Until the credit crunch and crash of 2008/9, there appeared to be a degree of consensus amongst economists about how economies worked. Agents were generally assumed to be rational and markets generally worked to balance demand and supply at both a micro and a macro level. Although economies were subject to fluctuations associated with the business cycle, these had become relatively mild given the role of central banks in targeting inflation and the general belief that we had seen the end of boom and bust.
True, markets were not perfect. There were problems of monopoly power and externalities. Also information was not perfect. But asymmetries of information were generally felt to be relatively unimportant in the information age with easy access to market data through the internet.
Then it all went wrong. With the exception of a few economists, people were caught unawares by the credit crunch. There was too little understanding of the complexities of securitisation and the leveraged risk in these pyramids of debt built on small foundations. And there was too little regard paid to the potentially destructive power of speculation and herd behaviour.
So how should economists model what has been happening over the past three years? Do we simply need to go back to Keynesian economics, which emphasised the importance of aggregate demand and the ability of economies to settle at a high unemployment equilibrium? Can the persistence of high unemployment in the USA and elsewhere be put down to a lack of demand or is the explanation to be found in hysteresis: the persistence of a problem after the initial cause has disappeared? Can failures of markets be incorporated into standard microeconomics?
Or do we need a new paradigm: one that emphasises the behaviour of economic agents and examines how people act when there are information asymmetries? These are the questions that are examined in the podcast below. It is an interview with Nobel Prize winning economist, Joseph Stiglitz.
Podcast
Joseph Stiglitz: ‘Building blocks’ of a new economics BBC Today Programme (25/8/10)
Articles
Needed: a new economic paradigm Financial Times, Joseph Stiglitz (19/8/10)
Obama should get rid of Geithner, Summers Market Watch, Wall Street Journal, Darrell Delamaide (25/8/10)
This rebel’s heresy is not so earth-shaking Fund Strategy, Daniel Ben-Ami (23/8/10)
Questions
- What are Stiglitz’s criticisms of the economics profession in recent years?
- What, according to Stiglitz, should be the features of a new economic paradigm?
- Is such a paradigm new?
- Provide a critique of Stiglitz’s analysis.
- What do you understand by ‘behavioural economics’? Would a greater understanding of human behaviour by economists have helped avert the credit crunch and subsequent recession?
What will happen to interest rates over the next two or three years? There is considerable disagreement between economists on this question at the moment.
There are those who argue that recovery in the UK, the USA and Europe is faltering. With much tighter fiscal policy being adopted as countries attempt to claw down their deficits, there is a growing fear of a double-dip recession. In these circumstances central banks are likely to keep interest rates at their historically low levels for the foreseeable future and could well embark on a further round of quantitative easing (see Easy money from the Fed?). But what about inflation? With demand still expanding in developing countries and commodity prices rising, won’t cost pressures on inflation continue? Those who forecast that interest rates will stay low, argue that the pressure on commodity prices will ease as global demand slows. Also, in the UK, now that sterling is no longer depreciating, this will remove a key ingredient of higher inflation.
These views are not shared by other economists. They argue that interest rates could soar over the next two years. In fact, one economist, Andrew Lilico, the Chief Economist at Policy Exchange argues that interest rates in the UK will reach 8% by 2012. Central to their argument is the role of the money supply. The monetary base has been expanded enormously through programmes of quantitative easing. And yet, consumer credit has fallen. When the economy does eventually start to recover strongly, Lilico and others argue that there is a danger that consumer credit and broad money will expand rapidly, thereby fuelling inflation. But won’t the spare capacity that has built up during the recession allow the increase in aggregate demand to be met by a corresponding increase in output, thereby keeping inflation low. No, say these economists. A lot of capacity has been lost and output cannot easily expand to meet a rise in demand.
It’s not uncommon for economists to disagree! See, by reading the articles below, if you can unpick the arguments and establish where the disagreements lie and whose case is the strongest.
Articles
America’s century is over, but it will fight on Guardian, Larry Elliott (23/8/10)
Rates to remain low for foreseeable future Interactive Investor, Rhian Nicholson (18/8/10)
BoE gets benefit of doubt on inflation – for now Reuters, Christina Fincher (19/8/10)
BGilts reflect continued uncertainty AXA Elevate, Tomas Hirst (23/8/10)
A bull market in pessimism The Economist (19/8/10)
Interest rates ‘may hit 8%’ by 2012 says think tank BBC News (22/8/10)
Interest rates ‘may hit 8pc’ in two years Telegraph, Philip Aldrick (21/8/10)
Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says Bloomberg, Scott Lanman and Simon Kennedy (23/8/10)
Inflation, not deflation, Mr. Bernanke Market Watch, Andy Xie (22/8/10)
Inflation comes through the door and wisdom flies out of the window Telegraph, Liam Halligan (21/8/10)
Data
British Government Securities, Yields Bank of England
Bankstats: Data on UK money and lending Bank of England
Questions
- Summarise the arguments of those who believe that interest rates will stay low for the foreseeable future.
- Summarise the arguments of those who believe that interest rates will be significantly higher by 2010.
- What factors will be the most significant in determining which of the two positions is correct?
- Why are the yields on long-term bonds a good indicator of people’s expectations about future inflation and monetary policy?
- Why has consumer credit fallen? Why might it rise again?
- Why may unemployment not fall rapidly as the economy recovers? Is this an example of hysteresis?
The latest ONS labour market release reveals that in the three months to April the number of people unemployed in the UK was 2.472 million, up by 23,000 on the previous three months (i.e. the three months to January). The rate of unemployment – the number of people unemployed expressed as a percentage of those economically active – nudged upwards to 7.9% from 7.8% in the previous three months.
In a previous article A labour challenge for Osborne we considered the possibility that some of the emerging patterns in the labour market numbers could act as an impediment on the future potential output of the UK economy. The latest figures seem to offer little obvious comfort in this respect. Here, we note three causes for possible concern.
Firstly, we note the continued rise in inactivity. Of those of working age, inactivity rose by a further 29,000 in three months to April to stand at 8.186 million. This is an historic high and equates to 21.5% of the potential working population.
Secondly, we note the continued rise in long-term unemployment. The number of people unemployed for more than one year rose by 85,000 in the three months to April to stand at 772,000. This compares with 399,000 in the same three month period in 2007, just as the first clear signs of the impending financial crisis were being drawn to the public’s attention. In other words, this measure of long-term unemployment has effectively doubled since the financial crisis. But, more than this, 31.2% of those unemployed have been so for at least one year.
Thirdly, we note the high levels of youth unemployment. In the three months to April the number of unemployed people aged 18-24 was 713,000. This was down on the previous three months, but by a mere 2,000. The unemployment rate amongst 18-24 year-olds is 17.3% which is more than double the overall unemployment rate of 7.9%.
Aside from the very obvious personal costs of unemployment and of inactivity, each of these labour market issues poses important economic challenges for the country and its policy-makers. These are difficult challenges at the best of times. But, they could hardly be more difficult given the current national and international economic environment and, of course, the tendency for fiscal consolidation both at home and abroad.
Articles
Unemployment: public sector feels the pain as jobless hits 2.47 million Telegraph, Harry Wallop (16/6/10)
Unemployment: what the experts say Guardian (16/6/10)
Unemployment rises as public sector shrinks Financial Times, Brian Groom (16/5/10)
UK unemployment rises to 2.47 million BBC News (16/6/10)
Unemployment levels a ‘challenge’ for government: Interview with Work and Pensions minister, Chris Grayling BBC News (16/6/10)
Data
Latest on employment and unemployment Office for National Statistics (16/6/10)
Labour Market Statistics, June 2010 Office for National Statistics (16/6/10)
Labour market statistics portal Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission
Questions
- Evaluate the possible consequences for the UK economy, both now and in the future, of: (i) high and rising levels of inactivity; (ii) high and rising levels of long-term unemployment; and (iii) high levels of youth unemployment.
- Again, thinking about the issues of labour market activity, the duration of unemployment and youth unemployment, what policy recommendations would you make in trying to tackle them?
- If you were writing this blog in a year’s time, what would you expect will have happened to levels or rates of inactivity, long-term unemployment and youth unemployment? Explain your answer.
- Again, if you were writing this blog in a year’s time, would you expect to find any other emerging patterns in labour market statistics? Explain your answer.
With the Conservatives and Liberal Democrats now in power in the UK and with the Labour Party, having lost the election, being now in the midst of a leadership campaign, politicians from across the political spectrum are balming Gordon Brown for the ‘mess the country’s in’. The UK has a record budget deficit and debt, and is just emerging from a deep recession, when only a few years ago, Gordon Brown was claiming the end of boom and bust. But is the condition of the UK economy Mr Brown’s fault? Would it have been any better if others had been in charge, or if there had been even greater independence for the Bank of England of if there had been an Office of Budget Responsibility (see)?
The following podcast by Martin Wolf, chief economics commentator of the Financial Times, considers this question. He argues that:
Everybody would like to blame Gordon Brown for the financial crisis. But he was only acting in line with the national consensus on economic policy.
The economic legacy of Mr Brown FT podcasts, Martin Wolf (13/5/10)
The economic legacy of Mr Brown Financial Times, Martin Wolf (13/5/10)
Questions
- Explain what is meant by ‘the great moderation’.
- Should regulation of the banks be handed back to the Bank of England?
- Why may controlling inflation not necessarily result in stable economic growth? Is this a case of Goodhart’s Law?
- Why was the UK economy especially fragile during the banking crisis and its aftermath?
- What, according to Martin Wolf, was Mr Brown’s biggest mistake?
- Could a mistake be now being made by following the conventional wisdom that cutting the deficit is the solution to achieving sustained recovery?
It was the 12th May 2010 and George Osborne’s first day as the UK’s new Chancellor of the Exchequer. His arrival at HM Treasury coincided with the latest ONS labour market release. Just in case you were rather distracted by political events, we take the opportunity here to trawl through some of the latest labour market numbers, focusing, in particular, on those that may pose real challenges for George Osborne and the new coalition government.
From the ONS release we observe that in the three months to March the total number of economically active individuals in the UK was 31.340 million. Of these, 28.829 million were employed while 2.510 million were unemployed (but actively seeking work). The number of people employed fell by 76,000 over the quarter (and by 341,000 over the year) while the number unemployed rose by 53,000 (279,000 over the year).
Now we consider the rate of unemployment. The unemployment rate expresses the total number unemployed as a percentage of those economically active. Over the first quarter of 2010 the unemployment rate rose to 8.0%, a rise of 0.2 percentage points on the previous quarter and a rise of 0.9 percentage points from a year earlier. It is the highest quarterly unemployment rate since the 8.1% recorded in Q3 1996.
Next, consider unemployment and gender. Of those unemployed in the first quarter of the year, 61.6% were male and 38.4% were female. The increase in the male unemployment rate during the economic slowdown has been especially marked. The male unemployment rate in Q1 2010 rose to 9.2%, up from 7.9% a year ago and 5.6% two years ago. The female unemployment rate has increased to 6.7% in Q1 2010 from 6.1% in Q1 2009 and 4.8% in Q1 2008. Therefore, over the past two years the male unemployment rate has risen by 3.6 percentage points while the female rate has increased by 2.1 percentage points.
Another troubling issue is unemployment amongst the young. The unemployment rate amongst those aged 18-24 is considerably higher than the overall rate. In the three months to March the unemployment rate for this age group was 17.9% compared with the overall rate of 8%. But, more than this, the current rate of unemployment amongst those aged 18-24 is actually higher than during the early 1990s when it peaked at 17.8% in Q1 1993. The male unemployment rate amongst this age group is especially high having risen to 20.7% in the first quarter of the year, up 2 percentage points on the year and up from 14.2% in Q1 2008. The female rate amongst this age group is 14.6%, up 1.3 percentage points on the year and up from 9.8% in Q1 2008.
Another issue that emerges out of the statistics is the rise in long-term unemployment. The number of people unemployed for more than one year rose to 757,000 in the first quarter, up from 509,000 a year ago and 397,000 two years ago. Perhaps, it is easier to see the magnitude of this problem when we note that 30.2% of those unemployed have been unemployed for at least one year – this is up from 24.5% in Q1 2008. Amongst females, 25% of those unemployed have been without work for at least one year, but amongst males this rises to 33.4%. In other words, one-quarter of unemployed females and one-third of unemployed males are now regarded as being long-term unemployed.
As troubling as these numbers are, the issue of long-term unemployment is one that, over the past two decades, has never really gone away. On average since 1992, 29.4% of those unemployed have been without work for at least one year (34.2% amongst men and 21.6% amongst women).
And now to our final observation: the historically high number of economically inactive individuals of working age. In the first quarter of 2010, 8.166 million of those of working age were economically inactive, up by 86,000 over the year. As a proportion of the working population, this equates to 21.5%, which is not in itself a record high – during 1983 it reached 23.2% – but it is, nonetheless, up from 20.7% a year ago. The inactivity rate amongst those of working age is highest amongst females at 25.9% (up from 25.7% a year ago) compared with 17.4% amongst men (up from 16.1% a year ago).
One factor that helps to explain the overall rise in inactivity is the 43,000 increase in the number of students who have become economically inactive over the past year. But, we also note upward pressures on inactivity over the past year from the increase of 37,000 in the number of people who are ‘long-term sick’ and from the 13,000 increase in the number who feel ‘discouraged’ from seeking work. These pressures highlight some of the many costs that arise from unemployment and potentially raise some tricky policy challenges for the new government.
Articles
UK unemployment rises in first quarter Investment Week, Hannah Smith (12/5/10)
UK unemployment climbs to a 16-year high Irish Independent, Svenja O’Donnell Brian Groom (13/5/10)
UK unemployment increases to 2.51 million BBC News (12/5/10)
Unemployment: what the experts say Guardian (12/5/10)
UK unemployment hits highest since 1994 The Times, Robert Lindsay (12/5/10)
Jobs recovery still fragile, ‘dire’ data shows Financial Times, Brian Groom (12/5/10)
Scottish unemployment rises by 10,000 in three months BBC News (12/5/10)
Unemployment rises to highest level since 1994, ONS says inthenews.co.uk, Sarah Garrod (12/5/10)
Data
Latest on employment and unemployment Office for National Statistics (12/5/10)
Labour Market Statistics, May 2010 Office for National Statistics (12/5/10)
Labour market statistics page Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission
Questions
- What is meant by somebody being economically active? Do they have to be in a job to be economically active?
- Using the figures in the commentary, calculate the number of economically active people in Q1 2009 and so the change up to Q1 2010.
- If the number of people unemployed rises does this mean the rate of unemployment rises? Explain your answer.
- What factors might explain the persistent problem of long-term unemployment? What policy prescriptions would you offer the new coalition government in attempting to tackle this problem?
- Looking back through the commentary, pick out some of the notable gender differences. What factors might help to explain these?
- Are there any factors identified in the commentary that may be affecting the economy’s potential output?