What will happen to interest rates over the next two or three years? There is considerable disagreement between economists on this question at the moment.
There are those who argue that recovery in the UK, the USA and Europe is faltering. With much tighter fiscal policy being adopted as countries attempt to claw down their deficits, there is a growing fear of a double-dip recession. In these circumstances central banks are likely to keep interest rates at their historically low levels for the foreseeable future and could well embark on a further round of quantitative easing (see Easy money from the Fed?). But what about inflation? With demand still expanding in developing countries and commodity prices rising, won’t cost pressures on inflation continue? Those who forecast that interest rates will stay low, argue that the pressure on commodity prices will ease as global demand slows. Also, in the UK, now that sterling is no longer depreciating, this will remove a key ingredient of higher inflation.
These views are not shared by other economists. They argue that interest rates could soar over the next two years. In fact, one economist, Andrew Lilico, the Chief Economist at Policy Exchange argues that interest rates in the UK will reach 8% by 2012. Central to their argument is the role of the money supply. The monetary base has been expanded enormously through programmes of quantitative easing. And yet, consumer credit has fallen. When the economy does eventually start to recover strongly, Lilico and others argue that there is a danger that consumer credit and broad money will expand rapidly, thereby fuelling inflation. But won’t the spare capacity that has built up during the recession allow the increase in aggregate demand to be met by a corresponding increase in output, thereby keeping inflation low. No, say these economists. A lot of capacity has been lost and output cannot easily expand to meet a rise in demand.
It’s not uncommon for economists to disagree! See, by reading the articles below, if you can unpick the arguments and establish where the disagreements lie and whose case is the strongest.
Articles
America’s century is over, but it will fight on Guardian, Larry Elliott (23/8/10)
Rates to remain low for foreseeable future Interactive Investor, Rhian Nicholson (18/8/10)
BoE gets benefit of doubt on inflation – for now Reuters, Christina Fincher (19/8/10)
BGilts reflect continued uncertainty AXA Elevate, Tomas Hirst (23/8/10)
A bull market in pessimism The Economist (19/8/10)
Interest rates ‘may hit 8%’ by 2012 says think tank BBC News (22/8/10)
Interest rates ‘may hit 8pc’ in two years Telegraph, Philip Aldrick (21/8/10)
Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says Bloomberg, Scott Lanman and Simon Kennedy (23/8/10)
Inflation, not deflation, Mr. Bernanke Market Watch, Andy Xie (22/8/10)
Inflation comes through the door and wisdom flies out of the window Telegraph, Liam Halligan (21/8/10)
Data
British Government Securities, Yields Bank of England
Bankstats: Data on UK money and lending Bank of England
Questions
- Summarise the arguments of those who believe that interest rates will stay low for the foreseeable future.
- Summarise the arguments of those who believe that interest rates will be significantly higher by 2010.
- What factors will be the most significant in determining which of the two positions is correct?
- Why are the yields on long-term bonds a good indicator of people’s expectations about future inflation and monetary policy?
- Why has consumer credit fallen? Why might it rise again?
- Why may unemployment not fall rapidly as the economy recovers? Is this an example of hysteresis?
August is usually a quiet month for mergers and acquisitions. But not this August! As the linked Independent article below states:
Korea National Oil Corporation’s £1.87bn hostile bid for Dana Petroleum yesterday was just the latest in a surge of activity taking merger and acquisition (M&A) levels to a nine-month high.
Despite edgy economic data from the US, global deal-making has already topped $197bn (£127bn) so far this month, and is on course to beat the August record of $260bn set in 2006, according to Thomson Reuters. This week’s $89.8bn total is the highest weekly total since early November.
During the global recession of 2008/9, M&A activity slumped. In 2007, global M&As were worth $4162bn. In 2009 they were worth only $2059bn. Not only were companies cautious of acquiring other companies in a period of great economic uncertainty, but finance for deals was hard to obtain. Now, with many companies having cut costs and having much healthier balance sheets, they are in a position to bid for other companies. And banks too are much more able and willing to provide the finance to support takeovers.
So does this signify a continuing surge in M&A activity? Or are the August figures likely to be a ‘blip’, with fears of a double-dip recession dampening any renewed takeover fever? The articles below look at the recent cases and at the factors influencing current M&A activity.
Articles
Stock markets catch deal fever as M&A booms again Independent, Sarah Arnott (21/8/10)
BHP, Intel, RSA shatter usual August M&A lull Reuters, Quentin Webb (20/8/10)
Global M&A volume could be highest in August International Business Times, Surojit Chatterjee (21/8/10)
Mergers and acquisitions mania disrupts bankers’ summer breaks Guardian, Elena Moya (21/8/10)
Merger mania predicted as cash-rich firms stalk takeover targets Observer, Richard Wachman (22/8/10)
M&A Signal Higher Stock Prices Ahead Minyanville, Terry Woo (20/8/10)
From slowest to busiest TodayOnline (21/8/10)
Data and Reports
International
The era of globalized M&A: Winds of change Thomson Retuers and J.P.Morgan (June 2009)
Preliminary M&A Financial Press Release 2Q10 Thomson Reuters (25/6/10)
World Investment Report 2010: Annex Tables United Nations Conference on Trade and Development (UNCTAD) (see tables 9–16)
UK data
Mergers and Acquisitions involving UK companies Office for National Statistics
Mergers & Acquisitions data Office for National Statistics
Mergers and acquisitions involving UK companies: 1st Quarter 2010 Office for National Statistics (2/6/10)
Mergers and Acquisitions Tables Office for National Statistics
Questions
- Identify the reasons why firms want to take over other firms.
- Why does M&A activity tend to increase during a period of economic boom and decline during a recession?
- What is likely to happen to M&A activity over the coming months?
- Exmamine two recent mergers or acquistions and explain why the acquiring company was keen to take over the other company, or why the two companies were keen to merge. Were there any economies of scale to be gained? Would the merger increase the acquiring company’s market power?
‘eBay has declared that Britain’s small businesses have “come of age” online, after reporting that the number of its traders who are turning over £1m a year had nearly doubled over the last 12 months.’
So begins the linked article below from the Guardian. Unlike other small and medium-sized businesses (SMEs), many of which did not survive the recession, the number of successful online SMEs is increasing and their survival rates are generally high. According to eBay, some 25,000 people have set up business on its site since the recession and it is predicted that 127 will have a turnover of over £1 million in 2010 (up from 66 in 2009).
So what is it about the online environment that helps small business to develop and thrive? Does going down the e-commerce route avoid many of the pitfalls of traditional business models? And does it have any specific pitfalls of its own? Read the articles below and then attempt the questions that follow.
eBay doubles number of traders with turnover above £1m Guardian, Graeme Wearden (21/8/10)
Why e-commerce IPOs will soon be the smarter buy VentureBeat, Owen Thomas (18/8/10)
Small businesses prosper in eBay’s millionaires’ club InternetRetailing, Chloe Rigby (21/8/10)
Ecommerce technology is retail investment priority: report InternetRetailing, Chloe Rigby (13/8/10)
Move into ecommerce could transform the Scottish economy Sunday Herald, Colin Donald (22/8/10)
Small businesses ‘tend to be a risk’ to lenders BBC Today Programme (23/8/10)
Questions
- What advantages does e-commerce have for SMEs: (a) in the startup phase; (b) over the long term?
- What are meant by ‘network economies’? Does eBay offer such economies to SMEs?
- Follow the links in the above articles to study the experience of two specific online SMEs and identify the strengths and weaknesses of their business strategies.
- What considerations might an SME take into account that is currently trading on eBay or Amazon in deciding whether to set up its own website and trade directly from that?
- Why may a move into e-commerce prove particularly beneficial to the Scottish economy? Would this apply to all online SMEs or only certain types?
According to GDP figures released on 15 August, China overtook Japan in the second quarter of 2010 to become the world’s second largest economy. This raises two questions: just what do the GDP figures mean and why has this happened?
The GDP figures are total figures measured in US dollars at current exchange rates. According to these nominal figures, Japan’s GDP was $1.286 trillion in the second quarter of 2010; China’s was $1.335 trillion. This follows several years when Chinese growth rates have massively exceeded Japanese ones.
As far as explanations are concerned, economists look to a number of different factors, including investment policies, relative exchange rates, confidence, deflation in Japan and the scope for catching up in China.
The following podcasts and webcasts look at these questions, as do the articles.
Podcasts and webcasts
China eyes Japan’s slowing GDP growth BBC News, Roland Buerk (16/8/10)
Japan’s economic strategy ‘not happening’ BBC Today Programme Interview with Dr Seijiro Takeshita of Mizuho International banks (16/8/10)
China’s growth rate slows to 10.3% as lending tightens BBC News, Chris Hogg (15/7/10)
China exports jump in May BBC News, Chris Hogg (10/6/10)
China Overtakes Japan in 2Q As No. 2 Economy Associated Press on YouTube (16/8/10)
China’s economy takes over Japan’s AsianCorrespondent on YouTube (16/8/10)
Articles
China overtakes Japan to become world’s second-biggest economy Telegraph, Roland Gribben (17/8/10)
Chinese economy eclipses Japan’s Financial Times, Lindsay Whipp and Jamil Anderlini (16/8/10)
Decoding China’s modesty Financial Times blogs, Jamil Anderlini (17/8/10)
China ‘overtakes Japan in economic prowess’ asiaone news (17/8/10)
China overtakes Japan to become second largest economy in world Irish Times, Clifford Coonan (17/8/10)
China Passes Japan As Second-Largest Economy Huffington Post, Joe McDonald (16/8/10)
Data
World Economic Outlook July 2010 Update IMF (7/7/10)
China Economic Statistics and Indicators EconomyWatch
Japan Economic Statistics and Indicators EconomyWatch
Questions
- Why may simple GDP figures be a poor indicator of the relative size of the Chinese and Japanese economies?
- If purchasing-power parity figures were used, how would this affect the relative sizes of the two economies? Explain why purchasing-power parity exchange rates are so different from nominal exchange rates in the two countries.
- What impact have the relative exchange rates of the two countries had on economic growth?
- Why are simple GDP figures a poor indicator of living standards?
- What factors will determine whether income inequality is likely to widen or narrow in China over the coming years?
- What factors explain Japan’s low rate of economic growth since the early 1990s? How likely is it that these factors will apply in China in the future?
The link below is to a podcast by Martin Wolf of the Financial Times. It considers a new book, Fault Lines by Raghu Rajan of the University of Chicago Booth School of Business. Rajan argues that the global economy is severely unbalanced:
There is a fair amount of consensus that the world economy is in need of rebalancing. Countries like Iceland, Greece, Spain, and the United States overspent prior to the crisis, financing the spending with government or private borrowing, while countries like Germany, Japan, and China supplied those countries goods even while financing their spending habits. Simply put, the consensus now requires U.S. households to save more and Chinese households to spend more in order to achieve the necessary rebalancing.
Martin Wolf identifies these imbalances and discusses various possible solutions. The problem is that what may seem sensible economically is not always feasible politically.
Podcast
Three years and new fault lines threaten Financial Times podcasts, Martin Wolf (13/8/10)
Article
Three years and new fault lines threaten (transcript of podcast) Financial Times podcasts, Martin Wolf (13/8/10)
Questions
- What are the fault lines that Martin Wolf identifies?
- Have they become more acute since the credit crunch and subsequent recession?
- What risks do these fault lines pose to the future health of the global economy?
- How do political relationships make integrating the world economy more difficult? What insights does game theory provide for understanding the tensions in these relationships?
- Is a policy of export-led growth a wise one for the UK to pursue?
- Explain why global demand may be structurally deficient.
