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Posts Tagged ‘financial markets’

Has QE stimulated or dampened investment?

It is now some seven years since the financial crisis and nearly seven years since interest rates in the USA, the eurozone, the UK and elsewhere have been close to zero. But have these record low interest rates and the bouts of quantitative easing that have accompanied them resulted in higher or lower investment than would otherwise have been the case? There has been a big argument about that recently.

According to conventional economic theory, investment is inversely related to the rate of interest: the lower the rate of interest, the higher the level of investment. In other words, the demand-for-investment curve is downward sloping with respect to the rate of interest. It is true that in recent years investment has been low, but that, according to traditional theory, is the result of a leftward shift in demand thanks to low confidence, not to quantitative easing and low interest rates.

In a recent article, however, Michael Spence (of New York University and a 2001 Nobel Laureate) and Kevin Warsh (of Stanford University and a former Fed governor) challenge this conventional wisdom. According to them, QE and the accompanying low interest rates led to a rise in asset prices, including shares and property, rather than to investment in the real economy. The reasons, they argue, are that investors have seen good short-term returns on financial assets but much greater uncertainty over investment in physical capital. Returns to investment in physical capital tend to be much longer term; and in the post-financial crisis era, the long term is much less certain, especially if the Fed and other central banks start to raise interest rates again.

“We believe that QE has redirected capital from the real domestic economy to financial assets at home and abroad. In this environment, it is hard to criticize companies that choose ‘shareholder friendly’ share buybacks over investment in a new factory. But public policy shouldn’t bias investments to paper assets over investments in the real economy.”

This analysis has been challenged by several eminent economists, including Larry Summers, Harvard Economics professor and former Treasury Secretary. He criticises them for confusing correlation (low investment coinciding with low interest rates) with causation. As Summers states:

“This is a little like discovering a positive correlation between oncologists and cancer and asserting that this proves oncologists cause cancer. One would expect in a weak recovery that investment would be weak and monetary policy easy. Correlation does not prove causation. …If, as Spence and Warsh assert, QE has raised stock prices, this should tilt the balance toward real investment.”

Not surprisingly Spence and Warsh have an answer to this criticism. They maintain that their critique is less of low interest rates but rather of the form that QE has taken, which has directed new money into the purchase of financial assets. This then has driven further asset purchases, much of it by companies, despite high price/earnings ratios (i.e. high share prices relative to dividends). As they say:

“Economic theory might have something to learn from recent empirical data, and from promising new thinking in behavioral economics.”

Study the arguments of both sides and try to assess their validity, both theoretically and in the light of evidence.

Articles
The Fed Has Hurt Business Investment The Wall Street Journal, Michael Spence and Kevin Warsh (26/10/15) [Note: if you can't see the full article, try clearing cookies (Ctrl+Shift+Delete)]
I just read the ‘most confused’ critique of the Fed this yea Washington Past, Lawrence H. Summers (28/10/15)
A Little Humility, Please, Mr. Summers The Wall Street Journal, Michael Spence and Kevin Warsh (4/11/15) [Note: if you can't see the full article, try clearing cookies (Ctrl+Shift+Delete)]
Do ultra-low interest rates really damage growth? The Economist (12/11/15)
It’s the Zero Bound Yield Curve, Stupid! Janus Capital, William H Gross (3/11/15)
Is QE Bad for Business Investment? No Way! RealTime Economic Issues Watch, Joseph E. Gagnon (28/10/15)
Department of “Huh!?!?”: QE Has Retarded Business Investment!? Washington Center for Equitable Growth, Brad DeLong (27/10/15)
LARRY SUMMERS: The Wall Street Journal published the ‘single most confused analysis’ of the Fed I’ve read this year Business Insider, Myles Udland (29/10/15)
The Fed’s Loose Money, Financial Markets and Business Investment SBE Council, Raymond J. Keating (29/10/15)
How the QE trillions missed their mark AFR Weekend, Maximilian Walsh (4/11/15)
Financial Markets In The Era Of Bubble Finance – Irreversibly Broken And Dysfunctional David Stockman’s Contra Corner, Doug Noland (8/11/15)

Questions

  1. Go through the arguments of Spence and Warsh and explain them.
  2. Explain what are meant by the ‘yield curve’ and ‘zero bound yield curve’.
  3. What criticisms of their arguments are made by Summers and others?
  4. Apart from the effects of QE, why else have long-term interest rates been low?
  5. In the light of the arguments on both sides, how effective do you feel that QE has been?
  6. How could QE have been made more effective?
  7. What is likely to happen to financial markets over the coming months? What effect is this likely to have on the real economy?
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US rates: the dilemma

Interest rates are the main tool of monetary policy and have a history of being an effective tool in creating macroeconomic stability. There has been much discussion since the end of the financial crisis concerning when interest rates would rise in the US (and the UK) and for the US, the case is stronger, given its rate of growth, which has averaged at 2.2% per annum since June 2009.

As in the UK, the question of ‘will rates rise?’ has a clear and certain answer: Yes. The more challenging question is ‘when?’. Much of the macroeconomic data for the US is promising, with positive economic growth (and relatively strong in comparison to the UK and Eurozone), a low unemployment rate and inflation of 0.3%. This last figure is ‘too low’, but it comes in at a much more attractive 1.2% if you exclude food and energy costs and there is an argument for doing this, given the price of oil. The data on unemployment and growth might suggest that the economy is at a stage where a rate rise could be managed, but the inflation data indicates that low interest rates might be needed to keep inflation above 0%. Furthermore, there are concerns that the low unemployment figure is somewhat misleading, given that under-employment is quite high at 10.3% and there are still many who are long-term unemployed, having been out of work for more than 6 months.

Interest rates can be a powerful tool in affecting the components of aggregate demand (AD) and hence the macroeconomic variables. If interest rates fall, it can help to stimulate AD by reducing borrowing costs for consumers and businesses, reducing the incentive to save, cutting variable rate mortgage payments and depreciating the exchange rate. Collectively these effects can stimulate an economy and hence create economic growth, reduce unemployment and push up prices. However, interest rates have been at almost 0% since the financial crisis, so the only way is up. Reversing the aforementioned effects could then spell trouble, if the economy is not in a sufficiently strong position.

For many, the strength of the US economy, while relatively good, is not yet good enough to justify a rate rise. It may harm investment, growth and unemployment and none of these variables are sufficiently high to warrant a rate rise, especially given the slowdown in the emerging markets. Karishma Vaswani, from BBC News said:

“The current global hand-wringing and head-holding over whether the US Fed will or won’t raise interest rates later has got investors here in Asia worried about what this means for their economies.
The Fed has become the favourite whipping boy of Asia’s central bankers, with cries from India to Indonesia to “just get on with it”.”

There are many, including Professor John Taylor from Stanford University and a former senior Treasury official, a rate rise is well over-due. The market is expecting one and has been for some time and these expectations aren’t going away, so ‘just get on with it.’ Janet Yellen, the Chair of the Federal Reserve is in a tricky situation. She knows that whatever is decided, markets around the world will react – no pressure then! The following articles consider the interest rate debate.

Articles
FTSE slides ahead of Fed interest rates decision The Telegraph, Tara Cunningham (17/9/15)
US’s interest rate rise dilemma BBC News, Andrew Walker (17/9/15)
US interest rate rise: how it could affect your savings and your mortgage Independent (17/9/15)
All eyes on Federal Reserve as it prepares for interest rate announcement The Guardian, Rupert Neate (16/9/15)
Federal Reserve meeting: Will US interest rates rise and should they? The Telegraph, Peter Spence (16/9/15)
Markets push US rate rise bets into 2016 as China woes keep Fed on hold: as it happened The Telegraph, Szu Ping Chan (17/9/15)
Federal Reserve puts rate rise on hold The Guardian (17/9/15)
US central bank leave interest rates unchanged BBC News (17/5/15)
Fed leaves interest rates unchanged Wall Street Journal, Jon Hilsenrath (17/9/15)
Asian markets mostly rally, US Futures waver ahead of Fed interest rate decision International Business Times, Aditya Tejas (17/9/15)

Data
Selected US interest rates Board of Governors of the Federal Reserve System (see, for example, Federal Funds Effective rate (monthly))

Questions

  1. What happened to US interest rates in September?
  2. Present the main arguments for keeping interest rates on hold.
  3. What were the arguments in favour of raising interest rates and do they differ depending on whether interest rates rise slowly or very rapidly?
  4. How did stock markets around the world react to Janet Yellen’s announcement? Is it good news for the UK?
  5. Using a diagram to support your explanation, outline why interest rates are such a powerful tool of monetary policy and how they affect the main macroeconomic objectives.
  6. Do you think other central banks will take note of the Fed’s decision, when they make their interest rate decisions in the coming months? Explain your answer.
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US budget and debt ceiling deal

You may have been following the posts on the US debt ceiling and budget crisis: Over the cliff and Over the cliff: an update. Well, after considerable brinkmanship over the past couple of weeks, and with the government in partial shutdown since 1 October thanks to no budget being passed, a deal was finally agreed by both Houses of Congress, less than 12 hours before the deadline of 17 October. This is the date when the USA would have bumped up against the debt ceiling of $16.699 trillion and would be in default – unable to borrow sufficient funds to pay its bills, including maturing debt.

But the deal only delays the problem of a deeply divided Congress, with the Republican majority on the House of Representatives only willing to make a long-term agreement in exchange for concessions by President Obama and the Democrats on the healthcare reform legislation. All that has been agreed is to suspend the debt ceiling until 7 February 2014 and fund government until 15 January 2014.

A more permanent solution is clearly needed: not just one that raises the debt ceiling before the next deadline, but one which avoids such problems in the future. Such concerns were echoed by Christine Lagarde, Managing Director of the International Monetary Fund (IMF), who issued the following statement:

The U.S. Congress has taken an important and necessary step by ending the partial shutdown of the federal government and lifting the debt ceiling, which enables the government to continue its operations without disruption for the next few months while budget negotiations continue to unfold.

It will be essential to reduce uncertainty surrounding the conduct of fiscal policy by raising the debt limit in a more durable manner. We also continue to encourage the U.S. to approve a budget for 2014 and replace the sequester with gradually phased-in measures that would not harm the recovery, and to adopt a balanced and comprehensive medium-term fiscal plan.

US default: Congress votes to end shutdown crisis The Telegraph, Raf Sanchez (17/10/13)
US shutdown: Christine Lagarde calls for stability after debt crisis is averted The Guardian,
James Meikle, Paul Lewis and Dan Roberts (17/10/13)
America’s economy: Meh ceiling? The Economist (15/10/13)
Relief as US approves debt deal BBC News (17/10/13)
Shares in Europe dip after US debt deal BBC News (17/10/13)
Dollar slides as relief at U.S. debt deal fades Reuters, Richard Hubbard (17/10/13)
US debt deal: Analysts relieved rather than celebrating Financial Times, John Aglionby and Josh Noble (17/10/13)
Greenspan fears US government set for more debt stalemate BBC News (21/10/13)

Questions

  1. Explain what is meant by default and how the concept applies to the USA if it had not suspended or raised its budget ceiling.
  2. Is the agreement of October 16 likely to ‘reassure markets’? Explain your reasoning.
  3. What is likely to happen to long-term interest rates as a result of the agreement?
  4. Will the imposition of a new debt ceiling by February 2014 remove the possibility of using fiscal policy to stimulate aggregate demand and speed up the recovery?
  5. What is meant by ‘buy the rumour, sell the news’ in the context of stock markets? How was this relevant to the agreement on the US debt ceiling and budget?
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Over the cliff: an update

In a News Item of 1 October, Over the Cliff, we looked at the passing of the deadline that same day for Congress to agree a budget. We also looked at the looming deadline for Congress to agree a new higher ceiling for Federal Government debt, currently standing at $16.699 trillion. Without an agreement to raise the limit, the government will start becoming unable to pay some of its bills from around 17 October.

One week on and no agreement has been reached on either a budget or a higher debt ceiling.

Failure to agree on a budget has led to the ‘shut-down’ of government. Only essential services are being maintained; the rest are no longer functioning and workers have been sent home on ‘unpaid leave’. This has led to considerable hardship for many in the USA. It has had little effect, however, on the rest of the world, except for tourists to the USA being unable to visit various national parks and monuments.

Failure to raise the debt ceiling, however, could have profound consequences for the rest of the world. It could have large and adverse effects of global growth, global trade, global investment and global financial markets. The articles below explore some of these consequences.

U.S. Congress enters crucial week in budget, debt limit battles Reuters, Richard Cowan (7/10/13)
Debt ceiling: Understanding what’s at stake CBS Moneywatch, Alain Sherter (7/10/13)
Q&A: What is the US debt ceiling? BBC News, Ben Morris (3/10/13)
Five Reasons to Fear the Debt Ceiling Bloomberg (6/10/13)
A U.S. Default Seen as Catastrophe Dwarfing Lehma Bloomberg Businessweek, Yalman Onaran (6/10/13)
China tells US to avoid debt crisis for sake of global economy BBC News (7/10/13)
US shutdown is starting to hit business, says Commerce Secretary BBC News (6/10/13)
Why Australia should fear a US government default The Guardian, Greg Jericho (7/10/13)
Could the US default over just $6bn? BBC News, Linda Yueh (11/10/13)
IMF piles pressure on US to reconcile differences and prevent debt default The Guardian, Larry Elliott and Jill Treanor (10/10/13)
Republicans offer to raise US debt ceiling for six weeks The Telegraph, Peter Foster and Raf Sanchez (11/10/13)

Questions

  1. If a debt ceiling is reached, what does this imply for the budget deficit?
  2. How serious are the two current fiscal cliffs?
  3. How would a continuation of the partial government shut-down impact on the US private sector?
  4. What multiplier effects on the rest of the world are likely to arise from a cut in US government expenditure or a rise in taxes? What determines the size of these multiplier effects?
  5. Explain the likely effect of the current crisis on the exchange rate of the dollar into other currencies.
  6. Why might the looming problem of reaching the debt ceiling drive up long-term interest rates in the USA and beyond?
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Over the cliff

For the second time in nine months, the USA has approached a fiscal cliff. This is where the federal government is forced to make government expenditure cuts and/or impose tax rises. There are two types of cliff face. The first is a legal limit on the size of the federal government debt and hence deficit. The second is failure to agree on a budget.

On January 1st this year, a fiscal cliff was narrowly averted by a last-minute agreement to raise the size of the permitted debt. On the 1st October (the beginning of the financial year), however, the US economy ‘fell over the cliff’. This time is was a failure by Congress to reach agreement over the federal budget. The sticking point was an unwillingness of the Republican majority in the House of Representatives to agree to a budget without the government making concessions on its healthcare reform. The government was unwilling to do that and so no budget was passed.

With no budget, much of government has to shut down! In practice, this means that all non-essential workers will cease to be paid. That includes workers in housing, parts of healthcare, the civil law part of the justice system, immigration, regulatory agencies, the passport service, parks and museums. Even workers in essential areas, such as civilian workers in the military, police and social services, are likely to see their pay delayed until the problem is resolved. The articles below look at some of the implications of this partial shut-down.

It is hoped that, within a few days, agreement on a budget will be reached. But that will not be the end of the story because a second fiscal cliff looms. And that is of the first type. There is currently a legal limit to Federal Government debt of $16.699 trillion. Because that limit was reached earlier this year, from May 18 the government has been able to use various ‘extraordinary measures‘ to carry on borrowing. These measures will run out, however, around 17 October. From then, if a new higher debt ceiling has not been agreed by Congress, the government will be unable to pay some of its bills. For example, on 1 November it will get a bill of $67billion for social security, medicare and veterans benefits. As the second Independent article below explains:

In a government shutdown, the federal government is not allowed to make any new spending commitments. By contrast, if we hit the debt-ceiling then the Treasury Department won’t be able to borrow money to pay for spending that Congress has already approved. In that case, either Congress will have to lift the debt ceiling or the federal government will have to default on some of its bills, possibly including payments to bondholders or Social Security payouts. That could trigger big disruptions in the financial markets — or a long-term rise in borrowing costs.

Not surprisingly, financial markets are nervous. Although the direct effect of lost output will be relatively small, provided agreements on the budget and the debt are reached fairly soon, the impact on confidence in the US system of government could be more damaging. Not only could this curb recovery in the USA, it could have a significant effect on global recovery, given the size and importance of the US economy to the rest of the world.

Webcasts
What does the shutdown mean for normal Americans? BBC News, Keith Doyle (1/10/13)
How the government shut down is being reported in the US BBC News (1/10/13)
Shutdown could slam frail U.S. economy Reuters, Bobbi Rebell (1/10/13)
Shutdown Will Cost U.S. Economy $300 Million a Day, IHS Says Bloomberg, Jeanna Smialek & Ian Katz (1/10/13)
How will the US government shutdown affect the global economy? The Guardian, Larry Elliott and Guy Grandjean (1/10/13)
How would a government shutdown affect the rebounding economy? Aljazeera, Duarte Geraldino (30/9/13)
How will the US government shutdown affect the economy? BBC News, Richard Lister (1/10/13)
Shutdown continues as Obama and Republicans fail to agree BBC News, Rajini Vaidynathan (2/10/13)
Former US Secretary of Labor Robert Reich on shutdown BBC News, Robert Reich (2/10/13)
Government shutdown: What’s the cost? CBS News, Rebecca Kaplan (1/10/13)
US shutdown will have ‘minimal impact’ on global economy One News (New Zealand), Dan Zirker (2/10/13)
What is the US debt ceiling? BBC News, Hugh Pym (14/10/13)

Articles
US wakes up to government shutdown as Congress fails to strike budget deal Independent, Nikhil Kumar (1/10/13)
US begins government shutdown as budget deadline passes BBC News (1/10/13)
David Cameron warns on world growth as US government shuts down The Telegraph, Damien McElroy (1/10/13)
Shutdown showdown: A glossary Aljazeera, Ben Piven (30/9/13)
Everything you need to know about how the partial shutdown will work in US Independent, Brad Plumer (1/10/13)
What’s the economic impact of a US government shutdown? BBC News, Kim Gittleson (1/10/13) (follow links at top of screen for further articles)
US government shutdown isn’t the worst of it BBC News, Linda Yueh (30/9/13)
Onset of the storm BBC News, Robert Peston (1/10/13)
The gathering storm? BBC News, Robert Peston (30/9/13)
Government shutdown: what’s really going on – and who’s to blame? The Guardian, Dan Roberts (30/9/13)
Government shutdown threat is getting very old, very fast CNN, Julian Zelizer (30/9/13)
US fiscal cliff fears rattle the markets The Australian, Adam Creighton (1/10/13)
U.S. Government Shutdown Sinks Dollar Forbes, Dean Popplewell (1/10/13)
US Government Shutdown: European Markets Not Fretting Over Temporary Closure International Business Times, Ishaq Siddiqi (1/10/13)
The States to plunge into abyss of debt, off fiscal cliff Pravda, Irina Sabinina (1/10/13)
Shutting down the United States government nothing new The Vancouver Sun, Andrew Coyne (1/10/13)
Christine Lagarde urges US that debt crisis threatens world economy The Guardian, Larry Elliott (3/10/13)
U.S. failure to lift debt ceiling could damage world – IMF Reuters (3/10/13)

Data
US government shutdown: in numbers The Guardian (see also)
US Budget: Historical Tables White House Office of Management and Budget (includes estimates to 2018 as well as historical data)

Questions

  1. If a debt ceiling is reached, what does this imply for the budget deficit?
  2. How serious are the two current fiscal cliffs?
  3. How would a continuation of the partial government shut-down impact on the US private sector?
  4. What multiplier effects on the rest of the world are likely to arise from a cut in US government expenditure or a rise in taxes? What determines the size of these multiplier effects?
  5. Explain the likely effect of the current crisis on the exchange rate of the dollar into other currencies.
  6. Why might the looming problem of reaching the debt ceiling drive up long-term interest rates in the USA and beyond?
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Rolling out a Tobin tax

10 of the 17 eurozone countries have agreed to adopt a financial transactions tax (FTT), often known as a ‘Tobin tax’ after James Tobin who first proposed such a tax back in 1972. The European Commission has backed the proposal, which involves levying a tax of 0.1% on trading in bonds and shares and 0.01% on trading in derivatives.

The 10 countries, France, Germany, Austria, Belgium, Greece, Italy, Portugal, Slovakia, Slovenia and Spain, and possibly also Estonia, hope to raise billions of euros from the tax, which will apply whenever at least one of the parties to a trade is based in one of the 10 (or 11) countries.

On several occasions in the past on this site we’ve examined proposals for such a tax: see, for example: Pressure mounts for a Tobin tax (update) (Nov 2011), A ‘Robin Hood’ tax (Feb 2010), Tobin or not Tobin: the tax proposal that keeps reappearing (Dec 2009) and A Tobin tax – to be or not to be? (Aug 2009). Tobin taxes are also considered in Economics (8th ed) (section 26.3) and Economics for Business (5th ed) (section 32.4).

As we noted last year in the blog Is the time right for a Tobin tax?, the tax is designed to be too small to affect trading in shares or other financial products for purposes of long-term investment. It would, however, dampen speculative trades that take advantage of tiny potential gains from very short-term price movements. Such trades account for huge financial flows between financial institutions around the world and tend to make markets more volatile. The short-term dealers are known as high-frequency traders (HFTs) and their activities now account for the majority of trading on exchanges. Most of these trades are by computers programmed to seek out minute gains and respond in milliseconds. And whilst they add to short-term liquidity for much of the time, this liquidity can suddenly dry up if HFTs become pessimistic.

Supporters of the tax claim that it will make a major contribution to tackling the deficit problems of many eurozone countries. Critics claim that it will dampen investment and growth and divert financial business away from the participating countries. The following articles look at the arguments.

EU Commission backs 10 countries’ transaction tax plan Reuters, Jan Strupczewski (23/10/12)
EU ‘Robin Hood’ tax gets the nod fin24 (23/10/12)
European financial transaction tax moves step closer The Guardian, Larry Elliott (23/10/12)
Financial transaction tax for 10 EU states BBC News (23/10/12)
Rejecting a Robin Hood tax would be a spectacular own goal The Guardian, Max Lawson (11/10/12)
More than 50 financiers back Robin Hood Tax The Robin Hood Tax (23/10/12)
Topical Focus – Transaction Taxes Tax-News (23/10/12)
Could a transactions tax be good for capitalism? BBC News, Robert Peston (3/10/11)
A Tax to Kill High Frequency Trading Forbes, Lee Sheppard (16/10/12)

Questions

  1. Explain how the proposed financial transactions tax will work.
  2. Why would many parties to trades who are not based in one of the 10 participating countries still end up paying the tax?
  3. What are likely to be the advantages and disadvantages of the proposed tax?
  4. Is it appropriate to describe the proposed FTT as a ‘Robin Hood Tax’?
  5. How does a financial transactions tax differ from the UK’s stamp duty reserve tax?
  6. Explain why the design of the stamp duty tax has prevented the flight of capital and trading from London. Could a Tobin tax be designed in such a way?
  7. What are HFTs and what impact do they have on the stability and liquidity of markets?
  8. Would it be desirable for the FTT to ‘kill off’ HFTs?
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Pressure mounts for a Tobin tax (update)

Last October (2011) we considered the case for a Tobin tax: also known as a financial transactions tax (FTT) or a ‘Robin Hood tax’. Since then there have been increased calls for the world to adopt such a tax.

It was promoted by President Sarkozy and supported by many other leaders at the G20 conference in Cannes on 3 and 4 November 2011. It has also been publicly supported by Bill Gates, the Archbishop of Canterbury and the Vatican, as you can see from the video clips and articles below. It is also one of the demands of protesters at St Pauls in London and at other places around the world.

However, the introduction of such a tax is vehemently opposed by many banks and by the US, UK, Canadian and Australian governments, amongst others. In the articles below, we consider the latest arguments that are being used on both sides. With such strong feelings it looks as if the arguments are not going to go away.

Update
On 29 January 2012, French President, Nicolas Sarkozy, announced plans to introduce a 0.1% levy on financial transactions. Naturally, by taking the lead, he hopes that other EU countries will follow suit. The final set of articles consider his move.

What is a Tobin Tax? BBC News, Andrew Walker (2/11/11)
Rowan Williams: St Paul’s protest has ‘triggered awareness’ BBC News (2/11/11)
Bill Gates explains his support for a Tobin tax BBC News (2/11/11)
Robin Hood tax: What is the Tobin tax? BBC Newsnight, Andrew Verity (17/11/11)
Q&A: What is the Tobin Tax on financial trading BBC News (2/11/11)
Head-to-head: the Robin Hood tax BBC News, Gemma Godfrey and Prof Avinash Persaud (9/12/11)
Time for us to challenge the idols of high finance Financial Times, Rowan Williams, Archbishop of Canterbury (1/11/11)
Gates says ‘Robin Hood’ tax has part to play Financial Times, Chris Giles (3/11/11)
Sarkozy Pledges Fight for Transaction Tax Bloomberg, Rebecca Christie and Helene Fouque (4/11/11)
Financial Transaction or Speculation Taxes: Not Quite What They Seem Forbes, Tim Worstall (4/11/11)
Is a Robin Hood Tax the Answer? Forbes, Kelly Phillips Erb (3/11/11)
Bill Nighy takes Robin Hood tax to the G20 Guardian, Patrick Wintour and Larry Elliott (3/11/11)
G20 tax moves disappoint charities Press Association (4/11/11)
Jamaica should support the Robin Hood Tax Jamaica Observer (6/11/11)
World Leaders Need to Agree to the Robin Hood Tax at G20 Huffington Post, Bill Nighy (3/11/11)
Obama, the G20, and the 99 Percent Huffington Post, Jeffrey Sachs (1/11/11)
Now is the moment to bring banks to heel This is Money, Jeffrey Sachs (3/11/11)
Note on financial reform from the Pontifical Council for Justice and Peace The Vatican Today
Tobin Tax would cost £25.5bn and cause job losses says think-tank London loves Business, Rebecca Hobson (4/11/11)
The Spurious Case Against A Financial Transactions Tax – Analysis Eurasia Review, Dean Baker (2/11/11)

Update
Sarkozy Says France to Impose Transaction Tax From August Bloomberg Businessweek, Helene Fouquet and Mark Deen (30/1/12)
Struggling Sarkozy unveils financial transactions tax Sydney Morning Herald, AFP (30/1/12)
Sarkozy announces French financial transaction tax BBC News (30/1/12)
French president announces unilateral financial transaction tax Deutsche Welle Spencer Kimball, Andrew Bowen and Nicole Goebel (30/1/12)

Questions

  1. What are the main arguments in favour of a financial transactions tax?
  2. What are the main arguments against a financial transactions tax?
  3. To what extent is the debate a normative one and to what extent could evidence be used to support one side or the other?
  4. What would determine the extent to which the tax would be passed on to consumers?
  5. Would a financial transactions tax impede growth? Explain.
  6. Would financial intermediation be made more efficient by the imposition of such a tax?
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Is the time right for a Tobin tax?

On several occasions in the past on this site we’ve examined proposals for a Tobin tax: see, for example: A ‘Robin Hood’ tax (Feb 2010), Tobin or not Tobin: the tax proposal that keeps reappearing (Dec 2009) and A Tobin tax – to be or not to be? (Aug 2009). A Tobin tax is a tax on trading in financial products, sometimes known as a ‘financial transactions tax’ (FTT). It could also be levied on trading in foreign currencies. It is considered in Economics (7th ed) (section 26.3) and Economics for Business (5th ed) (section 32.4).

The tax would be levied at a very low rate: somewhere between 0.01% and 0.5% and would be too small to affect trading in shares or other financial products for purposes of long-term investment. It would, however, dampen speculative trades that take advantage of tiny potential gains from very short-term price movements. Such trades account for huge financial flows between financial institutions around the world and tend to make markets more volatile. The short-term dealers are known as high-frequency traders (HFTs) and their activities now account for the majority of trading on exchanges. Most of these trades are by computers programmed to seek out minute gains and respond in milliseconds. And whilst they add to short-term liquidity for much of the time, this liquidity can suddenly dry up if HFTs become pessimistic.

The President of the European Commission, José Manuel Barroso, has announced that the Commission has adopted the idea of a financial transactions tax with the backing of Germany, France and other eurozone countries. This Tobin tax could be in operation by 2014. According to the Commission, it could raise some €57bn a year. Unlike earlier proposals for a Tobin tax (sometimes called the ‘Robin Hood tax’), the money raised would probably be used to reduce EU deficits, rather than being given in aid to developing countries.

The UK government has been highly critical of the proposal, arguing that, unless adopted world-wide, it would divert trade away from the City of London.

The following articles consider how such a tax would work and its potential advantages and disadvantages.

Theory inches ever closer to practice Guardian, Larry Elliott (28/9/11)
Osborne expected to oppose EU’s proposal for Tobin tax on banks Guardian, Jill Treanor (28/9/11)
Tobin tax could ‘destroy’ business models Accountancy Age, Jaimie Kaffash (30/9/11)
Tobin tax is likely, says banking chief Accountancy Age, Jaimie Kaffash (5/10/11)
Could a transactions tax be good for capitalism? BBC News, Robert Peston (3/10/11)
EU to propose tax on financial transactions BusinessDay (South Africa), Mariam Isa (5/10/11)
European politicians plot to block UK veto on ‘Tobin tax’ The Telegraph, Louise Armitstead (3/10/11)
Opinion Divided on EU Transaction Tax Tax-News, Ulrika Lomas (5/10/11)
Tobin taxes and audit reform: the blizzard from Brussels The Economist (1/10/11)

Questions

  1. What are HFTs and what impact do they have on the stability and liquidity of markets?
  2. Explain how a Tobin tax would work.
  3. What would be the potential advantages and disadvantages of the Tobin tax as proposed by the European Commission (the ‘financial transactions tax’)?
  4. Are financial markets efficient? Can a market be ‘excessively efficient’?
  5. How are ‘execute or cancel’ orders used by HFTs?
  6. Why do HFTs have an asymmetric information advantage?
  7. How does a financial transactions tax differ from the UK’s stamp duty reserve tax?
  8. Explain why the design of the stamp duty tax has prevented the flight of capital and trading from London. Could a Tobin tax be designed in such a way?
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Down the big dipper again

Friday 5 August 2011 saw the end of a very bad fortnight for stock markets around the world. In Japan the Nikkei 225 had fallen by 8.2%, in the USA the Dow Jones had fallen by 9.8%, in the UK the FTSE 100 was down 11.6% and in Germany the Dax was down 14.9%. In the first five days of August alone, £148 billion had been wiped off the value of the shares of the FTSE 100 companies and $2.5 trillion off the value of shares worldwide.

But why had this happened and what are likely to be the consequences?

The falls have been caused by the growing concerns of investors about the health of the global economy and the global financial system. There are worries that the European leaders at their summit on 21 July did not do enough to prevent the default of large countries such as Spain and Italy. There are concerns that the US political system, following the squabbling in Congress over raising the sovereign debt ceiling for the country, may not be up to dealing with the country’s huge debts. Indeed, the rating agency, Standard & Poor’s, downgraded the USA’s credit rating from AAA to AA+. This is the first time that the USA has not had top rating.

Then there are worries about the general slowing down of the world economy and how this will compound the problem of sovereign debt as it hits tax revenues and makes it harder to reduce social security payments. Underlying all this is the fear that the problem of indebtedness that contributed to the banking crisis of 2007/8 has not gone away; it has simply been transferred from banks to governments. As Robert Peston states in his article, linked to below:

The overall volume of indebtedness in the economy is therefore still with us – although it has been shuffled from financial sector to public sector.

And if you took the view four years ago that the quantum of debt in the system was unsustainably large, then you would argue that by propping up the banks, the day of reckoning was being postponed, not cancelled.

… just like the awakening in 2007 to the idea that many of the housing loans and associated financial products were worthless, so there is a growing fear that a number of financially overstretched governments, especially in the eurozone, will not be able to repay their debts in full.

Which brings us to the consequences. Key to the answer is confidence. If governments can reassure markets over the coming days and weeks that they have credible policies to support highly indebted countries in the short term and to sustain demand in the global economy (e.g. through further quantitative easing in the USA (QE3)); and if they can also reassure markets that they have tough and credible policies to reduce their debts over the longer term, then confidence may return. But it will not be an easy task to get the balance right between sustaining recovery in the short term and fiscal retrenchment over the long term. Meanwhile consumers are likely to become even more cautious about spending – hardly the recipe for recovery.

Videos
Markets turmoil: What you need to know BBC News, Jonty Bloom (5/8/11)
Turmoil on stock markets persists as share prices fall BBC News, Robert Peston (5/8/11)
Global stock market crash – video analysis Guardian, Larry Elliott and Cameron Robertson (5/8/11)
S&P downgrade US AAA credit rating BBC News, Marcus George (6/8/11)
U.S. loses AAA credit rating Reuters, Paul Chapman (6/8/11)
U.S. loses AAA credit rating from S&P CNN (5/8/11)
US loses AAA rating ITN (6/8/11)
Shares slump amid euro fears Channel 4 News, Faisal Islam (4/8/11)
What triggered the turmoil? Financial Times, Sarah O’Connor and Edward Hadas (5/8/11)
Fears eurozone woes will spread BBC News, Stephanie Flanders (5/8/11)

Articles
FTSE 100 tumbles in worst week since height of the crisis The Telegraph, Richard Blackden (5/8/11)
Global recession fears as stock markets tumble to nine-month low The Telegraph, Alistair Osborne (3/8/11)
Global markets on the brink of crisis Guardian, Larry Elliott (5/8/11)
A week of financial turmoil: interactive Guardian, Nick Fletcher, Paddy Allen and James Ball (5/8/11)
Turmoil on stock markets persists BBC News (5/8/11)
Bank worries bring echoes of 2008 BBC News, Stephanie Flanders (5/8/11)
The origins of today’s market mayhem BBC News, Robert Peston (5/8/11)
Time for a double dip? The Economist (6/8/11)
Rearranging the deckchairs The Economist (6/8/11)
High hopes, low returns The Economist (4/8/11)
The debt-ceiling deal: No thanks to anyone The Economist (6/8/11)
Six years into a lost decade The Economist (6/8/11)
Debt crisis Q&A: what you need to know about Standard & Poor’s credit rating The Telegraph, Richard Tyler (6/8/11)
U.S. Will Roll Out QE3 After S&P Rating Cut, Li Daokui Says Bloomberg (6/8/11)
China flays U.S. over credit rating downgrade Reuters, Walter Brandimarte and Gavin Jones (6/8/11)
US credit rating downgraded to AA+ by Standard & Poor’s Guardian, Larry Elliott, Jill Treanor and Dominic Rushe (5/8/11)
Reaction to the US credit rating downgrade Guardian (6/8/11)
Market turmoil and the economics of self-harm Guardian, Mark Weisbrot (5/8/11)
Week ahead: Markets will sort through credit downgrade Moneycontrol (6/8/11)

S&P Statement
S&P statement on lowering US long-term debt to AA+ Guardian (6/8/11)

Stock market indices
FTSE 100: historical prices, 1984 to current day Yahoo Finance
Dow Jones Industrial Average: historical prices, 1928 to current day Yahoo Finance
Nikkei 225 (Japan): historical prices, 1984 to current day Yahoo Finance
DAX (Germany): historical prices, 1990 to current day Yahoo Finance
CAC 40 (France): historical prices, 1990 to current day Yahoo Finance
Hang Seng (Hong Kong): historical prices, 1986 to current day Yahoo Finance
SSE Composite (China: Shanghai): historical prices, 2000 to current day Yahoo Finance
BSE Sensex (India): historical prices, 1997 to current day Yahoo Finance
Stock markets BBC

Questions

  1. Why have share prices been falling?
  2. Does the fall reflect ‘rational’ behaviour on the part of investors? Explain.
  3. Why does ‘overshooting’ sometimes occur in share price movements?
  4. Why has the USA’s credit rating been downgraded by Standard & Poor’s? What are the likely implications for the USA and the global economy of this downgrading?
  5. How is the downgrading likely to affect the return on (a) existing US government bonds; (b) new US government bonds?
  6. Why might worries about the strength of the global recovery jeopardise that recovery?
  7. To what extent has the debt problem simply been transferred from banks to governments? What should governments do about it in the short term?
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The Greek Tragedy continues

Today (16/6/11) in Greece, the Prime Minister is trying to form a new government that will help the country tackle its large and growing debts. Austerity measures have been put in place by the Greek government and these cuts and subsequent job losses (unemployment now stands at 15.9%) have resulted in massive riots.

Critics of the eurozone and Greek membership are suggesting that the price Greece has to pay to remain a member might be too high. Billions of euros have already been given to the bankrupt country and yet it seems to have made little difference – more money is now needed, but Finance Ministers have so far been unable to agree on how best to finance another bailout. These concerns have adversely affected financial markets, as investors sell their shares in light of the economic concerns surrounding Greece. The trends in financial markets over recent weeks suggest a growing feeling that Greece may default on its debt.

If an agreement isn’t reached between European leaders and/or Greece doesn’t accept the terms, then it could spell even more trouble and not just for the Greek economy and the eurozone. Banks across Europe have lent money to Greece and if an agreement isn’t reached, then this will mean losses for the private sector. Whilst these losses may be manageable, further trouble may arise due to contagion. Other countries with substantial debts, including Spain, Ireland and Portugal could mean a significant increase in these potential losses.

As the crisis in Greece continues, doubts remain over whether the European leaders even know how to deal with the crisis and this creates a lack of confidence in the markets. Activities over the coming weeks will play a large part in the future of Greece’s eurozone membership, trends in financial markets and the direction of the UK economy. The following articles consider Greece’s debt crisis.

Greece debt crisis sends financial markets reeling BBC News (16/6/11)
Euro slumps vs Swissie, Greece intensifies concern Reuters (16/6/11)
EU and IMF agree Greek debt deal Financial Times, Peter Spiegel (16/6/11)
Greece crisis: Commissioners fear ‘future of Eurozone’ BBC News, Joe Lynam (15/6/11)
Stocks slump as Greece crisis turns violent Bloomberg Business Week, Pan Pylas (15/6/11)
Euro slides as Greek default fears deepen Financial Times, Peter Garnham (16/6/11)
Germany insists all of EU must pay for Greece bailout Guardian, Ian Traynor (15/6/11)
US stocks slump on US, Greek woes Associated Press (16/6/11)
More time to argue about Greece BBC News, Stephanie Flanders (16/6/11)
Greece: Eurozone ministers delay decision on vital loan BBC News (20/6/11)
Greece crisis: Revolution in the offing? BBC News, Gavin Hewitt (19/6/11)
Greece crisis: Not Europe’s Lehman (it could be worse) BBC News, Robert Peston (20/6/11)
Greek debt crisis: eurozone ministers delay decision on €12bn lifeline Guardian, Ian Traynor (20/6/11)
Eurozone must act before Greek crisis leads to global meltdown, IMF warns Guardian, Larry Elliott (20/6/11)
Greece: Private-sector voluntary aid may be impossible BBC News, Robert Peston (21/6/11)
Greece crisis and the best way to cook a lobster BBC News, Stephanie Flanders (22/6/11)

Questions

  1. What is meant by contagion and why is this a potential problem?
  2. What are the options open to European leaders to finance the bail out?
  3. If an agreement is not reached or Greece do no accept the terms, how might the UK economy be affected?
  4. What has been the impact of recent events in Greece and Europe on financial markets and currencies across the world? Explain your answer.
  5. Why are critics suggesting that the price of Greece remaining in the Eurozone might be too high? If Greece was not a member state what would it mean it could do differently to help it deal with its mounting debts?
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