Category: Economics for Business: 8e Ch 27

Inflation has been rising around the world as a combination of a recovery in demand and supply-chain issues have resulted in aggregate demand exceeding aggregate supply. Annual consumer price inflation at the beginning of 2022 is around 2.5% in China, 3.5% in Sweden, 5% in the eurozone, Canada and India, 6% in the UK and South Africa, 7% in the USA and 7.5% in Mexico. In each case it is forecast to go a little higher before falling back again.

Inflation in Turkey

In Turkey inflation is much higher. The official annual rate of consumer price inflation in December 2021 was 36.1%, sharply up from 21.3% in November. But according to Turkey’s influential ENAGrup the December rate was much higher still at 82.8%. Official producer price inflation was 79.9% and this will feed through into official consumer price inflation in the coming weeks.

The rise in inflation has hit the poor particularly badly. According to the official statistics, in the year to December 2021, domestic energy prices increased by 34.2%, food by 44.7% and transport by 53.7%. In response, the government has raised the minimum wage by nearly 50% for 2022.

Causes of high and rising inflation

Why is Turkey’s inflation so much higher than in most developed and emerging economies and why has it risen so rapidly? The answer is that aggregate demand has been excessively boosted – well ahead of the ability of supply to respond. This has driven inflation expectations.

Turkey’s leader, President Erdoğan, in recent years has been seeking to stimulate economic growth through a mixture of supply-side, fiscal and monetary policies. He has hoped that the prospect of high growth would encourage both domestic and inward investment and that this would indeed drive the high growth he seeks. To encourage investment he has sought to reduce the reliance on imports through various measures, such as public procurement favouring domestic firms, tax reliefs for business and keeping interest rates down. He has claimed that the policy is focused on investment, production, employment and exports, instead of the ‘vicious circle of high interest rates and low exchange rates’.

With the pandemic, fiscal policy was largely focused on health, social security and employment measures. Such support was aided by a relatively healthy public finances. General government debt was 32% of GDP in 2020. This compares with 74% for the EU and 102% for the G7. Nevertheless, the worsening budget deficit has made future large-scale expenditure on public infrastructure, tax cuts for private business and other supply-side measures more difficult. Support for growth has thus fallen increasingly to monetary policy.

The Turkish central bank is not independent, with the President firing senior officials with whom he disagrees over monetary policy. The same applies to the Finance Ministry, with independently-minded ministers losing their jobs. Monetary and exchange rate policy have thus become the policy of the President. And it is here that a major part of the current problem of rising inflation lies.

Monetary and exchange rate policy

Despite rising inflation, the central bank has reduced interest rates. At its monthly meeting in September 2021, the Turkish central bank reduced its key rate from 19% to 18% and then to 16% in October, to 15% in November and 14% in December. These unprecedented rate cuts saw a large increase in the money supply. M1 rose by 11.7% in November alone; the annual growth rate was 59.5%. Broad money (M2 and M3) similarly rose. M3 grew by an annual rate of 51% in November 2021. The cut in interest rates and rise in money supply led to a rise in nominal expenditure which, in turn, led to higher prices.

The cut in interest rates and rise in nominal aggregate demand led to a large depreciation in the exchange rate. On 1 September 2021, 100 Turkish lira exchanged for $12.05. By 11 January 2022 the rate had fallen to $7.22 – a 40.1% depreciation. This depreciation, in turn, further stoked inflation as the lower exchange rate pushed up the price of imported goods. (Click here for a PowerPoint of the chart.)

Attempts were made to stem this fall in the lira on 20 December, by which point 100 lira were trading for just $5.50 (see chart) and speculation against the lira was gathering momentum. President Erdoğan announced a scheme to protect lira deposits against currency volatility, guaranteeing lira deposits in hard currency terms. The mechanism adopted was a rise in the interest rate on lira deposits with a maturity of 3 to 12 months, thereby encouraging people to lock in deposits for the medium term and not, therefore, to use them to speculate against the lira by buying other currencies. Other interest rates would be unaffected. At the same time the central bank used foreign currency reserves to engage in large-scale purchases of the lira on the foreign exchange market.

The lira rallied. By 23 December, 100 lira were trading for $8.79. But then selling of the lira began again and, as stated above, by early January 100 lira had fallen to $7.22. The underlying problem of excess demand and high inflationary expectations had not been solved.

It remains to be seen whether the President will change his mind and decide that the central bank needs to raise interest rates to reduce inflation and restore confidence.





  1. Until the pandemic, the Turkish economy could be seen as a success story. Why?
  2. What supply-side policies did Turkey pursue?
  3. Use either an aggregate demand and supply diagram or a dynamic aggregate demand and supply (DAD/DAS) diagram to explain what has happened to inflation in Turkey in the past few months.
  4. Explain the thinking behind the successive cuts in interest rates since September 2021.
  5. Why did the measures introduced on 20 December 2021 only temporarily halt the depreciation of the lira?
  6. Choose a country with a higher rate of inflation than Turkey (see second data link above). Find out the causes of its high rate. Are they similar to those in Turkey?

One of the most enduring characteristics of the macroeconomic environment since the financial crisis of the late 2000s has been its impact on people’s pay. We apply the distinction between nominal and real values to evidence the adverse impact on the typical purchasing power of workers. While we do not consider here the distributional impact on pay, the aggregate picture nonetheless paints a very stark picture of recent patterns in pay and, in turn, the consequences for living standards and wellbeing.

While the distinction between nominal and real values is perhaps best know in relation to GDP and economic growth (see the need to get real with GDP), the distinction is also applied frequently to analyse the movement of one price relative to prices in general. One example is that of movements in pay (earnings) relative to consumer prices.

Pay reflects the price of labour. The value of our actual pay is our nominal pay. If our pay rises more quickly than consumer prices, then our real pay increases. This means that our purchasing power rises and so the volume of goods and services we can afford increases. On the other hand, if our actual pay rises less quickly than consumer prices then our real pay falls. When real pay falls, purchasing power falls and the volume of goods and services we can afford falls.

Figures from the Office for National Statistics show that in January 2000 regular weekly pay (excluding bonuses and before taxes and other deductions from pay) was £293. By December 2018 this had risen to £495. This is an increase of 69 per cent. Over the same period the consumer prices index known as the CPIH, which, unlike the better-known CPI, includes owner-occupied housing costs and Council Tax, rose by 49 per cent. Therefore, the figures are consistent with a rise both in nominal and real pay between January 2000 to December 2018. However, this masks the fact that in recent times real earnings have fallen.

Chart 1 shows the annual percentage changes in actual (nominal) regular weekly pay and the CPIH since January 2001. Each value is simply the percentage change from 12 months earlier. The period up to June 2008 saw the annual growth of weekly pay outstrip the growth of consumer prices – the blue line in the chart is above the red line. Therefore, the real value of pay rose. However, from June 2008 to August 2014 pay growth consistently fell short of the rate of consumer price inflation – the blue line is below the red line. The result was that average real weekly pay fell. (Click here to download a PowerPoint copy of the chart.)

Chart 2 show the average levels of nominal and real weekly pay. The real series is adjusted for inflation. It is calculated by deflating the nominal pay values by the CPIH. Since the CPIH is a price index whose value averages 100 across 2015, the real pay values are at constant 2015 prices. From the chart, we can see that the real value of weekly pay peaked in March 2008 at £482.01 at 2015 prices. The subsequent period saw rates of pay inflation that were lower than rates of consumer price inflation. This meant that by March 2014 the real value of weekly pay had fallen by 8.8 per cent to £439.56 at 2015 prices. (Click here to download a PowerPoint copy of the chart.)

Although real (inflation-adjusted) pay recovered a little during 2015 and 2016, 2017 again saw consumer price inflation rates greater than those of pay inflation (see Chart 1). Consequently, the average level of real weekly pay fell by 1 per cent between January and November 2017. Since then, real regular pay has again increased. In December 2018, average real pay weekly pay was £462.18 at 2015 prices: an increase of 1.1 per cent from November 2017. Nonetheless, inflation-adjusted average weekly pay in December 2018 remained 4.1 per cent below its March 2008 level.

Chart 3 shows very clearly the importance of the distinction between real and nominal when analysing the growth of earnings. The sustained period of real pay deflation (negative rates of pay inflation) that followed the financial crisis can be seen much more clearly by plotting growth rates rather than their levels. Since June 2008 the average annual growth of real regular weekly pay has been −0.2 per cent, despite nominal pay increasing at an annual rate of 2 per cent. In the period from January 2001 to May 2008 real regular weekly pay had grown at an annual rate of 2.1 per cent with nominal pay growing at an annual rate of 4.0 per cent. (Click here to download a PowerPoint copy of the chart.)

The distinction between nominal and real helps us to understand better why some argue that patterns in pay, living standards and well-being have been fundamental in characterising the macroeconomic environment since the financial crisis. Indeed, it is not unreasonable to suggest that these patterns have helped to shape macroeconomic debates and broader conversations around the role of government and of public policy and its priorities.



  1. Using the example of GDP and earnings, explain how the distinction between nominal and real relates to the distinction between values and volumes.
  2. In what circumstances would an increase in actual pay translate into a reduction in real pay?
  3. In what circumstances would a decrease in actual pay translate into an increase in real pay?
  4. What factors might explain the reduction in real rates of pay seen in the UK following the financial crisis?
  5. Of what importance might the growth in real rates of pay be for consumption and aggregate demand?
  6. Why is the growth of real pay an indicator of financial well-being? What other indicators might be included in measuring financial well-being?
  7. Assume that you have been asked to undertake a distributional analysis of real earnings since the financial crisis. What might be the focus of your analysis? What information would you therefore need to collect?

Today’s title is inspired from the British Special Air Service (SAS) famous catchphrase, ‘Who Dares Wins’ – similar variations of which have been adopted by several elite army units around the world. The motto is often credited to the founder of the SAS, Sir David Stirling (although similar phrases can be traced back to ancient Rome – including ‘qui audet adipiscitur’, which is Latin for ‘who dares wins’). The motto was used to inspire and remind soldiers that to successfully accomplish difficult missions, one has to take risks (Geraghty, 1980).

In the world of economics and finance, the concept of risk is endemic to investments and to making decisions in an uncertain world. The ‘no free lunch’ principle in finance, for instance, asserts that it is not possible to achieve exceptional returns over the long term without accepting substantial risk (Schachermayer, 2008).

Undoubtedly, one of the riskiest investment instruments you can currently get your hands on is cryptocurrencies. The most well-known of them is Bitcoin (BTC), and its price has varied spectacularly over the past ten years – more than any other asset I have laid my eyes on in my lifetime.

The first published exchange rate of BTC against the US dollar dates back to 5 October 2009 and it shows $1 to be exchangeable for 1309.03 BTC. On 15 December 2017, 1 BTC was traded for $17,900. But then, a year later the exchange rate was down to just over $1 = $3,500. Now, if this is not volatility I don’t know what is!

In such a market, wouldn’t it be wonderful if you could somehow predict changes in market sentiment and volatility trends? In a hot-off-the press article, Shen et al (2019) assert that it may be possible to predict changes in trading volumes and realised volatility of BTC by using the number of BTC-related tweets as a measure of attention. The authors source Twitter data on Bitcoin from and tick data from Bitstamp, one of the most popular and liquid BTC exchanges, over the period 4/9/2014 to 31/8/2018.

According to the authors:

This measure of investor attention should be more informed than that of Google Trends and therefore may reflect the attention Bitcoin is receiving from more informed investors. We find that the volume of tweets are significant drivers of realised [price] volatility (RV) and trading volume, which is supported by linear and nonlinear Granger causality tests.

They find that, according to Granger causality tests, for the period from 4/9/2014 to 8/10/2017, past days’ tweeting activity influences (or at least forecasts) trading volume. While from 9/10/2017 to 31/8/2018, previous tweets are significant drivers/forecasters of not only trading volume but also realised price volatility.

And before you reach out for your smartphone, let me clarify that, although previous days’ tweets are found in this paper to be good predictors of realised price volatility and trading volume, they have no significant effect on the returns of Bitcoin.




  1. Explain how the number of tweets can be used to gauge investors’ intentions and how it can be linked to changes in trading volume.
  2. Using Google Scholar, make a list of articles that have used Twitter and Google Trends to predict returns, volatility and trading volume in financial markets. Present and discuss your findings.
  3. Would you invest in Bitcoin? Why yes? Why no?

Late January sees the annual global World Economic Forum meeting of politicians, businesspeople and the great and the good at Davos in Switzerland. Global economic, political, social and environmental issues are discussed and, sometimes, agreements are reached between world leaders. The 2019 meeting was somewhat subdued as worries persist about a global slowdown, Brexit and the trade war between the USA and China. Donald Trump, Xi Jinping, Vladimir Putin and Theresa May were all absent, each having more pressing issues to attend to at home.

There was, however, a feeling that the world economic order is changing, with the rise in populism and with less certainty about the continuance of the model of freer trade and a model of capitalism modified by market intervention. There was also concern about the roles of the three major international institutions set up at the end of World War II: the IMF, the World Bank and the WTO (formerly the GATT). In a key speech, Angela Merkel urged countries not to abandon the world economic order that such institutions help to maintain. The world can only resolve disputes and promote development, she argued, by co-operating and respecting the role of such institutions.

But the role of these institutions has been a topic of controversy for many years and their role has changed somewhat. Originally, the IMF’s role was to support an adjustable peg exchange rate system (the ‘Bretton Woods‘ system) with the US dollar as the international reserve currency. It would lend to countries in balance of payments deficit to allow them to maintain their rate pegged to the dollar unless it was perceived to be a fundamental deficit, in which case they were expected to devalue their currency. The system collapsed in 1971, but the IMF continued to provide short-term, and sometimes longer-term, finance to countries in balance of payments difficulties.

The World Bank was primarily set up to provide development finance to poorer countries. The General Agreement on Tariffs and Trade (GATT) and then the WTO were set up to encourage freer trade and to resolve trade disputes.

However, the institutions were perceived with suspicion by many developing countries and by more left-leaning developed countries, who saw them as part of the ‘Washington consensus’. Loans from the IMF and World Bank were normally contingent on countries pursuing policies of market liberalisation, financial deregulation and privatisation.

Although there has been some movement, especially by the IMF, towards acknowledging market failures and supporting a more broadly-based development, there are still many economists and commentators calling for more radical reform of these institutions. They advocate that the World Bank and IMF should directly support investment – public as well as private – and support the Green New Deal.




  1. What was the Bretton Woods system that was adopted at the end of World War II?
  2. What did Keynes propose as an alternative to the system that was actually adopted?
  3. Explain the roles of (a) the IMF, (b) the World Bank, (c) the WTO (formerly the GATT).
  4. What is meant by an adjustable exchange rate system?
  5. Why did the Bretton Woods system collapse in 1971?
  6. How have the roles of the IMF, World Bank and WTO/GATT evolved since they were founded?
  7. What reforms would you suggest to each of the three institutions and why?
  8. What threats are there currently to the international economic order?
  9. Summarise the arguments about the world economic order made by Angela Merkel in her address to the World Economic Forum.

One of the key questions about Brexit is its effect on UK trade and cross-border investment. Once outside the customs union, will the freedom to negotiate trade deals lead to an increase in UK exports and GDP, as many who support Brexit claim; or will the increased frictions in trade with the EU, and the need to negotiate new trade deals with those non-EU countries which already have trade deals with the EU, lead to a fall in exports and in GDP?

Also, how will trade restrictions or new trade deals affect capital flows? Will there be an increase in inward investment or a flight of investment to the EU or elsewhere? Will many companies relocate away from the UK – or to it?

Although there has been a cost up to now from the Brexit vote, in terms of a depreciation in sterling and a fall in inward investment (see the first article below), the future effects have been hard to predict as the terms on which the UK will leave the EU have been unclear. However, with a draft withdrawal agreement between the EU and the UK government having been reached, the costs and benefits are becoming clearer. But there is still uncertainty about just what the effects on trade and investment will be.

  • First, the 585-page draft withdrawal agreement is not a trade deal. It contains details of UK payments to the EU, commitments on the rights of EU and UK citizens and confirmation of the transition period – initially until 31 December 2020, but possibly extended with mutual agreement. During the transition agreement, the UK would remain a member of the customs union and single market and remain subject to rulings of the European Court of Justice. The withdrawal agreement also provides for a continuation of the customs union beyond the transition period, if no long-term trade agreement is in place. This is to prevent he need for a hard border between Ireland and Northern Ireland.
  • Second, there is merely a 26-page ‘political declaration‘ about future trade relations. Negotiations on the details of these can only begin once the UK has left the EU, scheduled for 29 March 2019. So it’s still unclear about just how free trade in both goods and services will be between the UK and the EU and how freely capital and labour will move between them. But with the UK outside the single market, there will be some limitations on trade and factor movements – some frictions.
  • Third, it is not clear whether the UK Parliament will agree to the withdrawal agreement. Currently, it seems as if a majority of MPs is in favour of rejecting it. If this happens, will the UK leave without an agreement, with trade based on WTO terms? Or will the EU be prepared to renegotiate it – something it currently says it will not do? Or will the issue be put back to the electorate in the form of a People’s vote (see also), which might contain the option of seeking to remain in the EU?

So, without knowing just what the UK’s future trade relations will be with (a) the EU, (b) non-EU countries which have negotiated trade deals with the EU, (c) other countries without trade deals with the EU, it is impossible to quantify the costs and benefits from the effects on trade and investment. However, the consensus among economists is still that there will be a net cost in terms of lost trade and inward investment.

Such as view is backed by a government analysis of various Brexit scenarios, released in time for the House of Commons vote on 11 December. This concludes that the UK will be worse off under all Brexit alternatives compared with staying in the EU. The main brake on growth will be frictions in trade from tariff and non-tariff barriers.

This analysis was supported by a Bank of England paper which modelled various scenarios based on assumptions about different types of Brexit deal. While recognising the inherent uncertainty in some of the empirical relationships, it still concluded that Brexit would be likely to have a net negative effect. The size of this negative effect would depend on the closeness of the new relationship between the UK and EU, the degree of preparedness across firms and critical infrastructure, and how other policies respond.





  1. Identify the main economic advantages and disadvantages for the UK from leaving the EU?
  2. How does the law of comparative advantage relate to the question of the relative trade gains from leaving and remaining in the EU?
  3. What is the difference between the following models of relationship with the EU: the Switzerland model; the Norway model; the Turkey model; the Canada (plus or plus, plus) model; trading on WTO terms?
  4. Why is the consensus among economists that there will be a net economic cost from leaving the EU, no matter on what terms?
  5. Is the UK likely to achieve more favourable trade deals with non-EU countries as an independent country or as a member of the EU benefiting from EU-negotiated trade deals with such countries?