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Posts Tagged ‘expectations’

Bubbling bitcoin

What do tulips, nickel mining in Australia, South Seas trading, Beanie Babies and cryptocurrencies have in common? The answer is that they have all been the subject of speculative bubbles. In the first four cases the bubble burst. A question currently being asked is whether it will happen to bitcoin.

Bitcoin
Bitcoin was created in 2009 by an unknown person, or people, using the alias Satoshi Nakamoto. It is a digital currency in the form of a line of computer code. Bitcoins are like ‘electronic cash’ which can be held or used for transactions, with holdings and transactions heavily encrypted for security – hence it is a form of ‘crytocurrency’. People can buy and sell bitcoins for normal currencies as well as using them for transactions. People’s holdings are held in electronic ‘wallets’ and can be accessed on their computers or phones via the Internet. Transfers of bitcoins from one person or organisation to another are recorded in a public electronic ledger in the form of a ‘blockchain‘.

The supply of bitcoins is not controlled by central banks; rather, it is determined by a process known as ‘mining’. This involves individuals or groups solving complex and time-consuming mathematical problems and being rewarded with a new block of bitcoins.

The supply of bitcoins is currently growing at around 150 per hour and the current supply is around ₿16.7 million. However, the number of new bitcoins in a block is halved for every 210,000 blocks. This means that the rate of increase in the supply of bitcoins is slowing – the number generated being halved roughly every four years. The supply will eventually reach a maximum of ₿21 million, probably sometime in the next century, but around 99% will have been mined by around 2032.

The bitcoin bubble
The price of bitcoins has soared in recent months and especially in the past two. On 4 October, the price of a bitcoin was $4226; by 7 December it was nearly four times higher, at $16,858 – a rise of 399% in just nine weeks. Many people have claimed that this is a bubble, which will soon burst. Already there have been severe fluctuations. By December 10, for example, the price had fallen at one point to $13,152 – a fall of nearly 22% in just two days – only to recover to over $15,500 within a few hours.

So what determines the price of bitcoin? The simple answer is very straightforward – it’s determined by demand and supply. But what has been happening to demand and supply and why? And what will happen in the near and more distant future?

As we have seen, the supply is limited by the process of mining, which allows a relatively stable, but declining, increase. The explanation of the recent price rise and what will happen in the future lies on the demand side. Increasing numbers of people have been buying bitcoin, not because they want to use it for transactions, whether legitimate or illegal over the dark web, but because they want to invest in bitcoin. In other words, they want to hold bitcoin as an asset which is increasing in value. These people are known as ‘hodlers’ – a deliberate misspelling of ‘holders’.

But this speculation is of the destabilising form. The more prices have risen, the more people have bought bitcoin, thus pushing the price up further. This is a classic bubble, whereby the price does not reflect an underlying value, but rather the exuberance of buyers.

The problem with bubbles is that they will burst, but just when is virtually impossible to predict with any accuracy. If the price of bitcoins falls, what will happen next depends on how the fall is interpreted. It could be interpreted as a temporary fall, caused by some people cashing in to take advantage of the higher prices. At the same time, other people, believing that it is only a temporary fall, will rush to buy, snapping up bitcoins at the temporary low price. This ‘stabilising speculation’ will move the price back up again.

However, the fall in price may be seen as the bubble bursting, with even bigger falls ahead. In this case, people will rush to sell before it falls further, thereby pushing the price even lower. This destabilising speculation will amplify the fall in prices.

But even if the bubble does burst, people may believe that another bubble will then occur and, once they think the bottom has been reached, will thus start buying again and there will be a second speculative rise in the price.

The crash could be very short-lived. This happened with the second biggest cryptocurrency, Ethereum. On 21 June this year, the price at the beginning of the day was $360. It then began to fall during the say. Once its price reached $315, it then collapsed by 96% to $13 with massive selling, much of it automatic with computers programmed to sell when the price falls by more than a certain amount. But then, on the same day, it rebounded. Within minutes it had bounced back and was trading at $337 at the end of the day. It is now trading at around $450 – up from around $300 four weeks ago.

Whether the bubble in bitcoin has more to inflate, when it will burst, and when it will rebound and by how much, depends on people’s expectations. But what we are looking at here is people’s expectations of what other people are likely to do – in other words, of other people’s expectations, which in turn depend on their expectations of other people’s expectations. This situation is known as a Keynesian Beauty Contest (see the blog, A stock market beauty contest of the machines). Perhaps we need a crystal ball.

Articles
Is Bitcoin a bubble? Here’s what two bubble experts told us Trade Online, Timothy B. Lee (8/12/17)
Bitcoin and tulipmania have a lot more in common than you might think Business Insider, Seth Archer (8/12/17)
Bitcoin ends dramatic week with 20% slump followed by recovery The Guardian, Jill Treanor (8/12/17)
Putting a price on Bitcoin The Economist, Buttonwood’s notebook (8/12/17)
Is Bitcoin a Bubble Waiting to Pop? InvestorPlace, Matt McCall (8/12/17)
Bitcoin bubble follows classic pattern of investment mania Financial Times, John Authers (8/12/17)
The Bitcoin bubble – how we know it will burst The Conversation, Larisa Yarovaya and Brian Lucey (6/12/17)
Bitcoin isn’t a currency – and unless it becomes one it could be worthless The Conversation, Vili Lehdonvirta (6/12/17)
Op-ed: Bitcoin Is Not a Bubble; It’s in an S-Curve and It’s Just Getting Started Bitcoin Magazine, Brandon Green (8/12/17)
Bitcoin vs history’s biggest bubbles: They never end well CNN Money, Daniel Shane (8/12/17)
The 10 Most Ridiculous Price Bubbles In History Business Insider, Vincent Fernando and Anika Anand (11/10/10)
After bitcoin’s wild week, traders brace for futures launch Reuters, Saqib Iqbal Ahmed (10/12/17)

Bitcoin current market prices
Bitcoin live exchange prices and volumes ($) CryptoCompare

Questions

  1. To what extent does Bitcoin meet the functions of money?
  2. Why is bitcoin unsuitable for normal transactions?
  3. To what extent is bitcoin like gold as a means of holding wealth?
  4. How would you advise someone thinking of buying bitcoin today? Explain why.
  5. Does a rapid rise in the price of an asset always indicate a bubble? Explain
  6. To what extent is the current rise in the price of bitcoin similar to that of the tulip, Poseidon and Beanie Baby bubbles?
  7. If bitcoin is appreciating relative to the dollar and other currencies, does this mean that the price of goods and services valued in bitcoin are falling? Explain.
  8. Explain and comment on the following sentence from the first Conversation article: “Like any asset, Bitcoin has some fundamental value, even if only a hope value, or a value arising from scarcity.”
  9. How might the introduction of futures trading in bitcoin impact on its price and the volatility of price swings?
  10. Explain and assess the argument that the price trend of bitcoin is more likely to be an S curve rather than a roller coaster
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UK low productivity growth – even worse than thought

In various blogs, we’ve looked at the UK’s low productivity growth, both relative to other countries and relative to the pre-1998 financial crisis (see, for example, The UK productivity puzzle and Productivity should we be optimistic?). Productivity is what drives long-term economic growth as it determines potential GDP. If long-term growth is seen as desirable, then a fall in productivity represents a serious economic problem.

Recent data suggest that the problem, if anything, is worse than previously thought and does not seem to be getting better. Productivity is now some 21% below what it would have been had productivity growth continued at the rate experienced in the years before the financial crisis (see second chart below).

In its latest productivity statistics, the ONS reports that labour productivity (in terms of output per hour worked) fell by 0.1% in the second quarter of 2017. This follows a fall of 0.5% in quarter 1. Over the whole year to 2017 Q2, productivity fell by 0.3%.

Most other major developed countries have much higher productivity than the UK. In 2016, Italy’s productivity was 9.9% higher than the UK’s; the USA’s was 27.9%, France’s was 28.7% and Germany’s was 34.5% higher. What is more, their productivity has grown faster (see chart).

But what of the future? The Office for Budget responsibility publishes forecasts for productivity growth, but has consistently overestimated it. After predicting several times in the past that UK productivity growth would rise towards its pre-financial crisis trend of around 2% per year, in its October 2017 Forecast evaluation Report it recognises that this was too optimisitic and revises downwards its forecasts for productivity growth for 2017 and beyond.

As the period of historically weak productivity growth lengthens, it seems less plausible to assume that potential and actual productivity growth will recover over the medium term to the extent assumed in our most recent forecasts. Over the past five years, growth in output per hour has averaged 0.2 per cent. This looks set to be a better guide to productivity growth in 2017 than our March forecast of 1.6 per cent.

Looking further ahead, it no longer seems central to assume that productivity growth will recover to the 1.8 per cent we assumed in March 2017 within five years.

But why has productivity growth not returned to pre-crisis levels? There are five possible explanations.

The first is that there has been labour hoarding. But with companies hiring more workers, this is unlikely still to be true for most employers.

The second is that very low interest rates have allowed some low-productivity companies to survive, which might otherwise have been driven out of business.

The third is a reluctance of banks to lend for investment. After the financial crisis this was driven by the need for them to repair their balance sheets. Today, it may simply be greater risk aversion than before the financial crisis, especially with the uncertainties surrounding Brexit.

The fourth is a fall in firms’ desire to invest. Although investment has recovered somewhat from the years directly following the financial crisis, it is still lower than might be expected in an economy that is no longer is recession. Indeed, there has been a much slower investment recovery than occurred after previous recessions.

The fifth is greater flexibility in the labour market, which has subdued wages and has allowed firms to respond to higher demand by taking on more relatively low-productivity workers rather than having to invest in human capital or technology.

Whatever the explanation, the solution is for more investment in both technology and in physical and human capital, whether by the private or the public sector. The question is how to stimulate such investment.

Articles
UK productivity lagging well behind G7 peers – ONS Financial Times, Katie Martin (6/10/17)
UK productivity sees further fall BBC News (6/10/17)
UK resigned to endless productivity gloom The Telegraph, Tim Wallace (10/10/17)
UK productivity estimates must be ‘significantly’ lowered, admits OBR The Guardian, Richard Partington and Phillip Inman (10/10/17)
UK productivity growth to remain sluggish, says OBR BBC News (10/10/17)
Official Treasury forecaster slashes UK productivity growth forecast, signalling hole in public finances for November Budget Independent, Ben Chu (10/10/17)
The Guardian view on Britain’s productive forces: they are not working The Guardian, Editorial (10/10/17)
Mind the productivity gap: the story behind sluggish earnings The Telegraph, Anna Isaac (26/10/17)

Data and statistical analysis
Labour productivity: April to June 2017 ONS Statistical Bulletin (6/10/17)
International comparisons of productivity ONS Dataset (6/10/17)
Forecast evaluation report OBR (October 2017)

Questions

  1. Explain the relationship between labour productivity and potential GDP.
  2. What is the relationship between actual growth in GDP and labour productivity?
  3. Why does the UK lag France and Germany more in output per hour than in output per worker, but the USA more in output per worker than in output per hour?
  4. Is there anything about the UK system of financing investment that results in lower investment than in other developed countries?
  5. Why are firms reluctant to invest?
  6. In what ways could public investment increase productivity?
  7. What measures would you recommend to encourage greater investment and why?
  8. How do expectations affect the growth in labour productivity?
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Oil prices – the ups and the downs

Oil prices are determined by demand and supply. Changes in oil prices are the result of shifts in demand and/or supply, with the size of the price change depending on the size of the shift and the price elasticity of demand and supply.

Some of the shifts are long term, with the price of oil varying from year to year or even moving in a particular direction for longer periods of time. Thus the opening up of new supplies, such as from fracking wells, can lead to a long-term fall in oil prices, while agreements by, say, OPEC to curb output can lead to a long-term rise in prices (see the blogs The oil see-saw, OPEC deal pushes up oil prices and An oil glut).

Medium and long-term price movements can also reflect medium and long-term changes in demand, such as a recession – oil prices fell dramatically as the world economy slid into recession in 2008/9 and then recovered as the global economy recovered.

Another long-term factor is the development of substitutes, such as renewable energy, which can reduce the demand for oil; another is developments that economise on power, such as more fuel-efficient vehicles and machines.

But oil prices do not just reflect these long-term movements in demand and supply. They also reflect daily and weekly movements as demand and supply respond to global and national events.

Two such events occurred at the end of August/beginning of September this year. The first was Hurricane Harvey. Even though it was downgraded to a tropical storm as it made landfall across the coast of the Gulf of Mexico, it dumped massive amounts of rain on southern Texas and Louisiana. This disrupted oil drilling and refining, shutting down a quarter of the entire US refining capacity. The initial effect was a surge in US oil prices in late August as oil production in much of Texas shut down and a rise in petrol prices as supplies from refineries fell.

Then prices fell back again in early September as production and refining resumed and as it became apparent that there had been less damage to oil infrastructure than initially feared. Also the USA tapped into some of its strategic oil reserves to make up for the shortfall in supply.

Then in early September, the North Koreans tested a hydrogen bomb – much larger than the previous atom bombs it had tested. This prompted fears of US retaliation and heightened tensions in the region. As the Reuters article states:

That put downward pressure on crude as traders moved money out of oil – seen as high-risk markets – into gold futures, traditionally viewed as a safe haven for investors. Spot gold prices rose for a third day, gaining 0.9 per cent on Monday

Quite large daily movements in oil prices are not uncommon as traders respond to such events. A major determinant of short-term demand is expectations, and nervousness about events can put substantial downward pressure on oil prices if it is felt that there could be a downward effect on the global economy – or substantial upward pressure if it is felt that supplies might be disrupted. Often markets over-correct, with prices moving back again as the situation becomes clearer and as nervousness subsides.

Articles
U.S. crude edges higher, gasoline tumbles after Harvey Reuters, Libby George (4/9/17)
Global oil prices fall after North Korea nuclear weapon test Independent, Henning Gloystein (4/9/17)
Brent crude oil falls after North Korea nuclear test The Indian Express (4/9/17)
Oil prices remain volatile AzerNews, Sara Israfilbayova (4/7/17)

Questions

  1. What are the determinants of the price elasticity of demand for oil?
  2. Search news articles to find some other examples of short-term movements in oil prices as markets responded to some political or natural event.
  3. Why do markets often over-correct?
  4. Explain the long-term oil price movements over the past 10 years.
  5. Why is gold seen as a ‘safe haven’?
  6. If refineries buy oil from oil producers, what would determine the net effect on oil prices of a decline in oil production and a decline in demand for oil by the refineries?
  7. What role does speculation play in determining oil prices? Explain how such speculation could (a) reduce price volatility; (b) increase price volatility. Under what circumstances is (b) more likely than (a)?
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The housing market: feeling the pinch

According to the Halifax house price index, house prices fell in the UK in the three months to April. This is the first quarterly fall since 2012. The Nationwide index (see below), shows that prices in April were 0.4% lower than in March (although the 3-month rate was still slightly positive).

The fall in house prices reflects a cooling in demand. This, in turn, reflects a squeeze on household incomes as price rises begin to overtake wage rises. It also reflects buyers becoming more cautious given the uncertainty over the nature of the Brexit deal and its effects on the economy and people’s incomes.

The fall in demand is also driven by recent Bank of England rules which require mortgage lenders to limit the proportion of mortgages with a mortgage/income ratio of 4.5 or above to no more than 15% of their new mortgages. It is also affected by a rise in stamp duty, especially on buy-to-let properties.

Despite the fall in prices, this may understate the fall in demand relative to supply. House price movements often lag behind changes in demand and supply as people are reluctant to adjust to equilibrium prices. In the case of a falling market, sellers may be unwilling to sell at the lower equilibrium price, believing that a lower price ‘undervalues’ their property. Indeed, they may not even put their houses on the market. This makes prices ‘sticky’ downwards. The result is a fall in sales.

Eventually, such people will reluctantly be prepared to accept a lower price and prices will thus fall more. Once people come to expect price falls, supply may increase further as vendors seek to sell before the price falls even more. So we could well see further falls over the coming months.

Lower house prices and falling sales is a picture repeated in many parts of the UK. It is particularly marked in central London. There, estate agents have begun to offer free gifts to purchasers. As The Guardian puts it:

London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a ‘burnt-out core’ according to buying agents Garrington Property Finders, prompting developers to offer ever greater incentives to lure buyers.

… Land Registry figures show that in the heart of the city’s financial district, average property prices plummeted from £861,000 at the time of the EU referendum to £773,000 in February, a decline of 15%, although in London’s outer boroughs prices are still up over the year.

But lower property prices are good news for first-time buyers, although some of the biggest falls have been in the top end of the market.

The fall in property prices may continue for a few months. But population is rising, and with it the number of people who would like to buy their own home. Once real incomes begin to rise again, therefore, demand is likely to resume rising faster than supply. When it does, house prices will continue their upward trend.

Articles
UK house prices in first quarterly fall since 2012 BBC News (8/5/17)
UK house prices fall again in April as buyers feel the pinch The Guardian, Angela Monaghan (28/4/17)
Buy a home, get a car free: offers galore as London estate agents struggle to sell The Guardian, Patrick Collinson (3/5/17)
London is now one of the five cities with the lowest house price growth in the UK City A.M., Helen Cahill (28/4/17)
London Housing Market Property Bubble Vulnerable To Crash The Market Oracle, Jan Skoyles (3/5/17)
A key indicator of a healthy housing market is flashing red in London Business Insider, Thomas Colson (29/5/17)

House Price Data
UK House Prices – links to various sites Economic Data freely available online – Economics Network

Questions

  1. Why are UK house prices falling?
  2. What determines the rate at which they are falling? How is the price elasticity of demand and/or supply relevant here?
  3. How does speculation help to explain changes in house prices? How may speculation help to (a) stabilise and (b) destabilise house prices?
  4. Draw a demand and supply diagram to show how house transactions will be lower if the market is not in equailibrium.
  5. Why are house prices falling faster in central London than elsewhere in the UK?
  6. Why are rents falling in central London? How does this relate to the fall in central London property prices?
  7. How has the Help to Buy scheme affected house prices? Has it affected both demand and supply and, if so, why and how?
  8. How do changes in residential property transaction volumes relate to changes in property prices?
  9. What market imperfections exist in the housing market?
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Rising inflation

The latest figures from the ONS show that UK inflation rose to 2.3% for the 12 months to February 2017 – up from 1.9% for the 12 months to January. The rate is the highest since September 2013 and has steadily increased since late 2015.

The main price index used to measure inflation is now CPIH, as opposed to CPI. CPIH is the consumer prices index (CPI) adjusted for housing costs and is thus a more realsitic measure of the cost pressures facing households. As the ONS states:

CPIH extends the consumer prices index (CPI) to include a measure of the costs associated with owning, maintaining and living in one’s own home, known as owner occupiers’ housing costs (OOH), along with Council Tax. Both of these are significant expenses for many households and are not included in the CPI.

But why has inflation risen so significantly? There are a number of reasons.

The first is a rise in transport costs (contributing 0.15 percentage points to the overall inflation rate increase of 0.4 percentage points). Fuel prices rose especially rapidly, reflecting both the rise in the dollar price of oil and the depreciation of the pound. In February 2016 the oil price was $32.18; in February 2017 it was $54.87 – a rise of 70.5%. In February 2016 the exchange rate was £1 = $1.43; in February 2017 it was £1 = $1.25 – a depreciation of 12.6%.

The second biggest contributor to the rise in inflation was recreation and culture (contributing 0.08 percentage points). A wide range of items in this sector, including both goods and services, rose in price. ‘Notably, the price of personal computers (including laptops and tablets) increased by 2.3% between January 2017 and February 2017.’ Again, a large contributing factor has been the fall in the value of the pound. Apple, for example, raised its UK app store prices by a quarter in January, having raised prices for iPhones, iPads and Mac computers significantly last autumn. Microsoft has raised its prices by more than 20% this year for software services such as Office and Azure. Dell, HP and Tesla have also significantly raised their prices.

The third biggest was food and non-alcoholic beverages (contributing 0.06 percentage points). ‘Food prices, overall, rose by 0.8% between January 2017 and February 2017, compared with a smaller rise of 0.1% a year earlier.’ Part of the reason has been the fall in the pound, but part has been poor harvests in southern Europe putting up euro prices. This is the first time that overall food prices have risen for more than two-and-a-half years.

It is expected that inflation will continue to rise over the coming months as the effect of the weaker pound and higher raw material and food prices filter though. The current set of pressures could see inflation peaking at around 3%. If there is a futher fall in the pound or further international price increases, inflation could be pushed higher still – well above the Bank of England’s 2% target. (Click here for a PowerPoint of the chart.)

The higher inflation means that firms are facing a squeeze on their profits from two directions.

First, wage rises have been slowing and are now on a level with consumer price rises. It is likely that wage rises will soon drop below price rises, meaning that real wages will fall, putting downward pressure on spending and squeezing firms’ revenue.

Second, input prices are rising faster than consumer prices. In the 12 months to February 2017, input prices (materials and fuels) rose by 19.1%, putting a squeeze on producers. Producer prices (‘factory gate prices’), by contrast, rose by 3.7%. Even though input prices are only part of the costs of production, the much smaller rise of 3.7% reflects the fact that producer’s margins have been squeezed. Retailers too are facing upward pressure on costs from this 3.7% rise in the prices of products they buy from producers.

One of the worries about the squeeze on real wages and the squeeze on profits is that this could dampen investment and slow both actual and potential growth.

So will the Bank of England respond by raising interest rates? The answer is probably no – at least not for a few months. The reason is that the higher inflation is not the result of excess demand and the economy ‘overheating’. In other words, the higher inflation is not from demand-pull pressures. Instead, it is from higher costs, which are in themselves likely to dampen demand and contribute to a slowdown. Raising interest rates would cause the economy to slow further.

Videos
UK inflation shoots above two percent, adding to Bank of England conundrum Reuters, William Schomberg, David Milliken and Richard Hunter (21/3/17)
Bank target exceeded as inflation rate rises to 2.3% ITV News, Chris Choi (21/3/17)
Steep rise in inflation Channel 4 News, Siobhan Kennedy (21/3/17)
U.K. Inflation Gains More Than Forecast, Breaching BOE Goal Bloomberg, Dan Hanson and Fergal O’Brien (21/3/17)

Articles
Inflation leaps in February raising prospect of interest rate rise The Telegraph, Julia Bradshaw (21/3/17)
Brexit latest: Inflation jumps to 2.3 per cent in February Independent, Ben Chu (21/3/17)
UK inflation rate leaps to 2.3% BBC News (21/3/17)
UK inflation: does it matter for your income, debts and savings? Financial Times, Chris Giles (21/3/17)
Rising food and fuel prices hoist UK inflation rate to 2.3% The Guardian, Katie Allen (21/3/17)
Reality Check: What’s this new measure of inflation? BBC News (21/3/17)

Data
UK consumer price inflation: Feb 2017 ONS Statistical Bulletin (21/3/17)
UK producer price inflation: Feb 2017 ONS Statistical Bulletin (21/3/17)
Inflation and price indices ONS datasets
Consumer Price Inflation time series dataset ONS datasets
Producer Price Index time series dataset ONS datasets
European Brent Spot Price US Energy Information Administration
Statistical Interactive Database – interest & exchange rates data Bank of England

Questions

  1. If pries rise by 10% and then stay at the higher level, what will happen to inflation (a) over the next 12 months; (b) in 13 months’ time?
  2. Distinguish between demand-pull and cost-push inflation. Why are they associated with different effects on output?
  3. If producers face rising costs, what determines their ability to pass them on to retailers?
  4. Why is the rate of real-wage increase falling, and why may it beome negative over the coming months?
  5. What categories of people are likely to lose the most from inflation?
  6. What is the Bank of England’s remit in terms of setting interest rates?
  7. What is likely to affect the sterling exchange rate over the coming months?
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A worrying rise in unsecured borrowing

Household borrowing on credit cards and through overdrafts and loans has been growing rapidly. This ‘unsecured’ borrowing is now rising at rates not seen since well before the credit crunch of 2008 (click here for a PowerPoint of the chart below). Should this be a cause for concern?

Household confidence is generally high and, as a result, people continue to take out more loans and so household debt continues to increase. Saving rates are falling and, at 5.1% of household disposable income, are the lowest rate since 2008, mirroring the high levels of spending and borrowing.

But as long as the economy keeps growing and as long as interest rates stay at record low levels, people should be able to continue servicing this rising debt. Indeed, with generous balance transfer offers between credit cards and many people paying off their full balance each month, only 56.6% are paying any interest at all on credit card debt, the lowest level on record.

But there could be trouble ahead! Secured borrowing (i.e. on mortgages) is at record highs as house prices have soared, limiting the amount people have to left to spend, even with ultra low interest rates. Student debt is growing, putting a brake on graduate spending.

With economic growth set to slow and inflation set to rise as the effects of the lower pound filter through into retail prices, this could initially boost borrowing further as people seek to maintain levels of consumption. But then, if unemployment starts to rise and consumer confidence starts to fall, real spending could decline, putting further downward pressure on the economy.

Confidence could then fall further and we could witness a repeat of 2008–9, when people became worried about their levels of borrowing and cut back on consumption in an attempt to claw down their debt. The economy was pushed into recession.

The Bank of England is well aware of this scenario and wants banks to ensure that their customers can afford loans before offering them.

Articles
Bank governor Mark Carney warns on household debt BBC News, Brian Milligan (30/11/16)
Credit crunch: Household debt is rising just as the economy’s future is uncertain The Telegraph, Tim Wallace (10/12/16)

Bank of England publication
Financial Stability Report, November 2016 Bank of England (30/11/16)

Data
Money and lending Bank of England Interactive Database
United Kingdom Households Debt To GDP Trading Economics
Household debt OECD Data

Questions

  1. What determines the amount people borrow?
  2. What would cause people to cut back on the amount of debt they have?
  3. Distinguish between secured and unsecured borrowing and debt.
  4. Why has secured borrowing risen? Does this matter?
  5. What is meant by the term ‘re-leveraging’? What is its significance in terms of household borrowing?
  6. Find out what the affordability tests are for anyone wanting to take out a mortgage.
  7. What are the greatest risks to UK financial stability?
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OPEC deal pushes up oil prices

OPEC members agreed on 30 November 2016 to reduce their total oil output by 1.2m barrels per day (b/d) from January 2017 – the first OPEC cut since 2008. The biggest cut (0.49m b/d) is to be made by Saudi Arabia.

Russia has indicated that it too might cut output – by 0.3m b/d. If it carries through with this, it will be the first deal for 15 years to include Russia. OPEC members hope that non-OPEC countries will also cut output by 0.3m b/d. There will be a meeting between OPEC and non-OPEC members on 9 December in Doha to hammer out a deal. If all this goes ahead, the total cut would represent nearly 2% of world output.

The OPEC agreement took many commentators by surprise, who had expected that Iran’s unwillingness to cut its output would prevent any deal being reached. As it turned out, Iran agreed to freeze its output at current levels.

Although some doubted that the overall deal would stick, there was general confidence that it would do so. Markets responded with a huge surge in oil prices. The price of Brent crude rose from $46.48 per barrel on 29 November to $54.25 on 2 December, a rise of nearly 17% (click here for a PowerPoint of the chart)..

The deal represented a U-turn by Saudi Arabia, which had previously pursued the policy of not cutting output, so as to keep oil prices down and drive many shale oil producers out of business (see the blog, Will there be an oil price rebound?)

But if oil prices persist above $54 for some time, many shale oil fields in the USA will become profitable again and some offshore oil fields too. At prices above $50, the supply of oil becomes relatively elastic, preventing prices from rising significantly. As The Observer article states:

It is more likely that a $60 cap will emerge as the Americans, who stand outside the 13-member OPEC grouping, unplug the spigots that have kept their shale oil fields from producing in the last year or two.

… The return to action of once-idle derricks on the Texas and Dakota plains is the result of efficiency savings that have seen large jobs losses and a more streamlined approach to drilling from the US industry, after the post-2014 price tumble rendered many operators unprofitable. Only a few years ago, many firms struggled to make a profit at $70 a barrel. Now they can be competitive at much lower prices, with many expecting $50 for West Texas Intermediate – a lighter crude that typically earns $5 a barrel less than Brent.

OPEC as a cartel is much weaker than it used to be. It produces only around 40% of global oil output. Cheating from its members and increased production from non-OPEC countries, let alone huge oil stocks after two years when production has massively exceeded consumption, are likely to combine to keep prices below $60 for the foreseeable future.

Webcasts
OPEC Cuts Daily Production by 1.2 Million Barrels MarketWatch, Sarah Kent (30/11/16)
How Putin, Khamenei and Saudi prince got OPEC deal done Reuters, Rania El Gamal, Parisa Hafezi and Dmitry Zhdannikov (2/12/16)
Fuel price fears as OPEC agrees to cut supply Sky News, Colin Smith (30/11/16)
OPEC Confounds Skeptics, Agrees to First Oil Cuts in 8 Years Bloomberg, Jamie Webster (30/11/16)
Game of oil: Behind the OPEC deal Aljazeera, Giacomo Luciani (3/12/16) (first 10½ minutes)
Russia won’t stick with its side of the OPEC cut bargain CNBC, Silvia Amaro (1/12/16)

Articles
Oil soars, Brent hits 16-month high after OPEC output deal Reuters, Devika Krishna Kumar (1/12/16)
OPEC reaches a deal to cut production The Economist (3/12/16)
Opec doesn’t hold all the cards, even after its oil price agreement The Observer, Phillip Inman (4/12/16)
Saudi Arabia discussed oil output cut with traders ahead of Opec Financial Times, David Sheppard and Anjli Raval (4/12/16)
The return of OPEC Reuters, Jason Bordoff (2/12/16)
‘Unfortunately, We Tend To Cheat,’ Ex-Saudi Oil Chief Says Of OPEC Forbes, Tim Daiss (4/12/16)
After OPEC – What’s Next For Oil Prices? OilPrice.com (2/12/16)
The OPEC Oil Deal Sells Fake News for Real Money Bloomberg, Leonid Bershidsky (1/12/16)

Data and information
Brent crude prices, daily US Energy Information Administration
OPEC home page Organization of the Petroleum Exporting Countries
OPEC 171st Meeting concludes OPEC Press Release (30/11/16)

Questions

  1. What determines the price elasticity of supply of oil at different prices?
  2. Why is the long-term demand for oil more elastic than the short-term demand?
  3. What determines the likelihood that the OPEC agreement will be honoured by its members?
  4. Is it in Russia’s interests to cut its production as part of the agreement?
  5. Are higher oil prices ‘good news’ for the global economy and a boost to economic growth – a claim made by Saudi Arabia?
  6. What role does oil storage play in determining the effect on the oil price of a cut in output?
  7. What are oil prices likely to be in five years’ time? Explain your reasoning.
  8. Is it in US producers’ interests to invest in new shale oil production? Explain.
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Don’t bank on Italy’s economy

The Brexit vote has caused shockwaves throughout European economies. But there is a potentially larger economic and political problem facing the EU and the eurozone more specifically. And that is the state of the Italian banking system and the Italian economy.

Italy is the third largest economy in the eurozone after Germany and France. Any serious economic weaknesses could have profound consequences for the rest of the eurozone and beyond.

At 135% of GDP, Italy’s public-sector debt is one the highest in the world; its banks are undercapitalised with a high proportion of bad debt; and it is still struggling to recover from the crisis of 2008–9. The Economist article elaborates:

The adult employment rate is lower than in any EU country bar Greece. The economy has been moribund for years, suffocated by over-regulation and feeble productivity. Amid stagnation and deflation, Italy’s banks are in deep trouble, burdened by some €360 billion of souring loans, the equivalent of a fifth of the country’s GDP. Collectively they have provisioned for only 45% of that amount. At best, Italy’s weak banks will throttle the country’s growth; at worst, some will go bust.

Since 2007, the economy has shrunk by 10%. And potential output has fallen too, as firms have closed. Unemployment is over 11%, with youth unemployment around 40%.

Things seem to be coming to a head. As confidence in the Italian banking system plummets, the Italian government would like to bail out the banks to try to restore confidence and encourage deposits and lending. But under new eurozone rules designed to protect taxpayers, it requires that the first line of support should be from bondholders. Such support is known as a ‘bail-in’.

If bondholders were large institutional investors, this might not be such a problem, but a significant proportion of bank bonds in Italy are held by small investors, encouraged to do so by tax relief. Bailing in the banks by requiring bondholders to bear significant losses in the value of their bonds could undermine the savings of many Italians and cause them severe hardship, especially those who had saved for their retirement.

So what is the solution? Italian banks need recapitalising to restore confidence and prevent a more serious crisis. However, there is limited scope for bailing in, unless small investors can be protected. And eurozone rules provide little scope for government funding for the banks. These rules should be relaxed under extreme circumstances. At the same time, policy needs to focus on making Italian banking more efficient.

Meanwhile, the IMF is forecasting that Italian economic growth will be less than 1% this year and little better in 2017. Part of the problem, claims the IMF, is the Brexit vote. This has heightened financial market volatility and increasead the risks for Italy with its fragile banking system. But the problems of the Italian economy run deeper and will require various supply-side policies to tackle low productivity, corruption, public-sector inefficiency and a financial system not fit for purpose. What the mix of these policies should be – whether market based or interventionist – is not just a question of effectiveness, but of political viability and democratic support.

Articles
The Italian Job The Economist (9/7/16)
IMF warns Italy of two-decade-long recessionThe Guardian, Larry Elliott (11/7/16)
Italy economy: IMF says country has ‘two lost decades’ of growth BBC News (12/7/16)
What’s the problem with Italian banks? BBC News, Andrew Walker (10/7/16)
Why Italy’s banking crisis will shake the eurozone to its core The Telegraph, Tim Wallace Szu Ping Chan (16/8/16)
If You Thought Brexit Was Bad Wait Until The Italian Banks All Go Bust Forbes, Tim Worstall (17/7/16)
In the euro zone’s latest crisis, Italy is torn between saving the banks or saving its people Quartz, Cassie Werber (13/7/16)
Why Italy could be the next European country to face an economic crisis Vox, Timothy B. Lee (8/7/16)
Forget Brexit, Quitaly is Europe’s next worry The Guardian, Larry Elliott (26/7/16)

Report
Italy IMF Country Report No. 16/222 (July 2016)

Data
Economic Outlook OECD (June 2016) (select ‘By country’ from the left-hand panel and then choose ‘Italy’ from the pull-down menu and choose appropriate time series)

Questions

  1. Can changes in aggregate demand have supply-side consequences? Explain.
  2. Explain why there may be a downward spiral of asset sales by banks.
  3. How might the principle of bail-ins for undercapitalised Italian banks be pursued without being at the expense of the small saver?
  4. What lessons are there from Japan’s ‘three arrows’ for Italy? Does being in the eurozone constrain Italy’s ability to adopt any or all of these three categories of policy?
  5. Why may the Brexit vote have more serious consequences for Italy than many other European economies?
  6. Find out what reforms have already been adopted or are being pursued by the Italian government. How successful are they likely to be in increasing Italian growth and productivity?
  7. What external factors are currently (a) favourable, (b) unfavourable to improving Italian growth and productivity?
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Monetary and fiscal policies – a U-turn or keeping the economy on track?

What have been, and will be, the monetary and fiscal responses to the Brexit vote in the referendum of 23 June 2016? This question has been addressed in speeches by Mark Carney, Governor of the Bank of England, and by George Osborne, Chancellor the Exchequer. Both recognise that the vote will cause a negative shock to the economy, which will require some stimulus to aggregate demand to avoid a recession, or at least minimise its depth.

Mark Carney stated that:

The Bank of England stands ready to provide more than £250bn of additional funds through its normal facilities. The Bank of England is also able to provide substantial liquidity in foreign currency, if required.

In the coming weeks, the Bank will assess economic conditions and will consider any additional policy responses.

This could mean that at its the next meeting, scheduled for 13/14 July, the Monetary Policy Committee will consider reducing Bank Rate from its current level of 0.5% and introducing further quantitative easing.

In a speech on 30 June, he went further:

I can assure you that in the coming months the Bank can be expected to take whatever action is needed to support growth subject to inflation being projected to return to the target over an appropriate horizon, and inflation expectations remaining well anchored.

Then in a speech on 5 July, introducing the latest Financial Stability Report, he said that the Bank of England’s Financial Policy Committee is lowering the required capital ratio of banks, thereby freeing up capital for lending to customers. The part being lowered is the ‘countercyclical capital buffer’ – the element that can be varied according to the state of the economy. Mark Carney said:

The FPC is today reducing the countercyclical capital buffer on banks’ UK exposures from 0.5% to 0% with immediate effect. This is a major change. It means that three quarters of UK banks, accounting for 90% of the stock of UK lending, will immediately have greater flexibility to supply credit to UK households and firms.

Specifically, the FPC’s action immediately reduces regulatory capital buffers by £5.7 billion and therefore raises banks’ capacity to lend to UK businesses and households by up to £150 billion. For comparison, last year with a fully functioning banking system and one of the fastest growing economies in the G7, total net lending in the UK was £60 billion.

Thus although there may be changes to interest rates and narrow money in response to economic reactions to the Brexit vote, the monetary policy framework remains unchanged. This is to achieve a target rate of CPI inflation of 2% at the 24-month time horizon.

But what of fiscal policy?

In its Charter for Budget Responsibility, updated in the Summer 2015 Budget, the government states its Fiscal Mandate:

3.2 In normal times, once a headline surplus has been achieved, the Treasury’s mandate for fiscal policy is:
   a target for a surplus on public-sector net borrowing in each subsequent year.

3.3 For the period outside normal times from 2015-16, the Treasury’s mandate for fiscal policy is:
   a target for a surplus on public-sector net borrowing by the end of 2019-20.

3.4 For this period until 2019-20, the Treasury’s mandate for fiscal policy is supplemented by:
   a target for public-sector net debt as a percentage of GDP to be falling in each year.

The target of a PSNB surplus by 2019-20 has been the cornerstone of recent fiscal policy. In order to stick to it, the Chancellor warned before the referendum that a slowdown in the economy as a result of a Brexit vote would force him to introduce an emergency Budget, which would involve cuts in government expenditure and increases in taxes.

However, since the vote he is now saying that the slowdown would force him to extend the time for reaching a surplus beyond 2019-20 to avoid dampening the economy further. But does this mean he is abandoning his fiscal target and resorting to discretionary expansionary fiscal policy?

George Osborne’s answer to this question is no. He argues that extending the deadline for a surplus is consistent with paragraph 3.5 of the Charter, which reads:

3.5 These targets apply unless and until the Office for Budget Responsibility (OBR) assess, as part of their economic and fiscal forecast, that there is a significant negative shock to the UK. A significant negative shock is defined as real GDP growth of less than 1% on a rolling 4 quarter-on-4 quarter basis. If the OBR assess that a significant negative shock:

occurred in the most recent 4 quarter period;
is occurring at the time the assessment is being made; or
will occur during the forecast period

then:

  if the normal times surplus rule in 3.2 is in force, the target for a surplus each year is suspended (regardless of future data revisions). The Treasury must set out a plan to return to surplus. This plan must include appropriate fiscal targets, which will be assessed by the OBR. The plan, including fiscal targets, must be presented by the Chancellor of the Exchequer to Parliament at or before the first financial report after the shock. The new fiscal targets must be approved by a vote in the House of Commons.
  if the shock occurs outside normal times, the Treasury will review the appropriateness of its fiscal targets for the period until the public finances return to surplus. Any changes to the targets must be approved by a vote in the House of Commons.
  once the budget is in surplus, the target set out in 3.2 above applies.

In other words, if the OBR forecasts that the Brexit vote will result in GDP growing by less than 1%, the Chancellor can delay reaching the surplus and thus not have to introduce tougher austerity measures. This, in effect, is what he is now saying and maintaining that, because of paragraph 3.5, it does not break the Fiscal Mandate. The nature of the next Budget, probably in the autumn, will depend on OBR forecasts.

A few days later, George Osborne announced that he plans to cut corporation tax from the current 20% to less than 15% – below the rate of 17% previously scheduled for 2019-20. His aim is not just to stimulate the economy, but to attract inward investment, as the rate would below that of any major economy and close the rate of 12.5% in Ireland. His hope would also be to halt the outflow of investment as companies seek to relocate in the EU.

Videos and podcasts
Statement from the Governor of the Bank of England following the EU referendum result Bank of England (24/6/16)
Uncertainty, the economy and policy – speech by Mark Carney Bank of England (30/6/16)
Introduction to Financial Stability Report, July 2016 Bank of England (5/7/16)
Osborne: Life will not be ‘economically rosy’ outside EU BBC News (28/6/16)
Osborne takes ‘realistic’ view over surplus target BBC News (1/7/16)
Why has George Osborne abandoned a key economic target? BBC News (1/7/16)

Articles
Mark Carney says Bank of England ready to inject £250bn into economy to keep UK afloat after EU referendum Independent, Zlata Rodionova (24/6/16)
Carney Signals Rate Cuts as Brexit Chaos Engulfs Political Class Bloomberg, Scott Hamilton (30/6/16)
Bank of England hints at UK interest rate cuts over coming months to ease Brexit woes International Business Times, Gaurav Sharma (30/6/16)
Carney prepares for ‘economic post-traumatic stress’ Financial Times, Emily Cadman (30/6/16)
Bank of England warns Brexit risks beginning to crystallise BBC News (5/7/16)
Bank of England tells banks to cut buffer to boost lending Financial Times, Caroline Binham and Chris Giles (5/7/16)
George Osborne puts corporation tax cut at heart of Brexit recovery plan Financial Times (3/7/16)
George Osborne corporation tax cut is the wrong way to start EU negotiations, former WTO boss says Independent, Hazel Sheffield (5/7/16)
George Osborne abandons 2020 UK surplus target Financial Times, Emily Cadman and Gemma Tetlow (1/7/16)
George Osborne scraps 2020 budget surplus plan The Guardian, Jill Treanor and Katie Allen (1/7/16)
Osborne abandons 2020 budget surplus target BBC News (1/7/16)
Brexit and the easing of austerity BBC News, Kamal Ahmed (1/7/16)
Osborne Follows Carney in Signaling Stimulus After Brexit Bloomberg, Simon Kennedy (1/7/16)

Questions

  1. Explain the measures taken by the Bank of England directly after the Brexit vote.
  2. What will determine whether the Bank of England engages in further quantitative easing beyond the current £385bn of asset purchases?
  3. How does monetary policy easing (or the expectation of it) affect the exchange rate? Explain.
  4. How effective is monetary policy for expanding aggregate demand? Is it more or less effective than using monetary policy to reduce aggregate demand?
  5. Explain what is meant by (a) capital adequacy ratios (tier 1 and tier 2); (b) countercyclical buffers. (See, for example, Economics 9th edition, page 533–7 and Figure 16.2))
  6. To what extent does increasing the supply of credit result in that credit being taken up by businesses and consumers?
  7. Distinguish between rules-based and discretionary fiscal policy. How would you describe paragraph 3.5 in the Charter for Budget Responsibility?
  8. Would you describe George Osborne’s proposed fiscal measures as expansionary or merely as less contractionary?
  9. Why is the WTO unhappy with George Osborne’s proposals about corporation tax?
  10. What is the Nash equilibrium of countries seeking to undercut each other’s corporation tax rates?
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Brexit: the economic consequences

The UK has voted to leave the EU by 17 410 742 votes (51.9% or 37.4% of the electorate) to 16 141 241 votes (48.1% or 34.7% of the electorate). But what will be the economic consequences of the vote?

To leave the EU, Article 50 must be invoked, which starts the process of negotiating the new relationship with the EU. This, according to David Cameron, will happen when a new Conservative Prime Minister is chosen. Once Article 50 has been invoked, negotiations must be completed within two years and then the remaining 27 countries will decide on the new terms on which the UK can trade with the EU. As explained in the blog, The UK’s EU referendum: the economic arguments, there are various forms the new arrangements could take. These include:

‘The Norwegian model’, where Britain leaves the EU, but joins the European Economic Area, giving access to the single market, but removing regulation in some key areas, such as fisheries and home affairs. Another possibility is ‘the Swiss model’, where the UK would negotiate trade deals on an individual basis. Another would be ‘the Turkish model’ where the UK forms a customs union with the EU. At the extreme, the UK could make a complete break from the EU and simply use its membership of the WTO to make trade agreements.

The long-term economic effects would thus depend on which model is adopted. In the Norwegian model, the UK would remain in the single market, which would involve free trade with the EU, the free movement of labour between the UK and member states and contributions to the EU budget. The UK would no longer have a vote in the EU on its future direction. Such an outcome is unlikely, however, given that a central argument of the Leave camp has been for the UK to be able to control migration and not to have to pay contributions to the EU budget.

It is quite likely, then, that the UK would trade with the EU on the basis of individual trade deals. This could involve tariffs on exports to the EU and would involve being subject to EU regulations. Such negotiations could be protracted and potentially extend beyond the two-year deadline under Article 50. But for this to happen, there would have to be agreement by the remaining 27 EU countries. At the end of the two-year process, when the UK exits the EU, any unresolved negotiations would default to the terms for other countries outside the EU. EU treaties would cease to apply to the UK.

It is quite likely, then, that the UK would face trade restrictions on its exports to the EU, which would adversely affect firms for whom the EU is a significant market. Where practical, some firms may thus choose to relocate from the UK to the EU or move business and staff from UK offices to offices within the EU. This is particularly relevant to the financial services sector. As the second Economist article explains:

In the longer run … Britain’s financial industry could face severe difficulties. It thrives on the EU’s ‘passport’ rules, under which banks, asset managers and other financial firms in one member state may serve customers in the other 27 without setting up local operations. …

Unless passports are renewed or replaced, they will lapse when Britain leaves. A deal is imaginable: the EU may deem Britain’s regulations as ‘equivalent’ to its own. But agreement may not come easily. French and German politicians, keen to bolster their own financial centres and facing elections next year, may drive a hard bargain. No other non-member has full passport rights.

But if long-term economic effects are hard to predict, short-term effects are happening already.

The pound fell sharply as soon as the results of the referendum became clear. By the end of the day it had depreciated by 7.7% against the dollar and 5.7% against the euro. A lower pound will make imports more expensive and hence will drive up prices and reduce the real value of sterling. On the other had, it will make exports cheaper and act as a boost to exports.

If inflation rises, then the Bank of England may raise interest rates. This could have a dampening effect on the economy, which in turn would reduce tax revenues. The government, if it sticks to its fiscal target of achieving a public-sector net surplus by 2020 (the Fiscal Mandate), may then feel the need to cut government expenditure and/or raise taxes. Indeed, the Chancellor argued before the vote that such an austerity budget may be necessary following a vote to leave.

Higher interest rates could also dampen house prices as mortgages became more expensive or harder to obtain. The exception could be the top end of the market where a large proportion are buyers from outside the UK whose demand would be boosted by the depreciation of sterling.

But given that the Bank of England’s remit is to target inflation in 24 month’s time, it is possible that any spike in inflation is temporary and this may give the Bank of England leeway to cut Bank Rate from 0.5% to 0.25% or even 0% and/or to engage in further quantitative easing.

One major worry is that uncertainty may discourage investment by domestic companies. It could also discourage inward investment, and international companies many divert investment to the EU. Already some multinationals have indicated that they will do just this. Shares in banks plummeted when the results of the vote were announced.

Uncertainty is also likely to discourage consumption of durables and other big-ticket items. The fall in aggregate demand could result in recession, again necessitating an austerity budget if the Fiscal Mandate is to be adhered to.

We live in ‘interesting’ times. Uncertainty is rarely good for an economy. But that uncertainty could persist for some time.

Articles
Why Brexit is grim news for the world economy The Economist (24/6/16)
International banking in a London outside the European Union The Economist (24/6/16)
What happens now that Britain has voted for Brexit The Economist (24/6/16)
Britain and the EU: A tragic split The Economist (24/6/16)
Brexit in seven charts — the economic impact Financial Times, Chris Giles (21/6/16)
How will Brexit result affect France, Germany and the rest of Europe? Financial Times, Anne-Sylvaine Chassany, Stefan Wagstyl, Duncan Robinson and Richard Milne (24/6/16)
How global markets are reacting to UK’s Brexit vote Financial Times, Michael Mackenzie and Eric Platt (24/6/16)
Brexit: What happens now? BBC News (24/6/16)
How will Brexit affect your finances? BBC News, Brian Milligan (24/6/16)
Brexit: what happens when Britain leaves the EU Vox, Timothy B. Lee (25/6/16)
An expert sums up the economic consensus about Brexit. It’s bad. Vox, John Van Reenen (24/6/16)
How will the world’s policymakers respond to Brexit? The Telegraph, Peter Spence (24/6/16)
City of London could be cut off from Europe, says ECB official The Guardian, Katie Allen (25/6/16)
Multinationals warn of job cuts and lower profits after Brexit vot The Guardian, Graham Ruddick (24/6/16)
How will Brexit affect Britain’s trade with Europe? The Guardian, Dan Milmo (26/6/16)
Britain’s financial sector reels after Brexit bombshell Reuters, Sinead Cruise, Andrew MacAskill and Lawrence White (24/6/16)
How ‘Brexit’ Will Affect the Global Economy, Now and Later New York Times, Neil Irwin (24/6/16)
Brexit results: Spurned Europe wants Britain gone Sydney Morning Herald, Nick Miller (25/6/16)
Economists React to ‘Brexit’: ‘A Wave of Economic and Political Uncertainty’ The Wall Street Journal, Jeffrey Sparshott (24/6/16)
Brexit wound: UK vote makes EU decline ‘practically irreversible’, Soros says CNBC, Javier E. David (25/6/16)
One month on, what has been the impact of the Brexit vote so far? The Guardian (23/7/16)

Questions

  1. What are the main elements of a balance of payments account? Changes in which elements caused the depreciation of the pound following the Brexit vote? What elements of the account, in turn, are likely to be affected by the depreciation?
  2. What determines the size of the effect on the current account of the balance of payments of a depreciation? How might long-term effects differ from short-term ones?
  3. Is it possible for firms to have access to the single market without allowing free movement of labour?
  4. What assumptions were made by the Leave side about the economic effects of Brexit?
  5. Would it be beneficial to go for a ‘free trade’ option of abolishing all import tariffs if the UK left the EU? Would it mean that UK exports would face no tariffs from other countries?
  6. What factors are likely to drive the level of investment in the UK (a) by domestic companies trading within the UK and (b) by multinational companies over the coming months?
  7. What will determine the course of monetary policy over the coming months?
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