Christine Lagarde, managing director of the IMF, has warned of the danger of deflation in the eurozone. She also spoke of the risks of a slowdown in the developing world as the Fed tapers off its quantitative easing programme – a programme that has provided a boost to many emerging economies.
Speaking at the World Economic Forum, in the Swiss Alps, she did acknowledge signs of recovery across the world, but generally her speech focused on the risks to economic growth.
Some of these risks are old, such as a lack of fundamental bank reform and a re-emergence of risky behaviour by banks. Banks have taken steps towards recapitalisation, and the Basel III rules are beginning to provide greater capital buffers. But many economists believe that the reforms do not go far enough and that banks are once again beginning to behave too recklessly.
Some of the risks are new, or old ones resurfacing in a new form. In particular, the eurozone, with inflation of just 0.8%, is dangerously close to falling into a deflationary spiral, with people holding back on spending as they wait for prices to fall.
Another new risk concerns the global impact of the Fed tapering off its quantitative easing programme (see Tapering off? Not yet). This programme has provided a considerable boost, not just to the US economy, but to many emerging economies. Much of the new money flowed into these economies as investors sought better returns. Currencies such as the Indian rupee, the Brazilian real and the Turkish lira are now coming under pressure. The Argentinean peso has already been hit by speculation and fell by 11% on 24/1/14, its biggest one-day fall since 2002. Although a fall in emerging countries’ currencies will help boost demand for their exports, it will drive up prices in these countries and put pressure on central banks to raise interest rates.
Christine Lagarde was one of several speakers at a session titled, Global Economic Outlook 2014. You can see the complete session by following the link below.
Articles
Lagarde warns of risks to global economic recovery TVNZ (27/1/14)
Lagarde Cautions Davos on Global Deflation Risk Bloomberg News, Ian Katz (26/1/14)
Davos 2014: Eurozone inflation ‘way below target’ BBC News (25/1/14)
IMF fears global markets threat as US cuts back on cash stimulus The Guardian, Larry Elliott and Jill Treanor (25/1/14)
Davos 2014: looking back on a forum that was meant to look ahead The Guardian, Larry Elliott (26/1/14)
Speeches at the WEF
Global Economic Outlook 2014 World Economic Forum (25/1/14)
Questions
- Why is deflation undesirable?
- What are the solutions to deflation? Why is it difficult to combat deflation?
- What are the arguments for the USA tapering off its quantitative easing programme (a) more quickly; (b) less quickly?
- How is tapering off in the USA likely to affect the exchange rates of the US dollar against other currencies? Why will the percentage effect be different from one currency to another?
- What are Japan’s three policy arrows (search previous posts on this site)? Should the eurozone follow these three policies?
There’s been much talk about the UK’s economic recovery and whether or not it has begun and whether consumer spending is actually the cause. The latest sector to post positive figures is the car industry, which has seen 2013 bring in the highest level of car sales since the onset of the credit crunch.
According to the Society of Motor Manufacturers and Traders (SMMT), vehicle registrations in 2013 were 2.26 million, which represented a 10.8% increase from 2012. That’s not to say that we have returned to the heights seen pre-crisis levels, as sales still remain some way below their 2007 figure, but the data is certainly moving in the right direction. The key questions are: What’s the cause of this growth and what does it mean for the UK economy?
The economy has certainly turned a corner and perhaps consumer confidence is improving to reflect this. With consumes more optimistic about future economic prospects, more luxury items may well be purchased. During the height of the recession, many families may well have said ‘it will last’ or ‘we’ll make do’, referring to their old cars. However, this improved confidence, together with attractive finance deals may have been instrumental in convincing consumers to splash out. This is reflected in the data, which indicates that some 75% of car sales involve a finance package. One further explanation that has been offered by industry analysts is that the refunds individuals are receiving through mis-sold payment protection insurance are providing a nice contribution towards the deposit.
PPI payments will certainly dry up, but as long as attractive finance packages remain, car sales should continue. A key factor affecting affordability may be interest rates. When they increase, any variable rate loans will become more expensive to service and this may act to deter consumers. However, if the car industry helps to stimulate other sectors and wages begin to increase, the overall effect may be to sustain and even further the growth of this key economic sector. The following articles consider the car industry.
UK car sales hit five-year high The Guardian, Angela Monaghan (7/1/14)
UK new car sales highest since 2007, SMTT says BBC News (7/1/14)
Car sales increased by almost 11% in 2013 Sky News (7/1/14)
UK new car sales rise to highest level since 2007 Reuters, David Milliken (7/1/14)
UK car sales up 11% in 2013, topping pre-crisis levels Wall Street Journal, Matthew Curtin and Ian Walker (7/1/14)
New car sales in UK at highest since before recession Independent, Sean O’Grady (7/1/14)
UK car sales top pre-recession levels Financial Times, Henry Foy (6/1/14)
Questions
- How important is the car industry in the context of the UK economy?
- How is the UK car industry performing relative to its Western rivals?
- Would a 30% single rate of income tax be equitable?
- Explain the way in which car sales have been affected by consumer confidence.
- How have finance packages helped to stimulate car sales?
- What are the key macroeconomic variables that are likely to affect the future performance of this key sector?
Interest rates in the UK have been at 0.5% since mid-2009, when they were reduced with the objective of stimulating the economy, through encouraging consumption and investment. Over the past 12 months, economic recovery has begun and with the housing market rising by 8.4% over the past year, what can we expect from interest rates?
Interest rates are a powerful tool of monetary policy and affect many of the components of aggregate demand. As such, they are also a key tool in achieving low and stable inflation rates and keeping unemployment low. Unemployment has been falling, as the economic recovery has taken hold, but is still above the 7% level that the Bank of England has said is needed before rates are increased. However, with the improvements in the housing market,
some are now expecting interest rates to go up sooner than previously thought. (Click here for a PowerPoint of the chart.)
28 economists were questioned about the future of interest rates in the UK and 93% of those asked were of the opinion that interest rates will still be at 0.5% by the end of 2014. Furthermore, more than 50% think that interest rates will not begin to go up until the second half of 2015 and 15% suggest that they will not increase until 2016.
What happens to interest rates will depend on many things, including changes in productivity, unemployment trends, wage growth and inflation. It is also likely to depend on economic changes in countries around the world. The following articles consider the future of interest rates.
UK interest rates to stay at 0.5% in 2014 – economists BBC News (3/1/14)
It is high time we raised interest rates and returned to normality The Telegraph, Jeremy Warner (2/1/14)
BoE will ‘move goalposts’ on interest rates Financial Times, Chris Giles and Claire Jones (1/1/14)
Interest rate rise with no wage increase ‘will push heavily-indebted to edge’ The Guardian, Heather Stewart (2/12/14)
BoE may lower jobless rate guidance, but not this month – Reuters poll Reuters, Suzanne Plunkett (3/1/14)
Questions
- Explain how each component of aggregate demand will be affected by changes in interest rates.
- How do interest rates affect unemployment?
- Interest rates are used to keep inflation on target. Explain how this is done.
- What might be the effect on the macroeconomic objectives if interest rates are increased?
- What are the arguments (a) for increasing Bank rate and (b) for maintaining it at the current 0.5% level?
As of 31 October 2013, British households had a stock of debt close to £1.43 trillion. Economists are increasingly recognising that the financial well-being of economic agents is an important macroeconomic issue. The financial position of households, businesses and governments can be expected to affect behaviour and, hence, economic activity.
We can calculate the net financial wealth of households as the difference between their stock of financial assets (savings) and their financial liabilities (debt). The latest figures from the Bank of England’s Money and Credit show that as of Halloween 2013, British households had amassed a stock of debt of £1.4296 trillion. It is certainly a large figure since it not far short of the expected GDP figure for 2013 of around £1.6 trillion.
The chart above helps to show that of the aggregate household debt, £1.271 trillion is secured debt (debt secured against property). The remaining stock of £158.589 billion is unsecured debt (e.g. overdrafts, outstanding credit card debt and personal loans). In short, 89 per cent of the stock of outstanding household debt is mortgage debt. (Click here to download a PowerPoint of the chart.)
In January 1994 the stock of secured debt stood at £358.75 billion and the stock of unsecured debt at £53.773 billion. 87 per cent of debt then was secured debt and, hence, little different to today. The total stock of debt has grown by 247 per cent between January 1994 and October 2013. Unsecured debt has grown by 199 per cent while secured debt has grown by 254 per cent.
But, consider now the path of debt between the end of October 2008 and October 2013. During this period, the monthly series of the stock of unsecured debt has fallen on 52 occasions and risen on only 9 occasions. In contrast, the stock of secured debt has fallen on only 10 occasions and often by very small amounts. Consequently, the stock of unsecured debt has fallen by 22.8 per cent between the end of October 2008 and October 2013. In contrast, the stock of secured debt has risen by 3.9 per cent. The total stock of debt has risen by 0.1 per cent over this period and, therefore, it is essentially unchanged.
The amount of debt accumulated by households is example of the increasing importance of the financial system in our everyday lives. The term financialisation helps to capture this. Financialisation means that economists need to think much more about how financial institutions and the financial well-being of people, businesses and governments affect economic activity. There is little doubt that the financial position or financial health of economic agents, such as households, affects their behaviour. We would expect in the case of households for their financial well-being to exert an influence on their propensities to spending or save. But, just how is an area in need of much, much more research.
Articles
UK household debt hits record high BBC News (29/11/13)
Average household debt ‘doubled in last decade’ Telegraph, Edward Malnick (20/11/13)
£1,430,000,000,000 (that’s £1.43 trillion): Britain’s personal debt timebomb Independent, Andrew Grice (20/11/13)
Data
Money and Credit – October 2013 Bank of England
Statistical Interactive Database Bank of England
Questions
- Outline the ways in which the financial system could impact on the spending behaviour of households.
- Why might the current level of income not always be the main determinant of a household’s spending?
- How might uncertainty affect spending and saving by households?
- Explain what you understand by net lending to individuals. How does net lending to individuals affect stocks of debt?
- Outline the main patterns seen in the stock of household debt over the past decade and discuss what you consider to be the principal reasons for these patterns.
- What factors might explain the rather different pattern seen in the growth of debt since October 2008 compared with that in earlier part of the 2000s?
- What do you understand by the term financialisation? Of what importance is this phenomenon to economic behaviour?
‘Deflation could be replacing debt as the main problem – and there’s nothing to suggest the ECB is up to the job.’ So begins the linked article below by Barry Eichengreen, Professor of Economics and Political Science at the University of California, Berkeley.
The good news in this is that worries about debt in eurozone countries are gradually receding. Indeed, this week Ireland officially ended its reliance on a bailout (of €67.5 billion) from the EU and IMF and regained financial sovereignty (see also).
The bad news is that this does not mark the end of austerity. Indeed, many eurozone countries could get stuck in a deflationary trap, with austerity policies continuing to depress aggregate demand. Eurozone inflation is less than 1% and falling.
Broad money supply growth is now below that of the US dollar, the yen and sterling (see chart: click here for a PowerPoint).
The ECB has been far more cautious than central banks in other countries in acting to prevent recession and deflation. Unlike the USA, Japan and the UK, which have all engaged in extensive quantitative easing, the ECB had been reluctant to do so for fear of upsetting German opinion and taking the pressure off southern European countries to reform.
But as Eichengreen points out, the dangers of inaction could be much greater. What is more, quantitative easing is not the only option. The ECB could copy the UK approach of ‘funding for lending’ – not for housing, but for business.
Europe’s economic crisis could be mutating again The Guardian, Barry Eichengreen (10/12/13)
Questions
- What problems are created by falling prices?
- What effect would deflation have on debt and the difficulties in repaying that debt?
- What measures have already been adopted by the ECB to stimulate the eurozone economy? (Search previous articles on this site.)
- Why have such measures proved inadequate?
- What alternative policies are open to the ECB?
- What are the arguments for the ECB being given a higher inflation target (such as 3 or 4%)?
- What are the arguments for and against relaxing fiscal austerity in the eurozone at the current time?
Christine Lagarde, managing director of the IMF, has warned of the danger of deflation in the eurozone. She also spoke of the risks of a slowdown in the developing world as the Fed tapers off its quantitative easing programme – a programme that has provided a boost to many emerging economies.
