Category: Economics for Business: Ch 32

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The world economy

Periodically, the BBC hosts debates on major global topics. The following links are to the January 2011 debate on the state of the world economy and on what policies governments and central banks should pursue.

Should governments be boosting aggregate demand by raising government expenditure and cutting taxes in order to stimulate growth and plan to bring down deficits over the long term once growth is established? Or should they embark on tough fiscal consolidation now by cutting government expenditure and/or raising taxes in order to stimulate confidence by international financiers, thereby keeping long-term interest rates down and creating the foundations for sustainable economic growth? The debate considers these two very different policy approaches.

The participants in the debate are Joseph Stiglitz (Professor of Economics, Columbia University), Christina Romer (Professor of Economics, University of California, Berkeley and Adviser to Barack Obama (2009–10)), George Papaconstantinou (Finance Minister of Greece), Dominique Strauss-Khan (Managing Director, IMF) and Zhou Xiaochuan (Governor, Chinese Central Bank). The debate is in five separate webcasts.

Webcasts

World debate on the global economy BBC World Service (20/1/11)
Part 1
Part 2
Part 3
Part 4
Part 5

Questions

  1. What are the arguments for maintaining economic stimulus, at least for the time being? What are the relative merits of fiscal and monetary stimulus? Explain whether such policies are consistent with Keynesian polcies.
  2. What are the arguments for tough fiscal consolidation? Explain whether such policies are consistent with new classical policies.
  3. How successful have US policies been in stimulating the US economy?
  4. What role can China play in the recovery and long-term growth of the global economy and are there any imbalances that need correcting?
  5. Why might countries’ domestic policies result in currency wars? Is currency realignment necessary for sustained global growth?
  6. How important are consumer and business confidence to short-term recovery and long-term growth and to what extent do government policies respond to swings in confidence?
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The wrong kind of economics?

Business leaders and politicians pay a great deal of attention to economic forecasts. And yet these forecasts often turn out to be quite wrong. Very few economists predicted the banking crisis of 2008 and the subsequent credit crunch and recession. And the recently released 2010 Q4 growth figures for the UK economy, which showed a decline in real GDP of 0.5%, took most people by surprise.

What is more, forecasters often disagree. If, for example, you look at the forecasts made by various panel members for Consensus Forecasts, you can see the divergence between their various predictions.

So why is economic forecasting so unreliable? Is it the fault of economic models? Or are there too many unpredictable factors that can impact on economies – factors such as business and consumer confidence, or political events, or natural disasters, such as the recent floods in Australia, South Africa and Brazil? Will economic forecasting always be a very inexact science?

Articles
Davos 2011: Why do economists get it so wrong? BBC News, Tim Weber (27/1/11)
Popular Semi-Science Slate, Robert J. Shiller (24/1/11)
Fed Often Gets It Wrong In Its Forecasts on US Economy American Public Media, Justin Wolfers (26/1/11)
Don’t bet on economic forecasting CNBC, Jeff Cox (21/9/10)

Forecasts
Forecasts for the UK economy HM Treasury
Econ Stats: The Economic Statistics and Indicators Database Economy Watch (large database of worldwide annual statistics, including forecasts to 2015)
World Economic Outlook IMF (follow link in right-hand panel)
OECD Economic Outlook: Statistical Annex OECD
European Economic Forecasts European Commission, Economic and Financial Affairs DG

Questions

  1. For what reasons may economic forecasts turn out to be wrong?.
  2. To what extent is economic forecasting like weather forecasting? Which is harder and why?
  3. Wo what extent can the poor accuracy of economic forecasts be blamed on the application of the ‘wrong type of economics’?
  4. How much variation is there in the independent forecasts of the UK economy reported by the Treasury (see HM Treasury link above)?
  5. Using the HM Treasury link, compare the forecasts made of 2010 in January 2010 with those made of 2010 in January 2011. Attempt an explanation of the differences.
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Powering growth

BP has just published its latest projection of energy trends – its Energy Outlook 2030. According to the press release:

World energy growth over the next twenty years is expected to be dominated by emerging economies such as China, India, Russia and Brazil while improvements in energy efficiency measures are set to accelerate.

The following podcast from the Financial Times features a discussion of the report and the factors affecting oil prices and their relationship to economic growth

Webcast
Emerging economies seen driving energy demand Financial Times videos, John Authers and Vincent Boland (19/1/11)

Articles
Energy outlook Financial Times, Lex column (19/1/11)
BP energy outlook: main points The Telegraph (20/1/11)
High energy prices need not mean doom Sydney Morning Herald, Jeremy Warner (21/1/11)

Report
BP Energy Outlook 2030 (January 2011)

Data
Power slide The Economist: Daily Chart (19/1/11)

Questions

  1. What are the most powerful driving forces behind the demand for energy?
  2. Why does the report forecast virtually no increase in energy demand in developed countries? What assumptions are made about growth rates in OECD and non-OECD countries?
  3. What factors would lead to a substitution of sustainable energy sources for fossil fuels? What would detrmine the size of such substitution?
  4. What is the role of the price elasticity of demand for and supply of oil and the income elasticity of demand for oil in determining oil consumption in different parts of the world?
  5. Why may high energy prices not necessarily mean ‘doom’?
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A financial health check

Every six months the Bank of England publishes its Financial Stability Report. “It aims to identify the major downside risks to the UK financial system and thereby help financial firms, authorities and the wider public in managing and preparing for these risks.”

In the latest report, published on 17 December 2010, the Bank expresses concern about the UK’s exposure to problems overseas. The two most important problems are the continuing weaknesses of a number of banks and the difficulties of certain EU countries in repaying government bonds as they fall due and borrowing more capital at acceptable interest rates. As the report says:

Sovereign and banking system concerns have re-emerged in parts of Europe. The IMF and European authorities proposed a substantial package of support for Ireland. But market concerns spilled over to several other European countries. At the time of writing, contagion to the largest European banking systems has been limited. In this environment, it is important that resilience among UK banks has improved over the past year, including progress on refinancing debt and on raising capital buffers. But the United Kingdom is only partially insulated given the interconnectedness of European financial systems and the importance of their stability to global capital markets.

The Bank identifies a number of specific risks to the UK and global financial systems and examines various policy options for tackling them. The following articles consider the report.

Articles
Bank warns of eurozone risks to UK as EU leaders meet Independent, Sean O’Grady (17/12/10)
Deep potholes on the road to recovery Guardian, Nils Pratley (17/12/10)
It’s reassuring that regulators are still worried about financial stability The Telegraph, Tracy Corrigan (17/12/10)
Europe is still searching for stability and the UK must find it too Independent, Hamish McRae (17/12/10)
Shafts of light between the storm clouds The Economist blogs: ‘Blighty’ (17/12/10)

Report
Financial Stability Report, December 2010: Overview Bank of England
Financial Stability Report, December 2010: Links to rest of report Bank of England

Questions

  1. What are the most important financial risks facing (a) the UK; (b) eurozone countries?
  2. What is the significance of the rise in banks’ tier-1 capital ratios since 2007?
  3. Which is likely to be more serious over the coming months: banking weaknesses or sovereign debt? Explain.
  4. What is being done to reduce the risks of sovereign default?
  5. Why might the weaker EU countries struggle to achieve economic growth over the next two or three years?
  6. How do interest rates on government debt, as expressed by bond yields, compare with historical levels? What conclusions can you draw from this?
  7. What is likely to happen to bond yields in the USA, the UK and Germany over the coming months?
  8. What has been the effect of the extra £200 billion that the Bank of England injected into the banking system through its policy of quantitative easing?