The articles linked below look at the dangers of deflation and policies of central banks to counter it.
Deflation in economics has three meanings. The first is falling prices: i.e. negative inflation. The second, more traditional meaning, is a fall in real aggregate demand, resulting in lower output, higher unemployment and lower inflation – and quite possibly an actual fall in the price level. These first two definitions describe what is generally seen as an undesirable situation. The third is a slowing down in the growth of real aggregate demand, perhaps as a result of a deliberate act of fiscal and/or monetary policy. This third meaning could describe a desirable situation, where unsustainable growth is reduced and inflation is reduced from an above-target level.
Here we focus on the first definition. The first two articles look at the dangers of a fall in the price level. The chart below shows falling inflation, although not actually deflation, in China, France, Germany and the UK (click here for a PowerPoint). Several European countries, however, are experiencing actual deflation. These include: Greece, Spain, Hungary, Poland and Sweden. Inflation in the eurozone for 2014 is expected to be a mere 0.5%.
The most obvious danger of deflation (or expected deflation) is that people will delay spending on durable goods, such as cars, furniture and equipment, hoping to buy the items cheaper later. The result could be a fall in aggregate demand and a fall in output and employment.
For retailers, this is all spelling Christmas doom. Already the runup to the most crucial time of the year for shops is being characterised by a game of chicken. Shoppers are wondering how long they can leave their festive buying in the hope of late bargains.
Interest rates may be low, but for people with debts, this is being offset by the fact that inflation is no longer reducing the real value of that debt. For people with credit card debt, personal loans and most mortgages, the interest rate they pay is significantly above the rate of inflation. In other words, the real interest rate on their debt is still significantly positive. This may well discourage people from borrowing and spending, further dampening aggregate demand. And, with a Bank Rate of just 0.5%, there is virtually no scope for lowering the official interest rate further.
In the USA, by contrast, there is little danger of deflation, as the US economy continues to grow strongly. The downside of this, has been a large rise in consumer debt (but not mortgages) – the ingredients of a possible future bubble and even a new financial crisis.
What are (a) the desirable and (b) the undesirable consequences of deflation? Does the answer depend on how deflation is defined?
What is meant by a ‘deflationary gap’? In what sense is ‘deflationary’ being used in this term?
Why have oil prices been falling? How desirable are these falls for the global economy?
Is there an optimal rate of inflation? If so, how would this rate be determined?
The chart shows that inflation in Japan is likely to have risen in 2014. This in large part is the result to a rise in the sales tax earlier this year. If there is no further rise in the sales tax, which there will probably not be if Mr Abe’s party wins the recently called election, what is likely to be the effect of the 2014 tax rise on inflation in 2015?
If the Bank Rate is below the rate of inflation, why are people facing a positive real rate of interest? Does this apply equally to borrowers and savers?
In what sense is there a cultural revolution at the Bank of England?
How much does the UK spend on welfare? This is a highly charged political question, with some arguing that benefit claimants are putting great demands on ‘hard-working tax payers’. According to information being sent by the government to all 24 million income tax payers in the UK, the figure of £168bn being spent on welfare is around 24.5% of public spending. But what is included in the total? Before you read on, try writing down the categories of government expenditure included under the heading ‘welfare’.
The heading does not include spending on certain parts of the ‘welfare state’, such as health and education. These are services, the production of which contributes to GDP. The category ‘welfare’ does not include expenditure on produced services, but rather transfer payments. The way the government is using the term, it does not include state pensions either, which account for 11.6% of public expenditure. So does the 24.5% largely consist of payments to the unemployed? The answer is no.
The category ‘welfare’ as used by the government includes the following elements. The percentages are of total managed expenditure (i.e. government spending).
•
Public service pensions, paid to retired public-sector employees, such as teachers, police officers, doctors and nurses
(2.6%)
•
Other support for the elderly, including pension credit, winter fuel allowance, bus passes, etc.
(1.5%)
•
Sickness and disability benefits, including long-term care for the elderly, sick and disabled
(6.6%)
•
Support for families and children, such as child benefit and child tax credits
(3.4%)
•
Social exclusion, including income support and housing benefit
(7.8%)
•
Unemployment benefits, including Job Seekers Allowance
(0.7%)
•
Other
(1.9%)
Lumping all these together under a single heading ‘welfare’ can be highly misleading, as many people have strongly held preconceptions about who gets welfare. In fact the term is used pejoratively by many who resent their taxes being given to those who do not work.
But, as you can see from the figures, only a small proportion goes to the unemployed, the majority of whom (around 65%) are unemployed for less than a year as they move between jobs (see). The bulk of benefits goes to children, the retired and the working poor.
Another preconception is that much of welfare spending goes to fraudulent claimants. But, as the article by Professor Hills states:
Just 0.7% of all benefits was over-paid as the result of fraud, less than the amount underpaid as a result of official error. For the main benefit for unemployed people, Jobseeker’s Allowance, estimated fraud was 2.9%, or an annual total of £150million.
It is also important to consider people’s life cycle. The same people receive benefits (via their parents or guardians) as children, pay taxes when they work and receive benefits when they retire or fall sick. Thus you might be a net contributor to public finances at one time and a net beneficiary at another. For example, the majority of pensioners were net contributors when they were younger and are now mainly net beneficiaries. Many unemployed people who rely on benefits now were net contributors when they had a job.
The message is that you should be careful when interpreting statistics, even if these statistics are factually accurate. How figures are grouped together and the labels put on them can give a totally misleading impression. And politicians are always keen to ‘spin’ statistics to their advantage – whether in government or opposition.
What benefits do you receive? How would you expect this to change over your lifetime?
What are the arguments for (a) reducing and (b) increasing welfare payments. In each case, under which categories of welfare would you decrease or increase the level of benefits?
Referring to Table 5.2 in the PESA data below (the table used for the government’s calculations), which of the categories would be classified as expenditure on goods and services and which as transfer payments?
Assess the arguments of the IFS for the reclassification of the categories of ‘welfare’ payments.
Referring to the pie chart above, also in the BBC video and articles and Table 5.2 in the PESA data, assess the arguments about the size of the UK’s contributions to the EU budget.
This weekend, Australia will play host to the world’s leaders, as the G20 Summit takes place. The focus of the G20 Summit will be on global growth and how it can be promoted. The Eurozone remains on the brink, but Germany did avoid for recession with positive (just) growth in the third quarter of this year. However, despite Australia’s insistence on returning the remit of the G20 to its original aims, in particular promoting growth, it is expected that many other items will also take up the G20’s agenda.
In February, the G20 Finance Ministers agreed various measures to boost global growth and it is expected that many of the policies discussed this weekend will build on these proposals. The agreement contained a list of new policies that had the aim of boosting economy growth of the economies by an extra 2% over a five year period. If this were to happen, the impact would be around £1.27 trillion. The agreed policies will be set out in more detail as part of the Brisbane Action Plan.
As well as a discussion of measures to promote global growth as a means of boosting jobs across the world, there will also be a focus on using these measures to prevent deflation from becoming a problem across Europe. Global tax avoidance by some of the major multinationals will also be discussed and leaders will be asked to agree on various measures. These include a common reporting standard; forcing multinationals to report their accounts country by country and principles about disclosing the beneficial ownership of companies. It it also expected that the tensions between Russia and Ukraine will draw attention from the world leaders. But, the main focus will be the economy. Australia’s Prime Minister, Tony Abbott said:
“Six years ago, the impacts of the global financial crisis reverberated throughout the world. While those crisis years are behind us, we still struggle with its legacy of debt and joblessness…The challenge for G20 leaders is clear – to lift growth, boost jobs and strengthen financial resilience. We need to encourage demand to ward off the deflation that threatens the major economies of Europe.”
Many people have protested about the lack of action on climate change, but perhaps this has been addressed to some extent by the deal between China and the USA on climate change and Barak Obama’s pledge to make a substantial contribution to the Green Climate Fund. This has caused some problems and perhaps embarrassment for the host nation, as Australia has remained adamant that despite the importance of climate change, this will not be on the agenda of the G20 Summit. Suggestions now, however, put climate change as the final communique.
Some people and organisations have criticised the G20 and questioned its relevance, so as well as discussing a variety of key issues, the agenda will more broadly be aiming to address this criticism. And of course, focus will also be on tensions between some of the key G20 leaders. The following articles consider the G20 Summit.
What is the purpose of the G20 and which countries are members of it? Should any others be included in this type of organisation?
What are the key items on the agenda for the G20 Summit in Brisbane?
One of the main objectives of this Summit is to discuss the policies that will be implemented to promote growth. What types of policies are likely to be important in promoting global economic growth?
What types of policies are effective at addressing the problem of deflation?
What impact will the tensions between Russia and Ukraine have on the progress of the G20?
Why are multinationals able to engage in tax evasion? What policies could be implemented to prevent this and to what extent is global co-operation needed?
Discuss possible reforms to the IMF and the G20’s role in promoting such reforms.
In his 1971 book, Income Distribution, Jan Pen, a Dutch economist, gave a graphic illustration of inequality in the UK. He described a parade of people marching by. They represent the whole population and the parade takes exactly one hour to pass by. The height of each person represents his or her income. People of average height are the people with average incomes – the observer is of average height. The parade starts with the people on the lowest incomes (the dwarfs), and finishes with those on the highest incomes (the giants).
Because income distribution is unequal, there are many tiny people. Indeed, for the first few minutes of the parade, the marchers are so small they can barely be seen. Even after half an hour, when people on median income pass by, they are barely waist high to the observer.
The height is growing with tantalising slowness, and forty-five minutes have gone by before we see people of our own size arriving. To be somewhat more exact: about twelve minutes before the end the average income recipients pass by.
In the final minutes, giants march past and then in the final seconds:
the scene is dominated by colossal figures: people like tower flats. Most of them prove to be businessmen, managers of large firms and holders of many directorships and also film stars and a few members of the Royal Family.
The rear of the parade is brought up by a few participants who are measured in miles. Indeed they are figures whose height we cannot even estimate: their heads disappear into the clouds and probably they themselves do not even know how tall they are.
Pen’s description could be applied to most countries – some with even more dwarfs and even fewer but taller giants. Generally, over the 43 years since the book was published, countries have become less equal: the giants have become taller and the dwarfs have become smaller.
The 2011 Economist article, linked below, uses changes in Gini coefficients to illustrate the rise in income inequality. A Gini coefficient shows the area between the Lorenz curve and the 45° line. The figure will be between 0 and 1 (or 0% and 100%). a figure of 0 shows total equality; a figure of 1 shows a situation of total inequality, where one person earns all the nation’s income. The higher the figure, the greater the inequality.
The chart opposite shows changes in the Gini coefficient in the UK (see Table 27 in the ONS link below for an Excel file of the chart). As this chart and the blog post Rich and poor in the UK show, inequality rose rapidly during the years of the 1979–91 Thatcher government, and especially in the years 1982–90. This was associated with cuts in the top rate of income tax and business deregulation. It fell in the recession of the early 1990s as the rich were affected more than the poor, but rose with the recovery of the mid- to late 1990s. It fell again in the early 2000s as tax credits helped the poor. It fell again following the financial crisis as, once more, the rich were affected proportionately more than the poor.
The most up-to-date international data for OECD countries can be found on the OECD’s StatExtracts site (see chart opposite: click here for a PowerPoint). The most unequal developed county is the USA, with a Gini coefficient of 0.389 in 2012 (see The end of the American dream?), and US inequality is rising. Today, the top 1% of the US population earns some 24% of national income. This compares with just 9% of national income in 1976.
Many developing countries are even less equal. Turkey has a Gini coefficient of 0.412 and Mexico of 0.482. The figure for South Africa is over 0.6.
When it comes to wealth, distribution is even less equal. The infographic, linked below, illustrates the position today in the USA. It divides the country into 100 equal-sized groups and shows that the top 1% of the population has over 40% of the nation’s wealth, whereas the bottom 80% has only 7%.
So is this inequality of income and wealth desirable? Differences in wages and salaries provide an incentive for people to work harder or more effectively and to gain better qualifications. The possibility of increased wealth provides an incentive for people to invest.
But are the extreme differences in wealth and income found in many countries today necessary to incentivise people to work, train and invest? Could sufficient incentives exist in more equal societies? Are inequalities in part, or even largely, the result of market imperfections and especially of economic power, where those with power and influence are able to use it to increase their own incomes and wealth?
Could it even be the case that excessive inequality actually reduces growth? Are the huge giants that exist today accumulating too much financial wealth and creating too little productive potential? Are they spending too little and thus dampening aggregate demand? These arguments are considered in some of the articles below. Perhaps, by paying a living wage to the ‘tiny’ people on low incomes, productivity could be improved and demand could be stimulated.
Distinguish between income and wealth. Is each one a stock or a flow?
Explain how (a) a Lorenz curve and (b) a Gini coefficient are derived.
What other means are there of measuring inequality of income and wealth other than using Gini coefficients (and giants and dwarfs!)?
Why has inequality been rising in many countries over the years?
How do (a) periods of rapid economic growth and (b) recessions affect income distribution?
Define ‘efficiency wages’. How might an increase in wages to people on low incomes result in increased productivity?
What is the relationship between the degree of inequality and household debt? What implications might this have for long-term economic growth and future financial crises? Is inequality the ‘enemy of growth’?
Lloyds Banking Group has announced that it plans to reduce its labour force by 9000. Some of this reduction may be achieved by not replacing staff that leave, but some may have to be achieved through redundancies.
The reasons given for the reduction in jobs are technological change and changes in customer practice. More banking services are available online and customers are making more use of these services and less use of branch banking. Also, the increasingly widespread availability of cash machines (ATMs) means that fewer people withdraw cash from branches.
And it’s not just outside branches that technological change is impacting on bank jobs. Much of the work previously done by humans is now done by software programs.
One result is that many bank branches have closed. Lloyds says that the latest planned changes will see 150 fewer branches – 6.7% of its network of 2250.
What’s happening in banking is happening much more widely across modern economies. Online shopping is reducing the need for physical shops. Computers in offices are reducing the need, in many cases, for office staff. More sophisticated machines, often controlled by increasingly sophisticated computers, are replacing jobs in manufacturing.
So is this bad news for employees? It is if you are in one of those industries cutting employment. But new jobs are being created as the economy expands. So if you have a good set of skills and are willing to retrain and possibly move home, it might be relatively easy to find a new, albeit different, job.
As far as total unemployment is concerned, more rapid changes in technology create a rise in frictional and structural unemployment. This can be minimised, however, or even reduced, if there is greater labour mobility. This can be achieved by better training, education and the development of transferable skills in a more adaptive labour force, where people see changing jobs as a ‘normal’ part of a career.
Is a reduction in banking jobs inevitable? Explain.
What could banks do to reduce the hardship to employees from a reduction in employment?
What other industries are likely to see significant job losses resulting from technological progress?
Distinguish between demand-deficient, real-wage, structural and frictional unemployment. Which of these are an example, or examples, of equilibrium unemployment?
What policies could the government pursue to reduce (a) frictional unemployment; (b) structural unemployment?
What types of industry are likely to see an increase in employment and in what areas of these industries?
The articles linked below look at the dangers of deflation and policies of central banks to counter it.
The result could be a fall in aggregate demand and a fall in output and employment.
