While inflation is a concern in the UK and is making the Bank of England think twice about keeping interest rates at their all time low of 0.5%, inflation in Japan is being celebrated. The Japanese economy has been plagued by deflation for over a decade and for the past 2 years inflation has never been above 0%. However, in April the consumer price index (CPI) rose to 0.6% from the previous year, fuelled by petrol prices. Strangely it might be the Japanese earthquake and tsunami that helped this situation, as Japan was unable to generate sufficient electricity and hence had to import fuel from abroad.
A typical question from non-economists is always about why deflation and hence falling prices is such a bad thing. Surely, it’s great for consumers? For those shopping for bargains, perhaps it is helpful – after all, if prices fall, a consumer’s real income will be higher. However, the problem with falling prices is that people start to hold off buying. If you want to buy a car, but expect prices to be lower next month, then it’s a rational decision to delay your purchase until next month when prices are lower. However, next month, you still expect prices to be lower in the following month and so delay purchasing again. And so the process continues. When people expect prices to fall they put off their purchases, this reduces demand and so prices do indeed fall. There are also costs for businesses: as consumers delay buying, sales begin to fall. And businesses are also consumers, and so they start delaying their purchases of inputs.
While many central banks across the world have begun to tighten monetary policy, the Japanese central bank seems inclined to keep monetary policy loose and has even considered expanding the emergency lending programme. As Azusa Kato, an economist at BNP Paribas, said:
“The bank will probably add stimulus if it sees more signs of weakening demand”. “If you strip out energy and food costs, consumer prices are basically flat now.”
Despite this inflationary pressure, many believe that it is unlikely to continue and deflationary pressures may appear once again in the near future. The following articles consider the Japanese deflationary situation.
Articles
Japan ends 25 months of deflation Bloomberg, Mayumi Otsuma (27/5/11)
Japan consumer prices log first rise in 28 months Associated Press (27/5/11)
Japan beats deflation for the first time in two years BBC News (275/11)
Japan overcomes deflation for first time in two years Guardian, Julia Kollewe (27/5/11)
Japanese consumer price rise (including video) BBC News (27/5/11)
Japan April core CPI rises 0.6 pct yr/yr Reuters (26/5/11)
Japan experiences inflation for first time in over two years Telegraph (27/5/11)
Data
Japan Inflation Rate Trading Economics
Consumer Price Index (Japan) Japanese Statistics Bureau
Inflation Rate and Consumer Price Index (CPI) (for USA, Canada, Australia, UK and Japan) Rate Inflation
Statistical Annex, Preliminary Version OECD
Questions
- What are the main costs of deflation? Think about the wider effects on consumers, businesses and the government.
- What has caused the increase in inflation to 0.6% in Japan and why was there an expectation that inflation would re-appear?
- What explanation can be given for the belief that deflation will soon re-emerge?
- Using a demand and supply diagram, explain the process by which consumers delaying their consumption will lead to prices falling continuously.
- What is the best policy for the Japanese central bank to pursue in light of the new data?
The snow the UK has seen over the past two winters created massive disruption, but that is only one reason for hoping for a milder winter to come. With the cold weather, the UK economy faced threats of gas shortages, as households turned on their heating. However, despite the freezing temperatures, many households were forced to turn off their heating regularly, due to the excessive bills they would face. This trend is expected to be even more prevalent if the 2011/12 winter is as cold, as fuel tariffs are predicted to rise. The Bank of England has said that gas and electricity prices could rise this year by 15% and 10% respectively. British Gas’s Parent company, Centrica said:
“In the UK the forward wholesale prices of gas and power for delivery in winter 2011/12 are currently around 25% higher than prices last winter, with end-user prices yet to reflect this higher wholesale market price environment.”
These predictions might see the average UK household paying an extra £148 over the next year. Although these are only estimates, we are still very likely to see many households being forced to turn off their heating. One thing which therefore is certain: a warmer winter would be much appreciated!
Articles
Switch energy tariff to help beat bill rises Guardian, Miles Brignall (14/5/11)
Quarter of households predicted to turn off heating BBC News, Brian Milligan (14/5/11)
Power bills set to soar by 50% in four years Scotsman (14/5/11)
Domestic fuel bills poised to rise by up to £200 Financial Times, Elaine Moore (13/5/11)
Data
Energy price statistics Department of Energy & Climate Change
Energy statistics publications Department of Energy & Climate Change
Questions
- Which factors have contributed to rising energy prices? Illustrate these changes on a demand and supply diagram.
- To what extent do these higher prices contribute to rising inflation?
- What impact might these price rises have on (a) poverty and (b) real income distribution in the UK?
- Why are energy prices currently being investigated by Ofgem? What powers does the regulator have and what actions could be taken?
Growth figures across many countries still remain vulnerable, including the UK, where growth lies at only 0.5%. Despite some countries starting to grow more rapidly, the numbers still remain close to 0. The eurozone area is a particularly interesting case, as there are so many individual countries that are all interdependent. So, despite growth in the eurozone area increasing to 0.8% in the first three months of 2011, which is higher than that for the UK, this doesn’t explain the full story in the area. Germany has grown by 1.5% and it is this figure which has largely contributed to the 0.8% figure. It was also helped by growth of 1% in France and incredibly of 0.8% in Greece, despite its huge debts. The growth in Greece is allegedly down to a better export market.
Why then wasn’t the figure higher? Whilst countries like Germany showed an acceleration in demand, growth remained sluggish in Spain and Italy at only 0.1% and 0.3% respectively and Portugal faced the second consecutive quarter of negative growth and so has officially gone back into recession. This situation may get even worse as the austerity measures put in place by the EU and IMF take effect. One of the key arguments against joining the eurozone is that the policies implemented are never going to be in the best interests of any one country. With some countries beginning to grow more quickly and others remaining sluggish, what should happen to macroeconomic policy? Should interest rates remain low in a bid to boost aggregate demand or should they rise as other countries see accelerating growth?
An interesting question here is why do countries, such as Italy, Spain and Portugal struggle, whilst France and Germany begin their recovery? One obvious explanation is that Germany and France are at the heart of the eurozone, where as Spain, Portugal and Italy remain on the periphery. Ken Wattret at BNP Paribas said:
“The periphery are getting the worst of both worlds. The core countries like Germany are doing really well and that’s keeping the euro strong, and it’s making the ECB [European Central Bank] more inclined to tighten policy.”
If the ECB do go ahead with a tightening of monetary policy, it could spell further trouble for those countries on the periphery of the Euro area that would benefit from interest rates remaining low and a weaker Euro. The following articles look at the conflicts within the 2-speed Eurozone.
Articles
Sterling lags euro on growth outlook; trails dollar Reuters (13/5/11)
Eurozone’s growth surprises as UK lags behind Telegraph, Emma Rowley (13/5/11)
Eurozone’s economic growth accelerates BBC News (13/5/11)
Solid finances help drive German economic revival Financial Times, Ralph Atkins (13/5/11)
UK’s economy in the slow lane as eurozone surges Scotsman, Scott Reid (14/5/11)
Euro growth eclipses rivals despite north-south divergences AFP, Roddy Thomson (13/5/11)
Eurozone economic growth data prompts political clash BBC News (13/5/11)
Fresh fears for UK economy as Germany and France power ahead Guardian, Larry Elliott (13/5/11)
Portugal’s GDP is set to shrink this year and next Wall Street Journal, Alex Macdonald and Patricia Kowsmann (14/5/11)
Data
UK GDP Growth National Statistics
Eurozone growth rates ECB
EU countries’ Growth rates of GDP in volume Eurostat News Release (13/5/11)
Real GDP growth rate for EU countries and applicant countries, EEA countries and USA and Japan Eurostat
Questions
- What has contributed to the German, French and Greek economies surging ahead?
- Why is there such a north-south divergence in growth within the eurozone?
- What is the most suitable monetary policy for those countries growing more strongly?
- What is the best direction for interest rates and hence the value of the euro for countries, such as Spain, Italy and Portugal?
- ’The UK economy would be in a worse position if it were a member of the eurozone’. What are the arguments (a) for and (b) against this statement?
- What is the relationship between interest rates, the exchange rate and growth?
Anyone investing in commodities over the past few weeks will have been in for a bumpy ride. During the first part of 2011, commodity prices have soared (see A perfect storm brewing?). This has fuelled inflation and has caused the Bank of England to revise upwards its forecast for inflation (see Busy doing nothing see also Prospects for Inflation).
But then in the first week of May, commodity prices plumetted. On the 5 May, oil prices fell by 7.9% – their largest daily amount since January 2009. Between 28 April and 6 May silver prices fell from $48.35 per ounce to just over $33.60 per ounce – a fall of over 30%. And it was the same with many other commodities – metals, minerals, agricultural raw materials and foodstuffs.
Many financial institutions, companies and individuals speculate in commodities, hoping to make money buy buying at a low price and selling at a high price. When successful, speculators can make large percentage gains in a short period of time. But they can also lose by getting their predictions wrong. In uncertain times, speculation can be destabilising, exaggerating price rises and falls as speculators ‘jump on the bandwagon’, seeing price changes as signifying a trend. In more stable times, speculation can even out price changes as speculators buy when prices are temporarily low and sell when they are temporarily high.
Times are uncertain at present. Confidence fluctuates over the strength of the world recovery. On days of good economic news, demand for commodities rises as people believe that a growing world economy will drive up the demand for commodities and hence their prices. On days of bad economic news, the price of commodities can fall. The point is that when undertainty is great, commodity prices can fluctuates wildly.
Articles
Commodities plunge: Blip or turning point? BBC News, Laurence Knight (6/5/11)
Commodity hedge fund loses $400m in oil slide Financial Times, Sam Jones (8/5/11)
Commodities: ‘epic rout’ or the new normal? BBC News blogs: Stephanomics, Stephanie Flanders (6/5/11)
Commodities Still a Bubble – But Prices May Continue to Rise Seeking Alpha, ChartProphet (9/5/11)
When a sell-off is good news The Economist, Buttonwood (6/5/11)
Gilt-edged argument The Economist, Buttonwood (28/4/11)
Commodities: What volatility means for your portfolio Reuters blogs: Prism Money (9/5/11)
Gold, silver rise again on debt, inflation concerns Reuters, Frank Tang (10/5/11)
Commodities After The Crash, No Way But Up The Market Oracle, Andrew McKillop (9/5/11)
Outlook 2011:Three Dominant Factors Will Impact Precious Metals in 2011 GoldSeek (9/5/11)
Energy bills set to rise sharply next winter, Centrica warn Guardian, Graeme Wearden (9/5/11)
Dollar triggered commodities ‘flash crash’, not Bin Laden The Telegraph, Garry White, and Rowena Mason (9/5/11)
The outlook for commodity prices Live Mint@The Wall Steet Journal, Manas Chakravarty (11/5/11)
Three ways to play the next commodities bubble Market Watch, Keith Fitz-Gerald (11/5/11)
Data
Commodity Prices Index Mundi
Commodities Financial Times
Commodities BBC Market Data
Questions
- Why did commodity prices fall so dramatically in early May, only to rise again rapidly afterwards?
- Why do commodity prices fluctuate more than house prices?
- What is the relevance of price elasticity of demand and supply in explaining the volatility of commodity prices?
- Under what circumstances is speculation likely to be (a) stabilising; (b) destabilising?
- To what extent are rising commodity prices (a) the cause of and (b) the effect of world inflation?
- If commodity prices go on rising every year, will inflation go on rising? Explain.
Just as the Bank of England has an inflation target of 2%, so does the ECB. UK inflation has been significantly above its target rate for many months and so has the eurozone’s inflation rate, which is up to 2.8% in April from its previous level of 2.7% the previous month. The increase in the general price level has been fuelled by rising costs of raw materials and high energy prices. Whilst interest rates in the UK have remained at 0.5% in a bid to stimulate economic growth, the ECB has increased interest rates by a quarter point to 1.25% and the latest inflation data may be further pressure for further rises. However, any increase in rates will put more pressure on countries such as Greece, Ireland and Portugal who are facing tough austerity measures and may put their recoveries in jeopardy.
The ECB has been optimistic about growth and it may need to be with this and possibly subsequent interest rate hikes, as they are likely to depress aggregate demand. Furthermore, European Commission’s ‘economic sentiment’ indicator has fallen to 106.2, which is the weakest since November. Eurozone unemployment remains at just under 10%, oil prices remain high and this has depressed optimism across the eurozone countries. The euro, meanwhile, continues to strengthen (up 12% against the dollar over the past year) and this has enhanced the fragile state of affairs in those countries suffering from tough austerity measures. An economist at ING has said:
“The combination of high oil prices, a strong euro, and fiscal and monetary tightening has started to dent the economic mood in the euro zone.”
Eurozone inflation rises again Telegraph, Emma Rowley (29/4/11)
Eurozone inflation rate rises to 2.8% BBC News (29/4/11)
Eurozone inflation jumps to 2.8% Financial Times, Ralph Atkins (29/4/11)
Euro zone inflation rises, points to higher ECB rates Reuters, Jan Strupczewski (29/4/11)
Eurozone inflation further above target at 2.8pct The Associated Press (29/4/11)
Questions
- What is the relationship between interest rates and inflation. Why have the ECB and the Bank of England reacted differently to rising inflation?
- Is the inflation currently being experienced in the Eurozone cost-push or demand-pull? Illustrate your answer with the help of a diagram.
- What is the relationship between interest rates and the exchange rate?
- Why is there some concern about the ‘economic sentiment’ indicator in the Eurozone?
- What is the relationship between interest rates and economic growth? Explain the process by which a change in interest rates could affect AD and then economic growth and employment.
- Why is this interest rate rise (and possible further rises) likely to hurt countries, such as Ireland and Greece more than other countries within the Eurozone?