In successive months the Monetary Policy Committee of the Bank of England (MPC) has cut Bank Rate from 4.5% down to 2% – the lowest level since November 1951. The dramatic changes show that the Bank is concerned that inflation and economic activity will fall sharply. Indeed the Governor has recognised that there is a possible danger of deflation (defined, in this context, as negative inflation: i.e. a fall in the price index, whether CPI or RPI). To the extent that these cuts in Bank Rate are passed on in interest rate cuts by banks and building socities, they will reduce the cost of borrowing. It is hoped that this, in turn, will result in a boost to aggregate demand – particularly in the run-up to Christmas.
Below is a selection of articles relating to the interest rate cuts, with many commentators wondering if the cuts will be enough and whether interest rates have much lower to go. For some background on interest rates, you may like to look at the History of Britain’s interest rate published by the Times Online. Martin Rowson’s cartoon in the Guardian clearly summarises the view that this may not be enough to revive an ailing British economy!
Bank enters uncharted territory BBC News Online (4/12/08)
Q&A: The Bank Rate cut and you BBC News Online (12/12/08)
Where will interest rates go now? BBC News Online (4/12/08)
Bank of England still has ammunition for the new year Guardian (4/12/08) Video
Farwell, convention Guardian (5/12/08)
No doubt that we’ve got further to go in this rate cutting Guardian (5/12/08) Podcast
Bank cuts rate by 1% to historic low Times Online (4/12/08)
Analysis: Shock and awe of rate cut Times Online (4/12/08)
Rates cut again as recession deepens Times Online (5/12/08)
Unconventional steps may slow the slide into global recession Times Online (7/12/08)
Bank cuts UK rates to 57-year low Times Online (4/12/08)
Questions
Paul Krugman won the Nobel Prize for Economics in 2008. He won the prize for his analysis of trade patterns and location of economic activity, but he is also well known in academic circles for his work on international finance. In the article below, he looks at the foundations of the current financial crisis. He explains the history of the crisis, the action that has been taken by governments around the world, the likely success of the policies and also the impact of the crisis on the real economy. This is perhaps the issue that is of most concern to us as economists. With recession having taken a grip on many countries, it is important for governments to understand the root causes of the crisis to ensure that their policies address these. The article is an edited extract from The Return of Depression Economics and The Crisis of 2008, by Paul Krugman.
We all go together when we go Guardian (6/12/08)
Questions
- Examine the role of the US housing market in the origins of the current financial crisis.
- What is meant by the ‘shadow banking system’? How does the regulatory approach to the shadow banking system differ from that of the mainstream banking system?
- “What’s really worrying is the loss of policy traction: the economy is stalling despite repeated efforts by policy-makers to get it going again.” What does Krugman mean by policy traction? Discuss the possible causes of this policy traction.
- Explain why Krugman believes that the financial rescue package will not be sufficient to turn the US economy around.
- Assess Krugman’s argument that the only way out of the crisis is a “good old Keynesian fiscal stimulus”..
Governments around the world have been reacting to the global financial crisis by cutting interest rates in the hope that an expansionary monetary policy will help prevent recession or perhaps minimise the length, depth and severity of recession. In the articles below, we look at interest rate cuts in some countries, but there are many others. Why not use Google news or an equivalent site to try to find some more examples?
Europe
ECB rate cut sets tone for worldwide attempt to spark stalled economies Times Online (5/12/08)
Is the ECB dragging its heels? BBC News Online (4/12/08)
ECB cuts eurozone rates to 2.5% BBC News Online (4/12/08)
Sweden
Sweden, like us, seems to have things in hand Times Online (5/12/08)
Sweden cuts interest rates to 2% BBC News Online (4/12/08)
mesSweden cuts interest rates to 2% BBC News Online (4/12/08)
Australia
Australia cuts interest rates to seven year low Times Online (2/12/08)
Thailand
Large cut in Thai interest rates BBC News Online (3/12/08)
China
China’s central bank cuts rates BBC News Online (26/11/08)
Questions
- Explain the transmission mechanism whereby cuts in interest rates are transmitted to an increase in consumer expenditure.
- Using diagrams as appropriate, show how interest rates are determined in the money markets.
- Discuss the relative effectiveness of monetary policy and fiscal policy in boosting consumer expenditure.
Some economists believe that deflation is now a more serious threat than inflation. If this is the case then conventional monetary policy may not be enough to prevent deflation. In the article below, Gavyn Davies argues that the solution is to start thinking like South American dictators and print more money!
We must start thinking like South American dictators Guardian (13/11/08)
Questions
- Explain what is meant by “deflation”.
- Examine the link between deflation and depression.
- Explain why deflation requires a different policy response from inflation.
- Discuss the likely success of a policy of “printing money” in preventing deflation.
- Assess the impact of financing tax cuts through the sale of government bonds in a deflationary situation.
The current financial crisis has led many to wonder whether this may mark the ‘death of capitalism’. While this may almost certainly be an over-statement, it may mark a fundamental sea change in the way in which we oversee and manage a capitalist system. The articles below look at some of the implication of this possible change in approach.
Positive thinking Guardian (18/10/08)
A category error Guardian (10/10/08)
History can guide, yet there are new limits of the possible Guardian (10/10/08)
I’ve watched the economy for 30 years. Now I’m truly scared Guardian (28/10/08)
The new New Dealers Guardian (26/9/08)
Europe and America in the shadows as a new era dawns Telegraph (26/10/08)
Questions
| 1. |
Explain what is meant by a capitalist system of economic organisation. |
| 2. |
Assess the extent to which a ‘soft-touch’ regulatory approach can be blamed for the current financial crisis. |
| 3. |
Discuss the extent to which greater levels of government intervention and economic regulation are likely to result from the current financial crisis. |
| 4. |
Are we witnessing the death of capitalism? |