On 28 November 2010, a deal was reached between the Irish government, the ECB, the IMF and other individual governments to bail out Ireland. The deal involved an €85bn package to bail out the collapsing Irish banks. Not all of the money went directly to the banks and the Irish government did set aside some of the loan. However, some of this money will now be required by four key lenders in Ireland, after a stress test by a group of independent experts found that the Republic of Ireland’s banks need another €24bn (that’s £21.2bn) to survive the continuing financial crisis. Allied Irish Banks require €13.5bn, Bank of Ireland €5.2bn, Irish Life €4bn and EBS a meager €1.5bn. The governor of the central bank, Professor Patrick Honohan said:
‘The new requirements are needed to restore market confidence, and ensure banks have enough capital to meet even the markets’ darkest estimates.’
The stress test focused on an assumption of a ‘cumulative collapse’ in property prices by 62%, together with rising unemployment. Following this, the Irish Finance Minister announced the government’s intention to take a majority stake in all of the major lenders. The Irish banks have been told they need to reduce the net loans on their balance sheets by some €71bn (£63bn) by the end of 2013. This process of deleveraging is likely to generate further losses, as many loans and assets will be sold for less than their true value. The causes of this ongoing financial crisis can still be traced back to the weakness within the Irish economy and more specifically to mortgage accounts being in arrears following the property market bubble that burst. A key question will be whether this second bail-out is sufficient to restore much needed confidence in the economy and particularly in the banking sector. The articles below consider this ongoing crisis.
Irish hope it is second time lucky for bail-out Telegraph, Harry Wilson (1/4/11)
Irish Bank needs extra €24bn euros to survive BBC News (31/3/11)
Ireland forced into new £21bn bailout by debt crisis Guardian, Larry Elliott and Jill Treanor (31/3/11)
The hole in Ireland’s banks is £21bn BBC News Blogs: Peston’s Picks, Robert Peston (31/3/11)
ECB has given Ireland serious commitment Reuters (1/4/11)
Ireland banking crisis: is the worst really over? Guardian: Ireland Business Blog, Lisa O’Carroll (1/4/11)
Ireland: a dead cert for default Guardian, Larry Elliott (1/4/11)
Timeline: Ireland’s string of bank bailouts Reuters (31/3/11)
Questions
- What is the process of deleveraging? Why is likely to lead to more losses for Ireland’s banks?
- What are the causes of the financial crisis in Ireland? How do they differ from financial crises around the world?
- What are the arguments for and against bailing out the Irish banks?
- Will this second bailout halt the possible contagion to other Eurozone and EU members?
- If this second bailout proves insufficient, should there be further intervention in the Irish economy?
Gross Domestic Product (GDP) is a measure of the total value of goods and services produced in the domestic economy. It gives us an idea about whether national output is growing or falling and by how much. A recession represents a period of 2 consecutive quarters where economic growth is negative. Following the quarters of declining growth, the UK economy slowly began to pick up, but in the final quarter of 2010, economic growth once again turned negative. Data first showed a decline of 0.5%, which was then revised down to 0.6%. However, the most recent data from the ONS has put the decline in economic growth back to just 0.5% and the snow we experienced is supposedly to blame. Still a decline, but not as much as previously thought.
What does this mean for the economy? It might be better than previously thought, but it does little to change the economic outlook for the economy. Furthermore, the UK’s position remains relatively weak compared to other nations. As Chris Williamson from Markit said:
“The decline [in growth] overstates the weakness in the economy, reflecting the bad weather at the end of last year, but is nevertheless still a dire reading compared to the UK’s peers.”
The UK also saw a declining trade balance in the final quarter of 2010 to £27bn, showing that the UK was importing more than it was exporting. This was the second biggest deficit since the second quarter of 2009. Whilst the data for growth is a little better, the key for the UK economy will be what happens in Q1 of 2011, especially given that inflation is so far above the target. In order to get inflation back to its 2% target, interest rates need to rise, but this may put the economic recovery in jeopardy. The key is likely to be confidence. If confidence returns to the economy, aggregate demand may begin to rise and put the economy back on track to achieve its 1.5% forecast rate of growth.
UK GDP less bad than forecast at end-2010, Q1 key Reuters (29/3/11)
UK GDP figures show smaller fall BBC News (29/3/11)
UK GDP shrinks by less than expected: reaction Telegraph (29/3/11)
UK growth figures: what the economists say Guardian (29/3/11)
Disposable income falls by 0.8% The Press Association (29/3/11)
British economy shrank 0.5% in fourth quarter Associated Press (29/3/11)
UK GDP figures revised higher The Economy News (29/3/11)
Questions
- What is GDP? Is it a good measure of the standard of living in a country?
- To what extent does the revised figure change the economic outlook for the UK economy?
- How do you think the Monetary Policy Committee will be affected in their decision on changing interest rates, given this new GDP data?
- What factors are worsening the UK’s relative to other countries who also suffered from the recession?
- How were financial and currency markets affected by the revised GDP data? Was it expected?
The Chancellor of the Exchequer, George Osborne, delivered the annual Budget on 23 March. He was very keen to have a ‘Budget for growth’ given the pessimism of consumers (see Table 1, UK, line 3, in Business and Consumer Survey Results, February 2011) and the bad news on inflation (see 4.4% and rising?).
But what could he do? Despite being urged by the Labour opposition to stimulate aggregate demand by cutting the deficit more slowly, he ruled out this alternative. It would be perceived by markets, he argued, as a sign that he was ‘gong soft’ on the commitment to tackle the deficit.
If stimulating aggregate demand directly was out, the alternative was to use supply-side policy: to provide more favourable conditions for business by cutting ‘red tape’, providing tax incentives for investment, reducing regulations, simplifying tax, cutting corporation tax financed by tax increases elsewhere, creating 21 ‘enterprise zones’ and funding extra apprenticeships and work experience placements.
The links below give details of the measures and consider their likely effectiveness. Crucially, the Budget will be much more successful in encouraging investment if people think it will be successful. In other words, its success depends on how it affects people’s expectations. Will it help confidence to return – or will the impending tax increases and cuts on government expenditure only make people more pessimistic?
Webcasts
Budget: Chancellor George Osborne opens speech BBC News (23/3/11)
Budget: Osborne wants to ‘simplify taxes’ BBC News (23/3/11)
Budget: Osborne lowers corporation tax BBC News (23/3/11)
Budget: BBC Economics editor Stephanie Flanders BBC News (23/3/11)
Budget: BBC business editor Robert Peston BBC News (23/3/11)
Enterprise Zones on the way back Channel 4 News, Siobhan Kennedy (22/3/11)
Articles
Osborne’s Budget ‘to fuel growth’ BBC News (23/3/11)
A budget for big business BBC News blogs, Peston’s Picks, Robert Peston (23/3/11)
Budget 2011: tax grab is the real story Guardian, Patrick Collinson (23/3/11)
Budget 2011 – full details Independent (23/3/11)
Osborne shakes up corporation tax Financial Times, Vanessa Houlder (23/3/11)
Osborne unveils ‘Budget for growth’ Financial Times, Daniel Pimlott and Chris Giles (23/3/11)
Budget 2011: Guardian columnists’ verdict Guardian, Jackie Ashley, Martin Kettle, George Monbiot, Julian Glover (23/3/11)
Budget 2011: a million low-paid people escape tax but fiscal drag catches others The Telegraph, Ian Cowie (23/3/11)
Budget 2011: some good news and lots of micro-management The Telegraph, Janet Daley (23/3/11)
Micro trumps macro BBC News Blogs: Stephanomics, Stephanie Flanders (23/3/11)
George Osborne, growing giant of the Tory party, launches ‘slow burn’ Budget Guardian, Nicholas Watt (23/3/11)
Budget documents
2011 Budget, HM Treasury (23/3/11)
Budget 2011 press notice, HM Treasury (23/3/11)
2011 Budget documents, HM Treasury (23/3/11)
Questions
- What supply-side policies were included in the Budget?
- What will be the impact of the Budget measures on aggregate demand?
- What are the major factors that are likely to influence the rate of economic growth over the coming months?
- What would have been the advantages and disadvantages of a more expansionary (or less contractionary) Budget?
- What will be the effects of the Budget measures on the distribution of income (after taxes and benefits)?
In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. Since then it has remained at the same level. Interest rates are used by the Bank of England, which aims to keep inflation at the 2% target within a 1% gap either side. However, inflation has been above 3% for some 15 months and the latest figures for February 2011 show that inflation is rising. In January, it was 4%, but data for February calculates an inflation rate of 4.4% – significantly above the Bank of England’s target rate of 2% and above the forecast rate for the month.
One of the causes of such high inflation is the price of fuel, food and clothing. No-one can have failed to notice that petrol prices are higher than ever and this is one of the factors contributing to an increase in the level of prices throughout the economy. Clothing and footwear costs, which rose by 3.6% after the January sales have also contributed to this rising figure and will put increasing pressure on the MPC to raise interest rates in the not so distant future.
In the February 2011 meeting of the Monetary Policy Committee, interest rates were kept at 0.5%, despite markets pricing the chance of a rate rise at 20%. The negative growth experienced in the final quarter of 2010 is likely to have influenced this decision, but will the inflation data we’re now seeing influence the next meeting of the MPC. This undoubtedly puts pressure on the central bank to increase interest rates to try to get inflation back on target. The cost? It could put the recovery in jeopardy and create the possibility of a double-dip recession. There is a conflict here and whatever happens to interest rates, some groups will say it’s the wrong decision. As David Kern said:
“The MPC must be careful before it takes action that may threaten the fragile recovery, particularly in the face of a tough austerity plan.”
Perhaps the Budget will provide us with some more information about how the government intends to cut the hole in public finances, ensure that the economy does not fall back into recession and keep inflation under control.
UK inflation revives talk of early interest rate rise Reuters, David Milliken and Christina Fincher (22/3/11)
How to inflation-proof your savings Telegraph, Emma Simon (22/3/11)
UK inflation rate rises to 4.4% in February BBC News (22/3/11)
Interest rates: What the economists say Guardian (10/2/11)
Q&A: Impact of rising inflation Guardian, Phillip Inman (22/3/11)
Inflation soars to over double target rate Sky News, Hazel Baker (22/3/11)
Inflation and public borrowing add to budget 2011 headaches Guardian, Larry Elliott (22/3/11)
Inflation cutting savers’ options BBC News, Kevin Peachey (22/3/11)
Inflation: What the economists say Guardian (22/3/11)
Questions
- Is inflation likely to continue going up? What might stop the rise?
- Why are interest rates such an important tool of monetary policy?
- What is the relationship between interest rates and inflation?
- What are the costs of high inflation? Does anyone benefit?
- Who would gain and who would lose if interest rates are increased in the next MPC meeting?
- Which factors have contributed towards rising inflation in the UK? Is it cost-push or demand-pull inflation?
- Why does this pose a dilemma for the government in terms of public finances and the recession?
An interesting article by Stephanie Flanders, the BBC’s Economics editor. She asks just how much (or how little) the pound in our pocket is now worth. With inflation above target, growth very slow and tax and benefit changes to cut the government deficit, everyone is feeling the squeeze. A key fact that Flanders identifies is that only those in the highest income quintile have actually lost from changes in the tax and benefits system: everyone else has (or will) gain. A very interesting read!
The shrinking pound in your pocket BBC News, Stephanomics (21/3/11)
Questions
- What are the main factors that have contributed to lower living standards this year? Explain how each factor works.
- What changes to taxes and benefits have occurred and what changes can we expect over the coming months and years? Who is likely (a) benefit and (b) lose from each change?
- Is it right that the richest families have been affected the most? Find an economic argument for both sides of the debate.
- Why have pensioners lost relatively more than other groups?