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Posts Tagged ‘international trade multiplier’

OECD goes public

In an attempt to prevent recession following the financial crisis of 2007–8, many countries adopted both expansionary monetary policy and expansionary fiscal policy – and with some success. It is likely that the recession would have been much deeper without such policies

But with growing public-sector deficits caused by the higher government expenditure and sluggish growth in tax receipts, many governments soon abandoned expansionary fiscal policy and relied on a mix of loose monetary policy (with ultra low interest rates and quantitative easing) but tight fiscal policy in an attempt to claw down the deficits.

But such ‘austerity’ policies made it much harder for loose monetary policy to boost aggregate demand. The problem was made worse by the attempt of both banks and individuals to ‘repair’ their balance sheets. In other words banks became more cautious about lending, seeking to build up reserves; and many individuals sought to reduce their debts by cutting down on spending. Both consumer spending and investment were slow to grow.

And yet government and central banks, despite the arguments of Keynesians, were reluctant to abandon their reliance solely on monetary policy as a means of boosting aggregate demand. But gradually, influential international institutions, such as the IMF (see also) and World Bank, have been arguing for an easing of austerity fiscal policies.

The latest international institution to take a distinctly more Keynesian stance has been the Organisation for Economic Co-operation and Development (OECD). In its November 2015 Economic Outlook it had advocated some use of public-sector investment (see What to do about slowing global growth?. But in its Interim Economic Outlook of February 2016, it goes much further. It argues that urgent action is needed to boost economic growth and that this should include co-ordinated fiscal policy. In introducing the report, Catherine L Mann, the OECD’s Chief Economist stated that:

“Across the board there are lower interest rates, except for the United States. It allows the authorities to undertake a fiscal action at very very low cost. So we did an exercise of what this fiscal action might look like and how it can contribute to global growth, but also maintain fiscal sustainability, because this is an essential ingredient in the longer term as well.

So we did an experiment of a two-year increase in public investment of half a percentage point of GDP per annum undertaken by all OECD countries. This is an important feature: it’s everybody doing it together – it’s a collective action, because it’s global growth that is at risk here – our downgrades [in growth forecasts] were across the board – they were not just centred on a couple of countries.

So what is the effect on GDP of a collective fiscal action of a half a percentage point of GDP [increase] in public investment in [high] quality projects. In the United States, the euro area, Canada and the UK, who are all contributors to this exercise, the increase in GDP is greater than the half percentage point [increase] in public expenditure that was undertaken. Even if other countries don’t undertake any fiscal expansion, they still get substantial increases in their growth rates…

Debt to GDP in fact falls. This is because the GDP effect of quality fiscal stimulus is significant enough to raise GDP (the denominator in the debt to GDP ratio), so that the overall fiscal sustainability [debt to GDP] improves.”

What is being argued is that co-ordinated fiscal policy targeted on high quality infrastructure spending will have a multiplier effect on GDP. What is more, the faster growth in GDP should outstrip the growth in government expenditure, thereby allowing debt/GDP ratios to fall, not rise.

This is a traditional Keynesian approach to tackling sluggish growth, but accompanied by a call for structural reforms to reduce inefficiency and waste and improve the supply-side of the economy.

Articles
Osborne urged to spend more on infrastructure by OECD Independent, Ben Chu (18/2/16)
OECD blasts reform fatigue, downgrades growth and calls for more rate cuts Financial Review (Australia), Jacob Greber (18/2/16)
OECD calls for less austerity and more public investment The Guardian, Larry Elliott (18/2/15)
What’s holding back the world economy? The Guardian, Joseph Stiglitz and Hamid Rashid (8/2/16)
OECD calls for urgent action to combat flagging growth Financial Times, Emily Cadman (18/2/16)
Central bankers on the defensive as weird policy becomes even weirder The Guardian, Larry Elliott (21/2/16)
Keynes helped us through the crisis – but he’s still out of favour The Guardian, Larry Elliott (7/2/16)
G20 communique says monetary policy alone cannot bring balanced growth
Reuters (27/2/15)

OECD publications
Global Economic Outlook and Interim Economic Outlook OECD, Catherine L Mann (18/2/16)
Interim Economic Outlook OECD (18/2/16)

Questions

  1. Draw an AD/AS diagram to illustrate the effect of a successful programme of public-sector infrastructure projects on GDP and prices.
  2. Draw a Keynesian 45° line diagram to illustrate the effect of a successful programme of public-sector infrastructure projects on actual and potential GDP.
  3. Why might an individual country benefit more from a co-ordinated expansionary fiscal policy of all OECD countries rather than being the only country to pursue such a policy?
  4. What determines the size of the multiplier effect of such policies?
  5. How might a new classical/neoliberal economist respond to the OECD’s recommendation?
  6. Why may monetary policy have ‘run out of steam’? Are there further monetary policy measures that could be adopted?
  7. Compare the relative effectiveness of increased government investment in infrastructure and tax cuts as alterative forms of expansionary fiscal policy.
  8. Should quantitative easing be directed at financing public-sector infrastructure projects? What are the benefits and problems of such a policy? (See the blog post People’s quantitative easing.)
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What to do about slowing global growth?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Questions

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

Given the interdependence of the global economy, the economic slowdown in the West is likely to have worldwide knock-on effects. How serious will these effects be for the emerging economies of South East Asia? The following articles consider this question.

The decoupling debate The Economist (6/3/08)
Can Asia escape the effects of the downturn in the West? Times Online (17/3/08)
Just enough power to save themselves Times Online (25/3/08)

Questions
1. Explain the term emerging economy.
2. Discuss the extent to which the economic performance of the emerging economies will help reduce the likelihood of recession in the UK.
3. Discuss the extent to which the economic performance of the emerging economies is likely to be affected by recession in the USA.
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