The UK’s trade deficit narrowed in March to £2.74bn from £2.95bn in February. The goods deficit fell just slightly to £8.56bn from £8.59bn, but the services surplus rose more substantially to £5.83bn from £5.64bn.
So was this a sign of the UK economy’s relative weakness holding back the demand for imports? Or was it a sign of a recovering export sector, especially in services?
And what of the coming months? What will be the effect of a growing crisis in the eurozone on (a) the sterling exchange rate, (b) the rate of economic growth outside the UK and (c) UK economic growth? And what will be the effect of these on the demand for imports and exports and on the trade balance? The following articles examine the issues.
(For a PowerPoint of the above chart, click on the following link: Balance of trade)
Articles
UK goods trade deficit stable as exports to non-EU countries rebound Reuters (15/5/12)
UK trade deficit narrows in March to £2.7bn BBC News (15/5/12)
Exports close UK trade deficit Guardian (15/5/12)
First trade surplus in cars since 1976 The Telegraph, Emma Rowley (15/5/12)
UK trade deficit narrows in March Fresh Business Thinking, Marcus Leach (15/5/12)
ONS Release
UK Trade, March 2012 ONS Release (15/5/12)
Questions
- Distinguish between the balance on trade in goods, the balance of trade and the balance on current account.
- Why did the UK’s trade deficit fall in March 2012?
- Why did the UK experience its first trade surplus in cars since 1976?
- What is likely to happen to the UK’s balance of trade in the coming months? How is the income elasticity of demand for UK exports and imports relevant to the answer?
- What has been happening recently to the sterling exchange rate? How will this impact on the UK’s balance of trade? How will the size of this impact depend on the price elasticity of demand and supply for imports and exports?
Centrica, owners of British Gas, has warned that electricity and gas prices in the UK are set to rise in the autumn. Centrica blames this on the expected rise in the costs of wholesale gas and other non-energy inputs.
One of the other ‘big six’ energy suppliers, E.On, has responded by saying that it will not raise energy prices this year. Whether it will raise prices after 1 Jan next year remains to be seen.
Last autumn, household energy prices rose substantially: between 15.4% and 18% for gas and between 4.5% and 16% for electricity. This spring, in response to lower wholesale energy prices, suppliers cut prices for either electricity or gas (but not both) by around 5%.
The government and various pressure groups are encouraging consumers to use price comparison sites to switch to a cheaper supplier. The problem with this is that supplier A may be cheaper than supplier B one month, but B cheaper than A the next. Nevertheless, switching does impose some degree of additional competitive pressure on suppliers.
More powerful pressure could be applied by ‘collective switching’. This is where a lot of people switch via an intermediary company, which sources a deal from an energy supplier. This collective buying is a form of countervailing power to offset the oligopoly power of the suppliers. Such schemes are being encouraged by the Energy Minister, Ed Davey.
The other approach, apart from doing nothing, is for Ofgem, the energy regulator, to impose tough conditions on pricing. But at present, Ofgem’s approach has been to try to make the market more competitive (see also), rather than regulating prices.
British Gas owner Centrica warns of higher energy bills BBC News (11/5/12)
E.ON to keep residential energy prices unchanged in 2012 Reuters, Adveith Nair (14/5/12)
E.ON promises to hold energy prices for 5million customers in 2012 This is Money, Tara Evans (14/5/12)
British Gas owner Centrica feels cold blast from critics ShareCast, John Harrington (11/5/12)
Gas and electricity price battle lines drawn BBC News (14/5/12)
Taking on the energy giants: The co-operative insurgency gains ground Left Foot Forward, Daniel Elton (11/5/12)
Group Energy Buying hits the UK Headlines Spend Matters UK/Europe, Peter Smith (11/5/12)
Think tank calls for competition to break Big Six rip-off Energy Live News, Tom Gibson (30/4/12)
Collective switching will not fix the UK’s broken energy market Guardian, Reg Platt (27/4/12)
Make your own small switch for cheaper energy The Telegraph, Rosie Murray-West (14/5/12)
Questions
- What are the barriers to entry in the electricity supply market?
- How competitive is the retail energy market at present?
- To what extent do price comparison sites put pressure on energy companies to reeduce prices or limit price increases?
- What scope is there for collective buying of gas and electricity from the six energy suppliers by (a) households; (b) firms?
- Assess Ofgem’s package of proposals for a simpler and more competitive energy market.
There seems to be consensus among most politicians on both sides of the Atlantic that there needs to be a reduction in government deficits and debt as a proportion of GDP. But there is considerable debate as to how such reductions should be achieved.
Conservatives, Republicans and centre right parties in Europe, such as Greece’s Νεα Διμοκρατια (New Democracy) party, believe that there should be tough policies to reduce government expenditure and that the deficit should be reduced relatively quickly in order to retain the confidence of markets.
Politicians on the centre left, including Labour, many Democrats in the USA and centre-left parties in Europe, such as François Hollande’s Socialists, argue that the austerity policies pursued by centre-right governments have led to a decline in growth, which makes it harder to reduce the current deficit.
Then there is debate about what is happening to the structural deficit – the deficit that would remain at a zero output gap. Politicians on the centre right argue that their austerity policies are leading to a rapid reduction in the structural deficit. This, combined with the supply-side policies they claim they are implementing, will allow growth to be resumed more quickly and will increase the long-term growth rate (i.e. the growth in potential output).
Politicians on the centre left argue that deep cuts, by reducing short-term growth (even making it negative in some cases, such as the UK), are discouraging investment and construction. This in turn will lower the growth in potential output and make it harder to reduce the structural deficit.
The following podcast and articles consider these arguments – arguments that are often badly put by politicians, who often use ‘questionable’ economics to justify their party line.
Podcast
A grand economic experiment (also at) More or Less: BBC Radio 4 (first part), Tim Harford (4/5/12) (Programme details)
Articles
The fine art of squeezing: Britain vs America BBC News, Stephanie Flanders (4/5/12)
The Slippery Structural Deficit Wall Street Journal (blog), Matthew Dalton (11/5/12)
The right kinds of austerity policy Financial Times (1/5/12)
We can fix up the old status quo to get out of this mess The Olympian, David Brooks (11/5/12)
Europe’s austerity drive is a misdiagnosis of its problems Gulf News, Joseph Stiglitz (13/5/12)
How Nick Clegg got it wrong on debt Guardian, Polly Curtis (9/5/12)
Ten Reasons Wall Street Should Be (Very) Worried About The U.S. Debt Forbes, Bruce Upbin (4/5/12)
Questions
- Distinguish between the structural and cyclical budget deficit.
- Explain the distinction between stocks and flows. Which of the following are stocks and which are flows: (a) public-sector deficit; (b) public-sector debt; (c) public-sector net cash requirement; (d) debt reduction; (e) a bank’s balance sheet?
- Under what circumstances will a reduction in the public-sector deficit lead to: (a) a reduction in the public-sector debt (total); (b) a reduction in the public-sector debt as a proportion of GDP?
- How would you decide what is the desirable level of the public-sector deficit: (a) in the short run; (b) in the long run?
- Explain and comment on the following statement from the Stephanie Flanders article: “What is clear is that America has been able to ‘cut its debt (sic) further and faster’ than Britain – but this has not been the result of any closet commitment to austerity. Quite the opposite.”
Original post (24/4/12)
The result of the first round of the French presidential elections on 22 April make it likely that François Hollande will be the new president.
M. Hollande can be described as an austerity sceptic. In other words, he questions the wisdom of trying to meet the target agreed by eurozone countries of reducing public-sector deficits to no more than 3% of GDP.
If elected, M. Hollande promises to adopt a more Keynesian stance of stimulating demand in order to prevent a slide into recession. This would mean a reversal of cuts and a growth, at least temporarily, of the public-sector deficit.
Currently France’s deficit is much higher than the 3% target. In 2010 it was 7.1%; in 2011 it had fallen somewhat to 5.2%. But it is set to rise in 2012, thanks to the slowing economy in France and most of the rest of Europe.
And it is not just in France that ‘austerity sceptics’ are on the ascendant. In the Netherlands the centre right government of Mark Rutte fell. He was unable to get his coalition partners to agree to sufficient cuts to achieve the 3% target. And yet, the Netherland’s deficit is considerably lower than most eurozone countries’. In 2012 it is projected to be just 4.6% of GDP.
So if doubts about the 3% target could lead to a change in policy in the Netherlands and France, what hope is there that the targets could be adhered to by countries with much larger deficits and where the pain of the cuts is already causing political turmoil?
The growth in austerity scepticism has spooked the markets. The day following M. Hollande’s first round victory and the fall of Mark Rutte’s government, stock markets around Europe plummeted and bond prices rose. The higher bond prices will make it even harder for governments to refinance maturing government debt. Take the case of France. As Robert Peston remarks in his article below:
According to IMF figures, 59% of France’s government debt is held overseas – which means that well over half of all lending to the French state is not motivated by sentimentality or patriotism in any way.
To put that figure into context, just 24.8% of UK general government debt is provided by foreigners.
Perhaps more relevantly, the French government has to borrow a colossal sum equivalent to 18.2% of GDP this year and 19.5% next year to finance debt that is maturing and the current deficit.
So what are the implications of the rise in austerity scepticism? Will it make deficits harder to finance? Will a collapse of confidence push the eurozone into a deep recession. Might the eurozone break apart? Or will a dose of Keynesian policies turn the tide and allow growth to resume, making it easier to service government debts? The following articles explore the issues?
Update (7/5/12)
François Hollande was indeed elected president on 6 May. The question now is to what extent he will be able to enact measures to simulate the economy. In his campaign he had talked about renegotiating the European treaty on budget discipline. Angela Merkel, responding to M. Hollande’s victory, said that the European fiscal treaty had been agreed and could not be renegotiated. Nevertheless, she said she was happy to consider new growth strategies that did not involve increased budget deficits.
Articles
François Hollande’s potential spending spree in France has caused concern in austerity Europe The Telegraph, Bruno Waterfield (23/4/12)
European turmoil, American collateral Guardian, Robin Wells (24/4/12)
Political risk returns to eurozone debt crisis Financial Times, Richard Milne (23/4/12)
The rise of Europe’s austerity foes Business Spectator, Karen Maley (23/3/12)
Europe: A crisis of the centre BBC News, Paul Mason (24/4/12)
Is Hollande enemy or prisoner of finance? BBC News, Robert Peston (23/4/12)
President Hollande and the IMF BBC News, Stephanie Flanders (23/4/12)
French Bond Yields Test Hollande’s Economic Fealty Bloomberg, Mark Deen and Anchalee Worrachate (24/4/12)
Dutch and French politics bring us back to reality BusinessDay (South Africa), Ron Derby (24/4/12)
Crisis topples governments like dominos Deutsche Welle, Bernd Riegert (24/4/12)
Eurozone leaders push for growth BBC News (25/4/12)
Additonal articles (after 6 May)
Francois Hollande to set France on new course after win BBC News (7/5/12)
Europe elections: German Chancellor Angela Merkel welcomes Francois Hollande but warns Greece The Telegraph, 7/5/12)
A Merkel-Hollande bust-up? Less likely than you might think Guardian, Philip Oltermann (7/5/12)
Merkel Rejects Stimulus in Challenge to Hollande BloombergBusinessweek, Patrick Donahue and Tony Czuczka (7/5/12)
François Hollande’s chemistry with Angela Merkel crucial for Europe Guardian, Ian Traynor (7/5/12)
Q&A: End of austerity? BBC News (7/5/12)
Austerity and the people’s verdict Guardian letters, Shanti Chakravarty and others (8/5/12)
Europe: The big debate BBC News, Stephanie Flanders (11/5/12)
Data
European Economy: Economic data Economic and Financial Affairs, European Commission
Eurozone Statistics ECB
French Economic Statistics INSEE, National Institute of Statistics and Economic Studies
Netherlands Statistics CBS, Statistics Netherlands
Questions
- Why do investors worry about the pursuit of Keynesian expansionary fiscal policies? Are their fears justified?
- How important is it for countries, such as the Netherlands, to retain their AAA credit rating?
- What determines bond yields?
- Do a search to find the policies advocated by M. Hollande. Assess the likely economic impact of these policies.
- What conditions are necessary for the pursuit of a tough austerity line to achieve economic growth in (a) the short term of 12 to 18 months; (b) the longer term of several years?
- Is an increased use of public-private partnerships a solution to finding a way of delivering greater infrastructure expenditure without increasing the short-term deficit?
Figures released by the Bank of England show that M4 fell by 5.0% in the year to March 2012. This record fall comes despite over £320 billion of assets purchased by the Bank under its quantitative easing programme. These are funded by the creation of reserves in the Bank of England. (See the Bank of England site for details of the timing and amounts of QE.)
Because of the considerable injection of new money into the banking system, notes and coin plus banks’ reserve balances in the Bank of England rose by 44.9%. So how is it that this measure of narrow money has increased massively and yet M4 has fallen?
One problem with using figures for changes in M4 to gauge economic activity is that they include intra-financial sector transactions – transactions between ‘other financial corporations’ (OFCs). Such transactions do not impact on the real economy. For this reason, the Bank of England prefers to focus on a measure that excludes these transactions between OFCs, a measure known as ‘M4 excluding intermediate OFCs’. This measure rose by 2.7% in the year to March 2012. Although this was positive, it was still weak.
So why does quantitative easing seem to be having such a small effect on bank lending? The following articles look at the issue.
Articles
Record collapse in UK money supply blamed on banks The Telegraph, Philip Aldrick (2/5/12)
UK March mortgage approvals rise unexpectedly London South East (2/5/12)
UK March Net Consumer Lending +GBP1.4 Billion NASDAQ, Jason Douglas and Nicholas Winning (2/5/12)
M4 Hits Record Low; Non-Residents Sell Gilts Market News International (2/5/12)
Data
Bankstats (Monetary & Financial Statistics) – March 2012 Bank of England (2/5/12): see Tables A1.1.1, A2.1.1 and A2.2.3
Questions
- How does quantitative easing impact on the narrow measure of money: notes, coin and banks’ reserve balances in the Bank of England?
- How might an increase in narrow money lead to an increase in broad money (such as M4)?
- How is it that notes, coin and banks’ reserve balances rose so rapidly in the year to March 2012, while M4 fell and even M4 excluding OFCs rose only slightly?
- Does this suggest that money supply is endogenous? Explain.
- How does requiring banks to rebuild their capital base impact on the relationship between narrow and broad money?
The UK’s trade deficit narrowed in March to £2.74bn from £2.95bn in February. The goods deficit fell just slightly to £8.56bn from £8.59bn, but the services surplus rose more substantially to £5.83bn from £5.64bn.
