In December 2011, the ECB provided some €489bn to banks in the form of three-year loans at low interest rates (1%) through open-market operations (see Will new ECB repo operations support the eurozone bond market?).
These ‘Longer-term refinancing operations’ or ‘LTROs’ are designed to ease the burden on European banks which have been struggling to persuade markets that they are dealing with their large amounts of toxic debt, some of which is sovereign debt. Indeed, some of the ECB loans have been used to purchase Italian and Spanish bonds, thereby reducing the likelihood that these countries will default on their debts – at least for the timebeing.
On 29 February 2012, the ECB offered another round of LTROs. Some 800 banks borrowed €530bn under the scheme, bringing the total to a little over €1tr. Initially, much of the money has been put back on overnight deposit with the ECB. The hope, however, is that the loans will be used to support increased credit throughout the eurozone and to fund further purchases of sovereign debt.
But will the increased narrow money supply in the eurozone through these open-market operations result in increased broad money and increased spending and growth? The answer to that depends a great deal on confidence: confidence of banks to lend to firms and consumers; confidence of firms and consumers to borrow. The hope is that the extra money supply will not simply see a corresponding reduction in the velocity of circulation.
The following articles consider the likely effects of these longer-term repos on the real economy.
Articles
ECB hands €529bn in emergency loans to European banks Guardian, Heather Stewart (29/2/12)
Q&A: The ECB’s bank funding programme The Telegraph, Angela Monaghan (29/2/12)
Fighting Debt with Debt Forbes, Bob McTeer (5/3/12)
Is ECB’s €1trn cash boost just the tip of the iceberg? Investment Week, Kyle Caldwell, Dan Jones (5/3/12)
Banks deposit record €821bn at ECB Financial Times, Mary Watkins (5/3/12)
Europe economy may see slim gain from supersize funding: poll Reuters, Sumanta Dey (5/3/12)
Who is the ECB helping? BBC News, Stephanie Flanders (29/2/12)
ECB information on OMOs
Open Market Operations ECB
Questions
- Explain how longer-term refinancing operations work.
- What will determine how much of these ECB loans will be lent to companies?
- Explain what is meant by (a) the velocity of circulation; (b) the money multiplier. Why will the size of these two determine the likely success of the ECB’s LTRO programme?
- Why may the ECB’s actions boost market sentiment? Why might they have the opposite effect?
- Explain what is meant by the “continued de-leveraging by banks”. How does this impact on the money multiplier?
A negative outlook for the UK economy – at least that’s what Moody’s believes. The credit rating agency has put the UK economy’s sovereign credit rating, together with 2 other European nations (France and Austria) on the ‘negative outlook’ list.
The UK currently has a triple A rating and we have been able to maintain this despite the credit crunch and subsequent recession. However, with weak economic data and the continuing crisis in the eurozone, Moody’s took the decision to give the UK a ‘negative outlook’, which means the UK, as well as France and Austria have about a 30% chance of losing their triple A rating in the next 18 months.
Both Labour and the Coalition government have claimed this decision supports their view of the economy. Labour says this decision shows that the economy needs a stimulus and the Coalition should change its stance on cutting the budget deficit. However, the Coalition says that it shows the importance the Credit ratings agencies attach to budget deficits. Indeed, Moody’s statement showed no signs that it feels the UK should ease up on its austerity measures. The statement suggested the reverse – that a downgrade would only occur if the outlook worsened or if the government eased up on its cuts. The Coalition’s focus on cutting the deficit could even be something that has prevented the UK being put on the ‘negative watch’ list, as opposed to the ‘negative outlook’ list. The former is definitely worse than the latter, as it implies a 50% chance of a downgrade, rather than the current 30%.
The triple A rating doesn’t guarantee market confidence, but it does help keep the cost of borrowing for the government low. Indeed, the UK government’s cost of borrowing is at an historic low. A key problem therefore for the government is that there is a certain trade-off that it faces. Moody’s says that 2 things would make the UK lose its rating – a worsening economic outlook or if the government eases on its austerity plans. However, many would argue that it is the austerity plans that are creating the bad economic outlook. If the cuts stop, the economy may respond positively, but the deficit would worsen, potentially leading to a downgrade. On the other hand, if the austerity plans continue and the economy fails to improve, a downgrade could also occur. The next few days will be crucial in determining how the markets react to this news. The following articles consider this issue.
The meaning of ‘negative’ for Mr Osborne and the UK BBC News, Stephanomics, Stephanie Flanders (14/2/12)
Relaxed markets remain one step ahead of Moody’s move The Telegraph, Philip Aldrick (14/2/12)
George Osborne tries to be positive on negative outlook for economy Guardian, Patrick Wintour (14/2/12)
Moody’s wants it may cut AAA-rating for UK and France Reuters, Rodrigo Campos and Walter Brandimarte (14/2/12)
Moody’s rating decision backs the Coalition’s path of fiscal consolidation The Telegraph, Damian Reece (14/2/12)
Moody’s rating agency places UK on negative outlook BBC News (14/2/12)
Britain defends austerity measures New York Times, Julia Werdigier 14/2/12)
Questions
- What does a triple A rating mean for the UK economy?
- Which factors will be considered when a ratings agency decides to change a country’s credit rating? What similarities exist between the UK, France and Austria?
- Which political view point do you think Moody’s decision backs? Do you agree with the Telegraph article that ‘Moody’s rating decision backs the Coalition’s path of fiscal consolidation’?
- If a country does see its credit rating downgraded, what might this mean for government borrowing costs? Explain why this might cause further problems for a country?
- How do you think markets will react to this news? Explain your answer.
- What action should the government take: continue to cut the deficit or focus on the economic outlook?
- Why has the eurozone crisis affected the UK’s credit rating?
In the third quarter of 2011, the UK economy grew by 0.6% – nothing to shout about, but at least it was positive. Since then there has been growing concern about the state of the recovery with many commentators widely expecting to see much lower growth in the final quarter of last year.
Today, those commentators were proved right, as official figures released show the UK economy shrank by 0.2%. It doesn’t mean we’re in a recession (that requires 2 successive quarters of negative growth), but if growth doesn’t pick up in quarter 1 of 2012, then ‘Double-Dip Recession’ headlines will fill the front page.
Despite the disappointment that the UK economy has shrunk, the figures were not wholly unexpected, especially given the data released a week or so before, which showed unemployment had risen. Furthermore, with the crisis in the eurozone and many other countries still struggling to mount an economic recovery, there have been few external stimuli for the UK.
Although the fall in growth was larger than expected (0.2% as opposed to the predicted 0.1%), the UK economy is expected to grow throughout 2012. However, the IMF has reduced its forecast annual growth rate from 1.6% to 0.6%. The economic climate for 2012 remains uncertain and much will depend on developments in the eurozone. Further problems could spell trouble, but if there is an improvement in the fortunes of Europe, confidence could return to the markets and economic recovery could be faster. Ian McCafferty, the Chief Economic Adviser of the CBI said:
While the acute fears seen at the end of last year over global demand may be subsiding, 2012 will prove to be a difficult year for UK manufacturing, as the crisis in the eurozone – our biggest export market – has yet to reach any definitive resolution.
Whether or not we do move into a double-dip recession is uncertain and following this latest data, many commentators say it is a 50:50 change; and even then it hinges on many factors. However, even if quarter 1 of 2012 sees negative growth and hence a return to recession for the UK, Chris Williamson from Markit said that ‘there are growing indications that any downturn is likely to be ‘mild and short-lived’. The following articles consider the state of the UK economy.
Unemployment to soar as UK heads back into recession The Telegraph, Philip Aldrick (25/1/12)
UK economy shrinks by 0.2% in last 3 months of 2011 BBC News (25/1/12)
UK GDP: what the economists say Guardian (25/1/12)
UK recession threat: can we dodge the double dip? Citywire, Chris Marshall (25/1/12)
Double-dip recession fears as UK economy shrinks 0.2 percent Independent, Peter Cripps (25/1/12)
PM says ‘no complacency’ on economy Financial Times, Norma Cohen and Elizabeth Rigby (25/1/12)
The UK economy is shrinking. Time to listen to gloom-mongers? Guardian, Phillip Inman (25/1/12)
UK economy shrinks in Q4, raising recession fears The Associated Press (25/1/12)
FTSE CLOSE: Stocks slide as 0.2% GDP fall sparks recession fears; banks among the biggest fallers This is Money (25/1/12)
Sorrell: ‘UK will avoid double-dip recession’ Sky News, Tom Rayner (25/1/12)
Recovery in rehab BBC News, Stephanie Flanders (25/1/12)
Questions
- How is a recession defined? What are the typical characteristics of a recession? (Think about the macroeconomic objectives).
- Which particular sectors of the UK economy were the most severely affected in Q4 of 2011?
- Examine the main causes of the UK’s decline in national output.
- Which of the causes identified in question 3 do you think is the key factor keeping UK national output from growing? Explain your answer.
- Why is there a growing presence of companies from emerging markets in the top 100?
- Why are many commentators suggesting that even if the UK goes into a recession, it is likely to be ‘mild and short-lived’?
- What has happened to stock markets following the release of this latest economic data?
- Evaluate the options open to the Coalition government in stimulating the UK economy. To what extent would your policy solution damage the Coalition’s aim of cutting the UK’s structural budget deficit?
Disagreements are hardly an uncommon occurrence during Prime Minister’s Questions and today the key issue up for debate was UK unemployment. Figures released show that in the 3 months to November 2011, UK unemployment rose to 2.685 million – an increase of 118,000. The ONS said that unemployment now stands at 8.4% – the highest figure in well over a decade.
However, the increase in unemployment is not as high as it was in the 3 months previous to that, which is possibly an indication that the labour market is slowly beginning to recover and the government’s labour market policies are starting to take effect. The government claimed that cuts in the public sector will be compensated by growth in private sector jobs, but the evidence from the ONS did little to back this up.
The labour market is crucial for the recovery of the UK. Jobs mean income and income means consumer spending. If the job market remains uncertain and more people enter unemployment, consumer spending is likely to remain weak for some time. Chris Williamson, the chief economist at Markit:
The increase in unemployment, plus job security worries and low pay growth for those in work, means consumer spending may remain very subdued this year, despite lower inflation alleviating the squeeze on real incomes that caused so much distress to households in 2011.
One area of specific criticism leveled at the Coalition was the extent of youth unemployment, which reached 22.3%. Ed Miliband said the government had cut ‘too far and too fast’ and that it will be remembered for standing aside and doing nothing ‘as thousands of people find themselves unemployed’. The figures are clearly concerning, but the Coalition maintains that policies designed to tackle the labour market are beginning to take effect and over the coming months, the economy will begin to see a decline in the unemployment rate. The following articles look at the unemployment crisis.
Articles
UK unemployment rises to 2.8m Guardian, Heather Stewart (18/1/12)
Leaders clash in commons over jobless rise BBC News (18/1/12)
UK jobless rate hits new 17-year high Financial Times, Brian Groom (18/1/12)
Unemployment rise: reaction The Telegraph, Louise Peacock (18/1/12)
Unemployment total rises by 19000 The Press Association (18/1/12)
Politicians give cautious welcome as quarterly unemployment falls by 1000 in Wales WalesOnline, Claire Miller (18/1/12)
Employment Minister: unemployment is too high The Telegraph (18/1/12)
Chris Grayling: ‘Unemployment figures are complex’ BBC News (18/1/12)
Data
Unemployment in graphics BBC News (18/1/12)
Data Tables: Labour Market Statistics Excel Spreadsheets ONS January 2012
Questions
- What type of unemployment is being referred to in the above articles?
- Explain the mechanism by which a recession will lead to higher unemployment.
- Using a diagram to help your explanation, analyse the impact of a fall in aggregate demand on the equilibrium unemployment rate and wage rate. What happens to unemployment if wages are sticky downwards?
- What can explain such different stories of unemployment between Scotland, England and Wales?
- What policies have the Coalition implemented to tackle the rising problem of unemployment? On what factors will their effectiveness depend?
- Why is the UK’s job market so important for the future economic recovery of the UK?
There has been much talk of a double-dip recession, with many suggesting that the UK economy is already in a recession. However, according to the British Chambers of Commerce (BCC), a recession is not inevitable. Although the businesses surveyed showed that the economy had significantly weakened, John Longworth the Director General of the BCC said that a ‘new recession is not a foregone conclusion’.
Even though many of the figures showed a continued weakening of the economy, the results are still not as bad as they were back in 2008. The concern is that if the weakness continues, as it is predicted to do in the first quarter of 2012, confidence will remain low and then the economy may stagnate and a recession becomes a more likely scenario. Action is needed to prevent this from happening, especially with the eurozone crisis still causing concern. As John Longworth said:
The UK does have the potential to recover and make its way in the world. We have the talent, the energy and the enterprise. All we need is an environment that puts business first.
At the beginning of December 2011, many analysts thought retail sales would remain low, as they had been throughout 2011. However, British consumers came through in the second half of December and retail sales were up by 4.1% compared with a year ago. According to the British Retail Consortium, this Christmas rush should not be seen as a fundamental change in the direction of the economy and will have done little to boost the overall annual sales of most retailers.
Recession ‘not foregone conclusion’ Guardian (10/1/12)
UK economy likely to shrink amid eurozone crisis, says BCC The Telegraph, Angela Monaghan (10/1/12)
UK recession is not yet inevitable, survey says BBC News (10/1/12)
UK risks recession and lengthy stagnation – BCC Reuters, David Milliken (10/1/12)
U.K recession fears build Wall Street Journal, Ilona Billington (10/1/12)
BoE stimulus expansion may not be enough for recovery, BCC says (quick ad before article appears) Business Week, Scott Hamilton (10/1/12)
Questions
- How is a recession defined?
- What data has the BCC used to come to the conclusion that a recession is not inevitable?
- What action is needed by the government to tackle ‘short term stagnation and a lack of business confidence’?
- What could explain the 4.1% increase in sales in December compared with the previous year? Why is this data not thought to represent a ‘fundamental change in the circumstances of UK consumers’?
- What is expected to happen to UK inflation and employment during the first quarter of 2012?
- Why does the eurozone crisis present a problem for confidence and British exporters?
In December 2011, the ECB provided some €489bn to banks in the form of three-year loans at low interest rates (1%) through open-market operations (see Will new ECB repo operations support the eurozone bond market?).