Governments and central banks around the world are trying hard to minimise the impact of the economic downturn on their economies. One means of doing this is to cut interest rates. The aim is to boost aggregate demand by giving people more disposable income and making borrowing and investment cheaper. But how responsive will people be to the interest rate cuts? The articles and podcasts below look at the issues.
Combating the recession The Economist (8/1/09)
Economic downturn: ‘Interest rates may not be such a useful tool any more’ Guardian (9/1/09) Podcast
Beyond rate cuts Financial Times (15/1/09)
Beyond retail therapy Guardian (8/1/09)
Uncharted territory for interest rates BBC News Online (8/1/09)
Latest cut in interest rates will not revive flagging economy Times Online (9/1/09)
Interest rates – the setting of the LIBOR rate BBC Biz Daily (9/1/09) Podcast – Tim Harford
Questions
- Explain the process by which lower interest rates boost aggregate demand.
- Explain what is meant by the LIBOR rate. Listening to the BBC Biz Daily podcast above may help in answering this.
- Assess the importance of the LIBOR rate in determining the levels of borrowing and investment in the economy.
- Discuss the relative effectiveness of fiscal and monetary policy in boosting the level of aggregate demand in the UK economy.
A key cause of the financial crisis is arguably Maths. Many of the innovations in the finance industry were driven by Maths and a desire to generate higher returns from the money available. The BBC programme, More or Less, looks at the Maths of the credit crunch and considers the extent to which the misuse of mathematical principles may have contributed to the crisis. The links below look at the issues raised by the programme and also give access to the archived audio from the programme.
The Maths of the credit crunch BBC News Online (9/1/09)
More or less – programe summary (9th January programme) BBC News Online (9/1/09)
More or less – programe summary (2nd January programme) BBC News Online (2/1/09)
More less – programme (audio) BBC News Online (9/1/09)
Questions
- Analyse the extent to which quantitative analysis may have been responsible for the credit crunch.
- Consider whether the system of paying performance bonuses to bank traders created a distortion of incentives.
- Explain what is meant by a derivative. Discuss the role that derivatives played in the financial crisis.
Economists never like to use simple words when there are more complex ones available! So, the new term for printing money is ‘quantitative easing’. This refers to deliberate increases in the money supply aimed at preventing deflation. The real concern is whether quantitative easing will stoke up inflationary pressures for the future – the balance between inflation and deflation is a fine line to tread. Quantitative easing becomes necessary when there is danger of deflation and interest rates have already been cut as far as is possible.
Another problem, in the short term, is that an increase in the monetary base may have little effect on broader money (M4 in the UK) if people do not want to borrow and thus credit creation is limited.
The articles below all look at various different aspects of quantitative easing.
Europeans Disagree Drastically On Fed Rate Cut Deutsche Welle (17/12/08)
Financial crisis: Free money coming your way! Telegraph (17/12/08)
Wondering what on earth Nils was on about? He’s written this for you BBC News Online (PM programme) (18/12/08)
Japan forecasts no growth in 2009 BBC News Online (19/12/08)
New economic policy: If you haven’t got enough of this stuff, just print some more Scotsman (18/12/08)
Ground Zero The Economist (18/12/08)
Fed throws out the rulebook Times Online (18/12/08)
Quantitative easing: the modern way to print money or a therapy of last resort? Telegraph (8/1/09)
Forget hard choices. We need pampering Times Online (18/12/08)
Jeremy Warner: Darling wants say on ‘quantitative easing’ Independent (8/1/09)
Questions
- Define the term ‘quantitative easing’.
- Explain the mechanism by which the monetary authorities can implement a policy of quantitative easing.
- Discuss the relative effectiveness of cuts in interest rates and quantitative easing to boost aggregate demand in a recession.
- Analyse the impact on an economy of a prolonged period of deflation.
It is something of a media sport in these recessionary times to find ‘economic scapegoats’. One minute the recession is the fault of the banks and their poor lending practices; the next minute it is the fault of the media themselves, who are constantly reporting doom and gloom; the next minute it is the fault of the politicians, who have failed to react quickly enough to the economic uncertainties; the list goes on! However, the one group that is rarely blamed is ‘us’ – the consumers. Given that the state of the economy is the outcome of our collective decisions, it could be said that we have no real right to complain, as our collective lack of confidence could be what has caused much of the current situation. As James Meek puts it in the article below:
What makes the situation peculiar is that the crisis that threatens us also seems to be us; we are simultaneously menaced by the wave, and exist as elements of the wave. After all, that is what an economic crisis is: the sum of all the actions of billions of people around the world, deciding whether to lend or hoard, borrow or save, sell or buy, move or stay, hire or fire, study or look for work, be pessimistic or optimistic.
To live in remarkable times Guardian (5/1/09)
Questions
- Explain how changes in consumer confidence can affect the level of aggregate demand.
- Examine the importance of consumer confidence in determining the length and depth of a recession.
- Discuss policies that the government can implement to try to boost consumer confidence.
- Analyse the impact on an economy of a prolonged period of poor consumer confidence.
The current financial crisis had led to Keynesian theory coming back into fashion. Governments all around the world have put in place a significant fiscal and monetary stimulus to try to mitigate the impact of the downturn. But is this really Keynesian policy at work? Keynes argued for permanent and tough controls on the financial sector to allow the government to pursue a policy of full employment. It would be difficult that current policies are therefore pure Keynesian policies, so is there an economic theory vacuum with market economics discredited, but Keynesian economics not really taking its place? The article below looks at how economic theory has changed in recent months and considers whether we need a ‘new’ Keynes.
Wanted: the Keynes for our times Guardian (22/12/08)
Questions
- Explain the difference between classical and Keynesian beliefs with respect to government intervention in the ecoomy.
- Analyse the extent to which the recent policy stimulus has been Keynesian in nature.
- Discuss the changes that have taken place in economic policy during 2008/9 in the context of economic theory.