking open the Cava The Telegraph, Roger Bootle (8/6/14)

Data
Euro area economic and financial data ECB

Questions

  1. Why has the eurozone experienced falling inflation and a growing prospect of negative inflation?
  2. Explain how the Securities Markets Programme (SMP) worked (check it out on the ECB site). What countries’ bonds were purchased and why?
  3. What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the SMP?
  4. If it is practical for the ECB to set a negative interest rate on the deposit facility for banks, would it be practical to set a negative interest rate for the main refinancing operations or the marginal lending facility? Explain.
  5. Why has the ECB, up to now, been unwilling to engage in quantitative easing? What has changed?
  6. Why may the introduction of a negative interest rate on bank deposits in the ECB have only a very small effect on bank lending?
  7. How much is broad money supply growing in the eurozone? Is this enough or too much? Explain.
  8. What else could the ECB have done to ward off deflation? Should the ECB have adopted these measures?
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Argentina and the Paris Club

An historic agreement has been reached between Argentina over outstanding debt owed to creditor nations. Creditor nations come together as the ‘Paris Club’ and at a Paris Club meeting on May 28, details of a repayment plan were agreed. Argentina hopes that the agreement will enable it to start borrowing again on international markets: something that had been largely blocked by outstanding debt, which, up to now, Argentina had been unwilling to repay.

The problem goes back to 2001. Argentina was faced with international debt payments of $132bn, equalling some 27% of GDP and over 300% of export earnings. But at the time the country was in recession and debts were virtually impossible to service. It had received some help from the International Monetary Fund, but in December 2001, the IMF refused a request for a fresh loan of $1.3 billion

As Case Study 27.5 in MyEconLab for Economics, 8th edition explains:

This triggered a crisis in the country with mass rioting and looting. As the crisis deepened, Argentina announced that it was defaulting on its $166 billion of foreign debt. This hardly came as a surprise, however. For many commentators, it was simply a question of when.

Argentina’s default on its debts was the biggest of its kind in history. In a series of dramatic measures, the Argentine peso was initially devalued by 29%. Over the next three months, the peso depreciated a further 40%.

The economy seemed in free-fall. GDP fell by 11% in 2002 and, by the end of the year, income per head was 22% below that of 1998. Unemployment was 21%.

Then, however, the economy began to recover, helped by higher (peso) prices for exports resulting from the currency depreciation. In 2003 economic growth was 9.0% and averaged 8.4% per annum from 2004 to 2008.

But what of the debt? In 2005, Argentina successfully made a huge debt swap with banks and other private creditors (see Box 27.1 in Economics, 8th edition). A large proportion of its defaulted debt was in the form of bonds. It offered to swap the old bonds for new peso bonds, but worth only 35% as much (known as a ‘haircut’). By the deadline of 25 February, there was a 76% take-up of the offer: clearly people thought that 35% was better than nothing! At a stroke, bonds originally worth $104 billion now became worth just $36.2 billion. Later the take-up of the offer increased to 93%. But still 7% held out.

Then in 2006 its debt of nearly $10 billion was repaid to the IMF. General government debt stock as a percentage of GDP fell from 172% in 2002 to 106% in 2006 and to 48% in 2010.

In September 2008, the government of President Cristina Kirchner pledged to use some of its foreign currency reserves of $47 billion to pay back the remainder of the defaulted debt still owed to Paris Club creditors. But negotiations stalled.

However, at the Paris Club meeting of 28 May this year, agreement was finally reached. Argentina will repay the outstanding $9.7bn owed to individual creditor countries. This will take place over 5 years, with a first instalment of $1.15bn being paid before May 2015.

Argentina hopes that the agreement will open up access to overseas credit, which, up to now, has been limited because of this unresolved debt. However, Argentina still owes money to the holders of the 7% of bonds who did not accept the haircut offered in 2005. Their claims are being heard in the US Supreme Court on 12 June this year. The outcome will be critical in determining whether Argentina will be able to raise new funds on the bond market.

Argentina clinches landmark debt repayment deal with Paris Club Reuters, Leigh Thomas and Sarah Marsh (29/5/14)
Argentina Will Repay Paris Club Debt 13 Years After Default Bloomberg, Charlie Devereux and Pablo Gonzalez (29/5/14)
Argentina and the capital markets: At least they have Paris The Economist (30/5/14)
Argentina’s Paris Club Deal to Bring Investment, Kicillof Says Bloomberg, Charlie Devereux (30/5/14)
Argentina Leaves Singer for Last in Preparing Bond Market Return Bloomberg BusinessWeek, Camila Russo and Katia Porzecanski (30/5/14)
Argentina in deal with Paris Club to pay $10bn debts BBC News (29/5/14)
Argentina debt deal could help ease re-entry to international markets The Guardian (29/5/14)
Argentina agrees deal to pay back $10bn debt The Telegraph (29/5/14)

Questions

  1. What is the Paris Club? Why did the recent meeting of the Paris Club concerning Argentina’s debt not include the IMF?
  2. What moral hazards are involved in (a) defaulting on debt; (b) offering debt relief to debtor countries; (c) agreeing to pay bond holders who did not accept the haircut?
  3. In hindsight, was it in Argentina’s interests to default on its international debts in 2001?
  4. Assume a country has a severe debt problem. What are the benefits and costs of using devaluation (or depreciation) to tackle the problem?
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Cause for optimism?

The IMF has just published its 6-monthly World Economic Outlook report. The report is moderately optimistic, arguing that ‘global activity has broadly strengthened and is expected to improve further in 2014–15′. World growth is expected to rise from 3.0% in 2013 to 3.6% in 2014 and 3.9% in 2015,

Much of the impetus for an acceleration in growth is expected to come from advanced countries. Growth in these countries is expected to average 2¼% in 2014–15, a rise of 1 percentage point compared with 2013. Part of the reason is that these countries still have large output gaps and thus have considerable scope to respond to rises in aggregate demand.

Monetary policy in advanced countries remains accommodative, although the USA has begun to taper off its quantitative easing programme. It is possible, however, that the ECB may make its monetary policy more accommodative, with signs that it might embark on quantitative easing if eurozone growth remains weak and if the risks of deflation rise. If the average price level in the eurozone does fall, this could dampen demand as consumers defer consumption until prices have fallen.

As far as emerging economies are concerned, growth is projected to ‘pick up gradually from 4.7 percent in 2013 to about 5 percent in 2014 and 5¼% in 2015′. Although predicted growth is higher in emerging countries than in advanced countries, its acceleration is less, and much of the predicted growth is dependent on rising export sales to the advanced countries.

Global growth, however, is still fragile. Emerging market economies are vulnerable to a slowing or even reversal of monetary flows from the USA as its quantitative easing programme winds down. Advanced countries are vulnerable to deflationary risks. ‘The result [of deflation] would be higher real interest rates, an increase in private and public debt burdens, and weaker demand and output.’

The UK is predicted to have the strongest growth (2.9%) of the G7 countries in 2014 (see above chart). But the IMF cautions about being too optimistic:

Growth has rebounded more strongly than anticipated in the United Kingdom on easier credit conditions and increased confidence. However, the recovery has been unbalanced, with business investment and exports still disappointing.

Articles
IMF: World economy stronger; recovery uneven USA Today, Paul Davidson (8/4/14)
Emerging markets feel the pressure The Telegraph, Szu Ping Chan (8/4/14)
IMF cuts downturn danger to near zero Financial Times, Chris Giles (8/4/14)
IMF warns eurozone and ECB on deflation threat RTE News (8/4/14)
Recovery strong but risk shifts to emerging markets: IMF CNBC, Kiran Moodley (8/4/14)
IMF: World economy is stronger but faces threats Bloomberg Businessweek, Christopher S. Rugaber (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News (8/4/14)
IMF: UK economic growth to reach 2.9% in 2014 BBC News, Hugh Pym (8/4/14)
Five signs that the global economic recovery may be an illusion The Guardian, Larry Elliott (6/4/14)

Report and data
World Economic Outlook (WEO) International Monetary Fund (8/4/14)
World Economic Outlook Database IMF (8/4/14)

Questions

  1. Why does the IMF expect the world economy to grow more strongly in 2014 and 2015 than in 2013?
  2. What are the greatest risks to economic growth for (a) advanced countries; (b) developing countries?
  3. What geo-political events could negatively affect economic growth in (a) the eurozone; (b) the global economy?
  4. In what ways is the UK’s economic growth unbalanced?
  5. How much credence should be given to economic forecasts?
  6. Should countries’ economic performance be judged primarily by their growth in GDP?
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