The pound is regarded as an international currency, but its value has been declining throughout the financial crisis. Indeed, this downward trend is one of the factors that has prevented the recession in the UK from getting worse. As the exchange rate changes, the relative competitiveness of a country’s products changes and this therefore affects exports and imports.
However, despite a declining pound, exports from the UK have fallen and this has contributed to an unexpected global goods trade deficit in January of nearly £8 billion – the largest level since August 2008 and well above the forecast of £7 billion. This is putting further pressure on the pound. A key to the UK’s economic recovery was argued to be growth in exports, but this now appears to be a somewhat forlorn hope. The figures released show that exports slumped 6.9% to £19.5 billion in January, whilst imports only fell by 1.6%. A contributing factor might be the bad weather that hit the UK in January, but the long-term decline of manufacturing in Britain has also been put forward as a reason.
The following articles consider the UK’s trade deficit and the possibility of an export-led recovery.
Articles
January trade deficit widens as exports fall Guardian, Kathryn Hopkins (9/3/10)
UK trade gap widens to worst in 17 months BBC News (9/3/10)
Exports plunge heaps pressure on pound Independent (9/3/10)
Pound slides back against dollar and euro Guardian, Ashley Seager (21/9/09)
Trade gap widens despite weak pound Financial Times (9/3/10)
UK exports plunge by £1.4 billionThe Press Association (9/3/10)
Pound falls again on deficit fears Guardian (9/3/10)
UK trade gap widens as exports sink Wall Street Journal, Nicholas Winning (9/3/10)
Rebalancing, deferred BBC News blogs, Stephanomics Stephanie Flanders (9/3/10)
Global recovery is helping UK, says Bank of England’s Sentance Guardian, Larry Elliott (18/3/10)
Pound Declines as Investors Bet Bank of England Will Hold Rates BusinessWeek, Lukanyo Mnyanda (20/3/10)
Data
For UK balance of trade data, see UK Trade (Office for National Statstics)
For exchange rate data, see Statistical Interactive Database (Bank of England)
Questions
- How is the value of the pound determined?
- Illustrate a depreciation of the pound on a diagram. What are the factors that could cause this?
- When the value of the pound falls, why should UK goods become more competitive?
- Explain why an export-led recovery was a possibility for the UK economy. How can we use the transmission mechanisms to help explain this?
- Despite a weak pound, exports have fallen. What are the explanations for this?
- What are the consequences of a widening trade deficit and how can it be tackled?
On February 14, the Sunday Times published a letter by 20 eminent economists calling on the next government to cut the public-sector deficit more rapidly than that planned in last December’s pre-Budget report.
In order to minimise this risk and support a sustainable recovery, the next government should set out a detailed plan to reduce the structural budget deficit more quickly than set out in the 2009 pre-Budget report.
The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.
Then on 18 February the Financial Times published two letters, between them from more than 60 economists, backing Alistair Darling’s policy of delaying cuts until the recovery is firmly established. They openly disagreed with the 20 economists who wrote to the Sunday Times.
… while unemployment is still high, it would be dangerous to reduce the government’s contribution to aggregate demand beyond the cuts already planned for 2010-11 (which amount to 1 per cent of gross domestic product). Further immediate cuts – even supposing they are practicable – would not produce an offsetting increase in private sector aggregate demand, and could easily reduce it. History is littered with examples of premature withdrawal of the government stimulus, from the US in 1937 to Japan in 1997. With people’s livelihoods at stake, a responsible government should avoid reckless actions.
… A sharp shock now would not remove the need for a sustained medium-term programme of deficit reduction. But it would be positively dangerous. If next year the government spent less and saved more than it currently plans, this would not “make a sustainable recovery more likely”. The weight of evidence points in the opposite direction.
So why do such eminent economists have apparently such divergent views on tackling the public-sector deficit? Is there any common ground between them? What does the disagreement imply about the state of macroeconomics? Read the letters and articles and then try answering the questions.
Tories right on cuts, say economists Sunday Times, David Smith (14/2/10)
Letter: UK economy cries out for credible rescue plan Sunday Times, 20 economists (14/2/10)
Economists reject calls for budget cuts Financial Times, Jean Eaglesham and Daniel Pimlott (18/2/10)
Letter: First priority must be to restore robust growth Financial Times, Lord Skidelsky and others (18/2/10)
Letter: Sharp shock now would be dangerous Financial Times, Lord Layard and others (18/2/10)
Economists urge swift action to reduce budget deficit BBC News (14/2/10)
Economists back delay on government spending cuts BBC News (19/2/10)
Economists back delay on government spending cuts BBC News (19/2/10)
Men of letters III BBC News blogs: Stephanomics, Stephanie Flanders (19/2/10)
Daily View: When to cut spending? (including podcast) BBC News blogs, Clare Spencer (19/2/10)
Cautious economists and cutters battle it out in print Guardian (20/2/10)
The great economics rift reopens Guardian, Gavyn Davies (19/2/10)
Focus on growth. Don’t argue about cuts Times Online, Eamonn Butler (20/2/10)
Recession’s ruins hide plenty of spare capacity Sunday Times, David Smith (14/2/10)
Questions
- To what extent is the disagreement between the two sets of economists largely one of the timing of the cuts?
- Is the disagreement the result of (a) different analysis, (b) different objectives or (c) different interpretation of forecasts of the robustness of the recovery and how markets are likely to respond to alternative policies? Or is it a combination of two of them or all three? Explain your answer.
- How would new classical economists respond to the Keynesian argument that it is necessary to focus on aggregate demand if the economy is to experience a sustained recovery?
- How would Keynesian economists respond to the argument that rapid cuts will reassure markets and allow private-sector recovery to more than compensate for reduced public-sector activity?
- Why is the effect of the recession on the supply-side of the economy crucial in determining the sustainability of a demand-led recovery?
- Distinguish between the cyclical and structural deficits. How would the policies advocated by the two groups of economists impact on the structural deficit?
As the news item, A Greek tragedy reported, the level of debt in Greece and also in Portugal, Spain, Ireland and Italy, has caused worries, not just for their creditors, but also for the whole eurozone. Here we give you the opportunity to listen to a podcast from the Guardian in which some of the paper’s main economic columnists, along with Observer commentator, William Keegan, discuss the effects of this debt on the euro. To quote the introduction to the podcast:
“In Brussels, European leaders have pledged ‘determined and co-ordinated’ action to help Greece – they won’t let it fail. Our Europe editor Ian Traynor says the announcement of a deal was designed to keep the markets happy.
But leaders of wealthier euro nations like Germany are hoping they won’t have to ask their voters to bail Greece out. Kate Connolly, our Berlin correspondent, explains why Germans are so reluctant to provide financial assistance.
It’s being seen as a defining moment for the euro. Economics editor Larry Elliott says not signing Britain up to the single currency was the best decision Gordon Brown ever made.”
The debt crisis facing the Euro Guardian daily podcast (12/2/10)
Questions
- To what extent is Greece’s debt a problem for the whole eurozone?
- Consider the arguments for and against bailing Greece out (a) by stronger eurozone countries, such as Germany and France; (b) by the IMF.
- What support for Greece would minimise the problem of moral hazard?
- How would you set about establishing whether the current eurozone is an optimal currency area?
- How do the current problems of debt affect the arguments about whether Britain should adopt the euro?
Over the past week, Greece has been hogging the headlines when it comes to debt crisis. However, there is concern that there are a number of other countries ‘where credit defaults swaps are unusually high, suggesting there is risk in terms of default’. Greece’s deficit stands at 12.7% (£259bn), which is over 4 times higher than EU rules allow and its debt levels are expected to reach 120% of GDP this year if help is not given. Furthermore, if Greece’s debt problems are not tackled, there is a worry that other countries with big deficits, such as Portugal and Spain will become vulnerable. Public spending in Greece had been rising for some time but the tax revenue hadn’t increased to match this. As government spending rose and tax revenues fell, the growing debt was inevitable.
What is just as concerning is the cost of servicing this debt. This is costing Greece about 11.6% of GDP and the Greek government has estimated that it will need to borrow €53bn this year to cover budget shortfalls. Strikes by public-sector workers have also affected the country, as figures show that the unemployment rate has increased to 10.6%.
However, there are now reports that an agreement has been reached at the EU summit to rescue Greece and help it tackle its debt problems. Herman Van Rompuy, the European Union’s President, said that an agreement had been reached. The news was immediately welcomed by jittery markets, with the euro regaining some of its losses. Initially, it was thought that British taxpayers would be a part of any bailout package, but Alistair Darling, said there was no plan to use UK taxpayers’ money to support Greece. When asked about the comparison of the UK with Greece, Alistair Darling commented that:
“I don’t think you can compare the UK with Greece. We have different policies. We have a very good track record and, most importantly, the maturity of UK debt is much longer.”
The EU summit was officially meant to cover medium-term European economic strategy, but it was dominated by the Greek crisis. Germany and France are likely to stand together and pledge to come to Athens’s aid by guaranteeing Greek solvency, but only time will tell whether this will happen or will work.
EU leaders reach deal to rescue Greece from debt crisis, President Barroso says Telegraph, Bruno Waterfield (11/2/10)
Mervyn King on Greece, Britain’s deficit and a hung Parliament Telegraph (10/2/10)
FTSE rises amid Greece rescue hopes The Press Association (11/2/10)
Greece’s unemployment rate hits 10% BBC News (11/2/10)
Debt crisis: Experts see more skeletons tumbling News Center (11/2/10)
EU deal ‘agreed’ on Greece debt woes BBC News (11/2/10)
Greek bailout deal reached at EU summit Guardian, Ian Traynor and Graeme Wearden (11/2/10)
Greek bailout would hurt Eurozone – Germany’s Issing Reuters (29/1/10)
Greece must meet deficit target to get aid Reuters (11/2/10)
Could bailout be on the cards for Greece BBC News (10/2/10)
Germans must start buying to save Europe’s stragglers Financial Times, Martin Wolf (10/2/10)
Thinking the unthinkable BBC News Blogs, Stephanomics, Stephanie Flanders (11/2/10)
Angela Merkel dashes Greek hopes of rescue bid Guardian, Ian Traynor (11/2/10)
Greece faces devaluation, default or deflation. Next stop the IMF Guardian, Larry Elliott (11/2/10)
Germany demands austerity, not bailout, for spendthrift Athens Guardian, Ian Traynor (11/2/10)
See also the Guardian podcast in the news item, Debt and the euro
See too the news item from October 2008, The eurozone – our economic saviour?
Questions
- What is the cause of Greece’s debt problems?
- According to the European Central Bank chief economist Otmar Issing, a Greek bailout would weaken the euro and hurt the reputation and image of the eurozone. How can we explain this?
- What do we mean by servicing a debt?
- How could Greece’s debt problems cause problems for other countries with large debts, such as Ireland, Portugal and Spain?
- Which country is better off: the UK or Greece?
- Who will be the loser from a bailout?
- Are the EU rules about debt and deficit levels a good thing or are they too restrictive to be helpful?
- What are the arguments for and against the ECB increasing its target rate of inflation, say to 4%, as a means of stimulating recovery?
Over the weekend of the 5 and 6 February, the finance ministers of the G7 countries (Canada, France, Germany, Italy, Japan, the UK and the USA) met to discuss the state of the world economy. They agreed that the recovery was still too fragile to remove the various stimulus packages adopted around the world. To do so would run the risk of plunging the world back into recession – the dreaded ‘double dip’.
But further fiscal stimulus involves a deepening of public-sector debt – and it is the high levels of debt in various countries, and especially the ‘Piigs’ (Portugal, Ireland, Italy, Greece and Spain), that is causing worries that their debt will be unsustainable and that this will jeopardise their recovery. Indeed, the days running up to the meeting had seen considerable speculation against the euro as worries about the finances of various eurozone countries grew.
Of course, countries such as Greece, could be bailed out by other eurozone countries, such as Germany of France, or by the IMF. But this would create a moral hazard. If Greece and other countries in deep debt know that they will be bailed out, this might then remove some of the pressure on them to tackle their debts by raising taxes and/or cutting government expenditure.
Group of 7 Vows to Keep Cash Flowing New York Times, Sewell Chan (6/2/10)
Forget cuts and keep spending, Brown told Independent, Sean O’Grady (9/2/10)
European debt concerns drive dollar higher during past week Xinhua, Xiong Tong (6/2/10)
G7 prefers to stay on stimulants Economic Times of India (7/2/10)
G7 pledges to maintain economic stimulus Irish Times (8/2/10)
Mr. Geithner, On What Planet Do You Spend Most of Your Time? Veterans Today (6/2/10)
Gold Price Holds $1,050 – Gold Correction Over? Gold Price News (8/2/10)
Darling ‘confident’ on economic recovery at G7 meeting BBC News (7/2/10)
Britain has to fight hard to avoid the Piigs Sunday Times (7/2/10)
Europe needs to show it has a crisis endgame Financial Times, Wolfgang Münchau (7/2/10)
Speculators build record bets against euro Financial Times, Peter Garnham (8/2/10)
The wider financial impact of southern Europe’s Pigs Observer, Ashley Seager (7/2/10)
Medicine for Europe’s sinking south Financial Times, Nouriel Roubini and Arnab Das (2/2/10)
Yes, the eurozone will bail out Greece, but its currency has taken a battering Independent on Sunday, Hamish McRae (7/2/10)
Questions
- What is meant by a ‘double-dip recession? How likely is such a double dip to occur over the coming months?
- Why has there been speculation against the euro? Who gain and who lose from such speculation?
- Why might the ‘gold correction’ be over? Why might gold prices change again?
- What is meant by ‘moral hazard’? Does bailing out countries, firms or individuals in difficulties always involve a moral hazard?
- What is the case (a) for and (b) against a further fiscal stimulus to countries struggling to recover from recession?
- Would there be any problems in pursuing a tight fiscal policy alongside an expansionary monetary policy?