In the UK, we have an inflation target of 2% and it’s the Bank of England’s job to use monetary policy, in particular interest rates, to keep inflation within 1 percentage point of its target. However, with rising commodity prices and the onset of recession back in 2008, interest rates had another objective: to prevent or at least lessen the recession. Bank Rate fell to 0.5% and there it has remained in a bid to encourage investment, discourage saving and increase consumption, as a means of stimulating the economy.
However, at such a low rate, interest rates are not acting as a brake on inflation, which is now well above target. This rise in inflation, has been largely brought about by cost-push factors, such as the restoration of the 17.5% VAT (up from the temporary 15%), higher oil and commodity prices, and a fall in the exchange rate. But part of the reason might be found in the increase in money supply that resulted from quantitative easing.
There are concerns that the UK may lose its credibility on inflation if action isn’t taken. The OECD has advised the Bank of England to raise Bank Rate to 3.5% by the end of 2011. The following articles consider this issue.
Articles
Time to worry about inflation? BBC News blogs, Stephanomics, Stephanie Flanders (28/5/10)
UK must not fall for the false promise of higher inflation Telegraph, Charles Bean, Deputy Governor of the Bank of England (4/6/10)
Reports and documents
General Assessment of the Macroeconomic Situation OECD Economic Outlook, No. 87 Chapter 1 (see especially pages 53–4) (May 2010)
United Kingdom – Country Summary OECD Economic Outlook, No. 87 (May 2010)
Statistical Annex OECD Economic Outlook, No. 87 (available 10/6/10)
Inflation Report portal Bank of England (see May 2010)
Questions
- Explain the relationship between interest rates and inflation. Why have such low interest rates caused inflation to increase?
- In 2008, the UK moved into recession, but was also suffering from inflation. This was unusual, as AD/AS analysis suggests that when aggregate demand falls, growth will fall, but so will prices. What can explain the low growth and inflation we saw in 2008?
- What is the difference between real and nominal GDP?
- What are the causes of the current high inflation and what solutions are available and viable?
- Why are expectations of inflation so important and how might they influence the Bank of England’s plans for interest rates?
- Do you think the OECD should have advised the Bank of England? Will there be any adverse effects internationally if the UK doesn’t heed the OECD’s advice?
- Is the OECD’s assessment of the UK in the above Country Summary consistent with its view on UK interest rates contained in pages 53 and 54 in the first OECD link?
Whenever a sporting event comes around, there is mad frenzy from countries across the world to enter a bid – this was entirely evident with the 2018 World Cup bids! And it’s not really surprising with the attention that the World Cup and the Olympics receive. Hundreds of thousands of spectators, billions of pounds worth of investment in infrastructure, thousands of jobs created and television deals in every country of the world.
However, why is it that every sporting event of this magnitude fails to come in on budget? The costs are always underestimated. The Athens Olympics was supposed to cost £1.5 billion, but ended up costing over 10 times as much. It is also suggested that it may have played a part in the current Greek financial crisis. The 2002 Japanese World Cup had little effect on the struggling Japanese economy. The London 2012 Olympics was estimated to cost £2.35 billion, but suggestions say it will now cost taxpayers some £20 billion, although budget cuts are inevitable. What about South Africa? Costs of $300 million were estimated for stadiums and infrastructure, with a boost to GDP of $2.9 billion. However, $300 million was not even sufficient to renovate Soccer City (where the first and final game will be held). Add on to this over $1 billion to rebuild the rest of the stadiums and then take into account rising inflation, which has caused inevitable cost over-runs.
On top of this, every country says ‘look at the benefits’ when they enter their bid. However, economists have suggested that there are actually minimal employment benefits in the long term. Obviously there is substantial investment in infrastructure leading up to the World Cup, which will benefit locals, but the overall boost to GDP is not expected to be significant. A similar thing can be seen with the London Olympics. In the study by PriceWaterhouseCoopers in 2005, there were estimates of a direct gain to London’s GDP of £5900 million between 2005 and 2016. However, UK GDP would only rise by £1936 million. Some of the costly stadiums that were built for the Portuguese European Championships were simply knocked down after the event.
So, what can we expect from South Africa? There have been many criticisms of poor ticket sales and that this World Cup is only for the rich. Street sellers have been booted out of their normal selling ground, as they do not have the necessary permits to sell and cannot afford to buy the permits anyway. Whilst transport has been improved, there are still concerns about the distance that has to be travelled between stadiums and this has put off many potential spectators. However, the Super 14 Southern Hemisphere Rugby tournament was staged in South Africa, with the final at the end of May and the event was successful. Transport worked perfectly, spectators arrived by the thousand and it is hoped that this is a positive omen for the fast approaching World Cup!
Articles
Saved by the Ball Times Online (5/6/10)
South Africa World Cup just for the rich BBC News (10/5/10)
Footing South Africa’s World Cup bill BBC News (4/6/10)
Will South Africa reap rewards from hosting the tournament? Peace FM Online (5/6/10)
Did 2004 Olympics spark Greek financial crisis The Associated Press (4/6/10)
Cost of 2012 Olympic pool triples BBC News (8/4/08)
Watchdog attcks ‘astonishing’ £5bn rise in cost of 2012 games Times Online (22/4/08)
South Africa World Cup costs above budget Reuters (13/8/08)
Reports and papers
Olympic game impact Study PriceWaterhouseCoopers December 2005
A Cost-Benefit Analysis of an Olympic Games Queen’s Economics Department Working Paper No. 1097, Darren McHugh, Queen’s University (Canada) (August 2006)
Questions
- Why do costs tend to be under-estimated and benefits over-estimated?
- What technique could be used to determine whether a sporting event, such as the World Cup, should go ahead? Can you apply this to the London 2012 Olympics?
- How is the multiplier effect relevant to a sporting event, such as the World Cup or the 2012 Olympics?
- To what extent do you think the Athens Olympics contributed to the Greek Financial Crisis? Could the same thing happen with London?
- What might happen to the South African exchange rate during the South African World cup and the sterling exchange rate during the London 2012 Olympics?
- How has inflation affected the budget of South Africa?
Throughout 2009/10, a new millionaire was created in Brazil every 10 minutes – not bad for a developing country! Despite the global recession, Brazil has managed growth of almost 5% and is set to overtake both the UK and France to become the world’s 5th largest economy. Brazil will hold the next World Cup and the Olympic games after London, bringing it further recognition as a global power. It has the third largest aircraft manufacturing industry in the world and is even doing its bit to tackle climate change, with 50% of its cars running on bio-fuels. It exports more meat than any other country and is looking to become an energy power. With falling unemployment, a buoyant economy, growing confidence, fantastic beaches and 6 millionaires created every hour, Brazil looks like the perfect place to live.
However, that is just one side of the story. Brazil is still a country with deep poverty – approximately 60 million people. The slums, or favelas, are home to 1 million people in Rio alone, where unemployment is high and drug wars common. There has been a concerted effort to reduce the drug trafficking business, but this has only created more unemployment. There is little sanitation, poor electricity and minimal chance of escape. Neighbourhoods need rebuilding, and despite high growth and arguably the most popular president in the world (Lula da Silva), there are calls for political, social, taxation and labour market reforms. This cycle of poverty and the equality gap needs addressing before the Brazilian economy can really be considered a global power.
Webcasts and podcasts
Will Brazil’s economy keep growing? BBC News, Matt Frei (27/5/10)
Brazil’s bid to be ‘world’s breadbasket’ BBC World News America, Paulo Cabral (26/5/10)
Tackling Brazil’s poverty BBC World News America, Gary Duffy (28/5/10)
Brazil’s development spurs economic quality hopes BBC World News America, Matt Frei (27/5/10)
Brazil’s air industry takes off BBC World News America, Paolo Cabral (24/5/10)
‘Our growth quality is better than China’ BBC World News America, Marcelo Neri (25/5/10)
Brazilian economy poised to overtake UK’s BBC News Today, Matt Frei (27/5/10)
Data
Economic data Banco Central do Brasil
Brazil Economy EconomyWatch
Brazil CIA World Factbook
Brazil Geognos
Brazil data World Bank
Questions
- What are the main causes of (a) inequality and (b) poverty in an economy? What is the difference between these concepts?
- How does the government subsidised housing programme aim to help low income households. Use a diagram to illustrate the effect.
- What policies can be used to reduce the equality gap?
- Are those living in the favelas in absolute poverty? How do we distinguish between absolute and relative poverty? Is it the same across the world?
- What are the adverse effects of fast growth in Brazil?
Fears of growing debt problems in the EU have caused global stock markets to plummet. On 25th May, the FTSE was down by 2.6%, Germany’s Dax index fell by 2.34% and in France the Cac 40 was also down 2.74%. Shares across Asia fell, including those in Australia, Hong Kong, Japan and Thailand. On top of this, there are concerns of rising military tensions between North and South Korea. This has only added to the pessimism of investors.
Then came the rescue of the Spanish bank Cajasur by the Bank of Spain, which did little to restore confidence in the world economy. The Spanish deficit has reached 11% of GDP, which is nearly 4 times higher than eurozone rules allow. Spain is also suffering from unemployment of more than 20%, which has led the IMF to call for massive structural reform in the country. The euro has also weakened, as investors sell the currency, because of growing fears of debt default amongst the eurozone countries.
Amid concerns of possible default by Greece, Spain and other countries, the IMF and the members of the European Union have agreed an emergency package of €750 billion (£650 billion). €250 billion comes from the IMF, with €440 billion available as loan guarantees for struggling nations and €60 billion from emergency European Commission funding. We can only wait to see how effective this rescue package will be in restoring confidence in the Eurozone economies.
Articles
Global stock markets see sharp falls BBC News (25/5/10)
Spain must make wide ranging reforms, weak recovery – IMF Reuters (24/5/10)
FTSE falls another 2.5% after Europe’s debt crisis sparks fears in Asian markets Mail Online (25/5/10)
IMF raises fresh concerns about the Spanish economy BBC News (24/5/10)
IMF Chief Economists – doubts over Greek aid remain Reuters, John Irish (24/5/10)
Markets still tense over eurozone debt Independent, Ian Chu (21/5/10)
FTSE falls below 5,000 due to eurozone crisis Telegraph (21/5/10)
FTSE plunges nearly 3% in opening seconds (including video) Sky News (25/5/10)
The contagion of austerity BBC News blogs: Gavin Hewitt’s Europe (25/5/10)
Europe debt crisis threatens recovery, OECD warns BBC News (26/5/10)
Data
In graphics: Eurozone in crisis BBC News (24/5/10)
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission (especially sections 1, 6, 16 and 18)
Questions
- Using a diagram, illustrate why the euro has weakened.
- Explain why stock markets have fallen across the world.
- What type of reforms are needed in Spain?
- What factors are likely to determine the effectiveness of the IMF emergency package?
- Are the austerity measures in the Spanish economy likely to lead to the similar outcomes that we saw in Greece, such as widespread strikes?
- Discuss the advantages and disadvantages of the rescue package. Does rescue involve a moral hazard?
Labour’s Chancellor, Alistair Darling, delivered his last budget on the 24th March 2010. However, with the new Coalition government planning to make more substantial cuts and with George Osborne and other ministers claiming to find ‘black holes’ in the budgets left by Labour, an emergency budget will take place on the 22nd June 2010. The Coalition government has agreed to make £6 billion of spending cuts in the current year in a bid to reduce the UK’s substantial budget deficit, which stands at nearly 12% of GDP. Vince Cable told the Times:
I fear that a lot of bad news about the public finances has been hidden and stored up for the new government. The skeletons are starting to fall out of the cupboard.
There are plans to reform capital gains tax, possibly increase VAT to 20% and remove tax credits from some middle-income families. In Alistair Darling’s budget, it was middle-income families who were among the ‘losers’, with tax rises of around £19 billion, and it looks as though middle-income families may be hit again. Throughout the election all parties pledged to continue to help the poorest families, but there appears to be a lot of uncertainty ahead for middle-income families. They are likely to face reduced benefits and higher taxes as the Coalition government tackles the £163 billion deficit.
Despite critics of spending cuts arguing that it could cause a double-dip recession, the government is confident that cutting spending now is the right thing to do. As Osborne told GMTV:
I am pretty clear that the advice from the Governor of the Bank of England was that [cutting spending now] was a sensible thing to do, and if there is waste in Government that people at home are paying for with their taxes, let’s start tackling that now.
Chancellor launches audit of government spending Independent, Andrew Woodcock (17/5/10)
Osborne to give details of £6bn spending cuts next week (including video) BBC News (17/5/10)
Savings cuts to ‘hit middle class families’ BBC News (15/5/10)
Osborne to deliver emergency budget on June 22nd Times Online, Susan Thompson (17/5/10)
David Cameron declares war on public sector pay Telegraph, Rosa Prince (16/5/10)
All eyes on the emergency Budget Financial Times, Matthew Vincent (14/5/10)
Tax rises likely under Coaliation government, says Institute of Fiscal Studies Telegraph, Edmund Conway (13/5/10)
Questions
- What will be the likely impact on middle-income families if proposed spending cuts go ahead? How might this affect the recovery?
- What are the arguments for a) cutting spending now and b) cutting spending later?
- In the future, the Coalition government plans to limit bonus payments. How might this policy affect jobs and recruitment?
- What is the likely impact of the future increase in personal tax allowance? Who will it benefit the most?
- How are the proposals for corporation tax and capital gains tax likely to affect the economic recovery?
- Is a rise in VAT a good policy? Who will it affect the most? Will it reduce consumption and hence aggregate demand or is it likely simply to raise tax revenue? (Hint: Think about the type of tax that VAT is.)