There has been much in the news recently about the attempts of governments around the world to tackle two problems: (a) soaring deficits and debt and (b) a slow recovery and a possible slide back into recession. As the previous news item, Over stimulation? Trying to prevent a double dip as Japan’s debt soars, reported, Japan’s approach has been to tackle the second problem first and to give a massive fiscal boost to the economy. Its debt can be tackled later as the economy, hopefully, recovers.
The Irish government, by contrast, in its Budget on 9 December announced sweeping cuts in government expenditure. This included substantial pay cuts for public-sector employees. Getting the public-sector deficit down (projected to be 11.6% of GDP in 2010) was the government’s major priority.
Greece too is under tremendous pressure to cut its public-sector deficit and debt. Forecast to be 125% of GDP in 2010, its public-sector debt is the highest in the eurozone. There are serious worries as to whether Greece will be able to fund the debt.
Meanwhile in the UK, Alistair Darling presented the government’s pre-Budget report. This took a mid-course between the two objectives. He announced modest increases in tax, including a 1% increase in national insurance contributions from 2010, and modest increases in benefits. The overall effect was pretty neutral, leaving the projected public-sector deficit at around 12.6% of GDP in 2010/11, hopefully falling to around 4.4% by 2014/15 as economic growth increases tax revenues. So was this the best compromise: not too tough so as to stifle recovery and not too expansionary so as to cause a soaring of debt and difficulty in funding the necessary borrowing?
So what is the correct balance? Are the situations very different in the four countries or have they merely chosen to prioritise them differently? Should countries make cuts early in order to get their deficits down and avoid a collapse in confidence, but risk falling back into recession? Or should they get growth firmly established before tightening fiscal policy? The following articles look at the issues.
The UK
Key points: The pre-Budget report at-a-glance BBC News (9/12/09)
Alistair Darling to borrow more this year (including video) BBC News (9/12/09)
Walking the line BBC News, Stephanomics, Stephanie Flanders’ blog (10/12/09)
Larry Elliott’s analysis on the pre-budget report (video) Guardian, Larry Elliott and Mustafa Khalili (9/12/09)
Pre-budget report: All boxed in Guardian (10/12/09)
Tax and mend Economist (9/12/09)
Darling defends economic forecasts (including video) Financial Times, Chris Giles and George Parker (9/12/09)
Prevarication and Newspeak will not fix our finances Financial Times, Willem Buiter (9/12/09)
Is UK government debt really that high? BBC News, Richard Anderson (22/12/09)
The measures announced in the pre-Budget report along with a video of the speech, press releases and the full report as a PDF document can be found at the Treasury’s Pre-Budget Report 2009 site.
The Institute for Fiscal Studies has a part of its site dedicated to the pre-Budget report. This contains briefings and analysis. See Pre-Budget Report 2009
Greece
Why Greece Could Be the Next Dubai Time, Adam Smith (9/12/09)
Greece’s debt crisis signals problems for the European Central Bank Guardian, Nils Pratley (8/12/09)
Greek stocks fall 6% on fears over the country’s debt BBC News (8/12/09)
Greek stocks fall 6% on fears over the country’s debt (video) BBC News (8/12/09)
Greece threatens bankruptcy, and the eurozone The Atlantic, Megan McArdle (8/12/09)
Greece Struggles to Stay Afloat as Debts Pile On New York Times, Rachel Donadio and Niki Kitsantonis (11/12/09)
Greece ‘worthy’ of eurozone place BBC News (14/12/09)
Greek PM to unveil steps to allay deficit fears Forbes, Dina Kyriakidou (14/12/09)
Default lines The Economist (3/12/09)
Greeks denying gifts BBC News blogs, Stephanomics, Stephanie Flanders (29/1/10)
Davos 2010: Greece denies a bail-out is needed BBC News (28/1/10)
Ireland
Ireland suffers harshest budget in decades Financial Times, John Murray Brown (9/12/09)
Strong medicine fails to soothe Irish Financial Times, John Murray Brown (9/12/09)
Irish Wince as a Budget Proposal Cuts to the Bone New York Times, Sarah Lyall (9/12/09)
A time to grin and bear it Irish Times (10/12/09)
Germany
German government heads for record debt BBC News (29/12/09)
German minister warns of fiscal crackdown Financial Times, Bertrand Benoit (17/12/09)
Goverment’s draft budget includes record debt levels Deutsche Welle (16/12/09)
General
The banking crisis: Till debt us do part Times Online, David Smith and Jenny Davey (13/12/09)
Sovereign debt burdens keep traders on red alert Fiinancial Times, David Oakley (12/12/09)
Questions
- Are the objectives of tackling recession and getting the public-sector deficit and debt down contradictory aims, or is it merely a question of sequencing?
- To what extent are the situations in the UK, Japan and Ireland similar? Should they be following similar macroeconomic policies?
- Why does it matter if a country has a rising public-sector debt as a proportion of GDP?
- Distinguish between a cyclical deficit and a structural deficit. Why has the UK’s structural deficit got worse? Will it fall as the economy recovers, or will it be only the cyclical deficit that falls?
- Why does Greece’s debt crisis signal problems for the European Central Bank?
- What determines a country’s sovereign credit rating?
Latest figures suggest that Japan could be entering a ‘double-dip’ or ‘W-shaped’ recession. In the second quarter of 2009, Japan managed to achieve a modest 0.9% growth after four quarters of contraction. Growth then accelerated to 1.2% in the third quarter. It now seems likely, however, that the fourth quarter could see a contraction of the economy again – or at best a slow-down in growth. Prices are falling as demand remains stagnant, and this deflation could encourage people to hold back from spending as they wait for prices to fall further.
As the British government announces planned spending cuts to tackle the rapidly mounting public-sector deficit and debt, so Japan has just announced a massive further fiscal stimulus of ¥7.2 trillion (£50 billion) or 1.5% of GDP. Although Japan’s public-sector deficit is no longer the highest of the G7 countries – 7.4% of GDP, compared with 12.6% for the UK, 11.4% for the USA and 8.2% for France (see OECD Economic Outlook November 2009, summary of projections – its debt, currently at 190% of GDP, is by far the highest of the G7 countries (this compares with 115% for Italy, 76% for France, 73% for Germany, 69% for the UK and 65% for the USA).
More than half of the fiscal stimulus will go on increases in government expenditure, especially on public works. However, much of the spending is in the form of a transfer to regional governments, which would otherwise be forced to make spending cuts because of falling tax revenues. So is the stimulus too much, too little, or of little relevance? Read the linked articles below, which consider the issues.
Japan growth estimate slashed Sydney Morning Herald (9/12/09)
Double dip could be taking shape for Japanese economy Market Watch, Lisa Twaronite (9/12/09)
Japan to boost recovery with giant stimulus plan Sydney Morning Herald, Kyoko Hasegawa (8/12/09)
Japan steps up stimulus spending Sydney Morning Herald (8/12/09)
Japan public debt to hit record this fiscal year AsiaOne News (Singapore) (8/12/09)
Japan govt unveils $81 bln economic stimulus Economic Times of India (8/12/09)
Japan’s economic growth figure lowered BBC News (9/12/09)
Japan agrees $81bn stimulus package BBC News (8/12/09)
Japan unveils $80bn of direct spending in $274bn stimulus package Telegraph (8/12/09)
It is Japan we should be worrying about, not America Telegraph (1/11/09)
Japan keeps pouring money into its ailing economy Times Online, Leo Lewis (9/12/09)
Japan’s Leader Promotes $81 Billion Stimulus Plan New York Times, Hiroko Tabuchi (8/12/09)
Japan sets out $81bn stimulus plan Financial Times, Mure Dickie (8/12/09)
Fiscal challenges ahead The Asahi Shimbun (Japan) (8/12/09)
Bond jitters as Japan launches yet another stimulus plan Telegraph, Ambrose Evans-Pritchard (8/12/09)
New Stimulus Won’t Save Japan From Deflation, Soaring Deficit Money Morning, Jason Simpkins (8/12/09)
Questions
- Use the threshold concepts of stocks and flows to explain the difference between public-sector deficits and public-sector debt.
- Why might an economy go into a ‘double-dip’ or ‘W-shaped’ recession?
- For what reasons might this latest stimulus package be regarded as (a) too large and (b) too small to tackle Japan’s macroeconomic problems?
- Discuss the proposed policy of banning firms from hiring temporary workers.
- Why does deflation (in the sense of falling prices) create a problem for governments?
- What are the implications for the market for Japanese government bonds of the latest stimulus package?
Life must be very hard for bankers in the UK. Not only are they being partly blamed for the current financial crisis, but they may now have to survive on just their salary. Imagine trying to have a happy Christmas when you’ve only earned £200,000 over the past year: it really will be a cold and hard Christmas for them. Unless of course, the government does call the bluff of the RBS directors who have threatened to quit if an estimated £1.5bn bonus pool for staff at the investment arm of the bank is blocked. Let’s not forget that RBS is largely owned by the public: 70% or an investment of £53.5bn. It’s our taxes that will be used to pay these bonuses giving 20,000 RBS bankers a salary that is at least 3 times greater than the national average.
RBS directors have threatened a mass walkout if the government does withhold the ‘competitive bonus package’. Given that many blame bank directors for plunging us into the credit crunch, some may laugh at their argument that if the bonus package is withheld, then ‘top talent will leave the bank’. However, it is a serious threat: pay out or we leave and you’ll see the profitability of the bank decline, making it less likely that taxpayers will see a ‘return’ on their investment. RBS needs to make profits to repay the taxpayer, but is the taxpayer willing to pay out? RBS directors argue that if its bankers do not receive bonuses, then RBS will lose out in recruiting the best talent. Why would a banker choose to work for a bank that doesn’t pay out bonuses?
Lord Mandelson said: “I understand the point that RBS directors are expressing – they say they have to remain competitive in the market in recruiting senior executives, and this is why it’s important that all the banks are equally restrained, and RBS is not singled out.” One solution here would be a one-off windfall tax on bonuses, or even a permanently higher rate of tax (a ‘supertax’) on bonuses.
Over the past year or so, not a day has gone by when banks are not in the news and the next few days look to be no exception. This is another issue that affects everyone, so read the articles below and make up your mind! The government has an important decision to make, especially given than it’s the taxpayers who will decide on the next government.
‘Bankers need to join the real world’ minister says BBC News (3/12/09)
UK seeks to calm fears of RBS walk-out over bonuses Reuters, (3/12/09)
RBS chief Stephen Hester set to walkout over bonus row Scotsman, Nathalie Thomas (3/12/09)
RBS directors threaten to quit over bonuses Big On News (3/12/09)
Thousands of Bankers paid £1m in bonuses Sky News (3/11/09)
Barclays bankers to get 150pc pay rise Telegraph, Jonathan Sibun and Philip Aldrick (3/12/09)
PM reacts to RBS Director’s threat ITN (3/12/09)
Banks criticise plans for windfall tax on bonuses BBC News (7/12/09)
Will biffing bankers also biff Britain? BBC News, Peston’s Picks, Robert Peston (3/12/09)
Roger Bootle: Bank reform hasn’t gone far enough (video) BBC News (25/12/09)
Questions
- How are wages determined in the labour market? Use a diagram to illustrate this.
- Why do bankers receive such a high salary? (Think about elasticity.)
- What are the main arguments for paying out bonuses to bankers?
- If bonuses were blocked, and the RBS directors did walk out, what do you think would be the likely repercussions? Who would suffer?
- One argument for paying bonuses is that bankers need an incentive. Excluding monetary benefits, are there any other methods that could be used to increase their productivity?
- When we consider the labour market, we look at economic power. Who do you think has the power in this case and what do you think will be the outcome?
Over the past year, the world has seen a massive change in the fortunes of Dubai. At one time, it was as if Dubai was immune from the credit crunch. Property prices rose and then rose again. Credit checks barely existed and anyone seemed to be able to get on the property ladder, including a large number of foreigners. Indeed, 75% of property in Dubai is owned by foreigners.
However, those living their dream in Dubai have entered their worst nightmare. Property prices have already fallen by 50% and further falls are predicted. Debt levels are at about $85 billion, although some suggest they could be closer to $100 billion. Oil prices have fallen as a result of the situation in Dubai, although they have recovered slightly in the past few days, partly boosted by an announcement by the United Arab Emirates central bank that it was providing additional liquidity to banks. Share prices across the world have also been adversely affected, but these also have experienced a recovery.
Dubai has acknowledged the extent of its debts by asking to delay repayments, but whilst some hope that the worst has passed, others are speculating that further debts may be revealed. Dubai asked for a six-month repayment freeze on debt issued by Dubai World and its unit Nakheel, a property developer. The fear of Dubai defaulting on its debts has continued to affect global markets and how quickly Dubai is able to recover may depend on the generosity of Abu Dhabi, its oil rich neighbour. It might be that Abu Dhabi only offer help in exchange for more control over Dubai.
Read the following articles and try answering the questions about this new example of a global issue that highlights the increasing interdependence of economies across the world.
What spoiled the party in Dubai? BBC News (27/11/09)
Dubai says not responsible for Dubai World debt Reuters, Rania Oteify and Tamara Walid (30/11/09)
Oil jumps on positive US data, waning Dubai worries AFP (30/11/09)
Dubai debt crisis should be a lesson to us all Times Online, John Waples (29/11/09)
US shares slide over Dubai fears BBC News (27/11/09)
European shares fall on Dubai fears, banks slip Reuters, Atal Prakash (30/11/09)
Dubai Debt Worries CNBC (30/11/09)
Questions
- What are the main causes behind the debt crisis in Dubai?
- If Abu Dhabi does step in, what do you think it will demand in return?
- Explain why oil prices have suffered as a result of Dubai’s debt crisis. Why have they recovered slightly? Illustrate this using demand and supply – don’t forget to consider elasticity!
- What lessons should we learn from this debt crisis to prevent it from happening again?
- Following Dubai’s debt crisis, share prices fell around the world. What’s the link between debt levels and share prices?
- Having listened to the CNBC report, do you think that tourism is enough to rescue Dubai or will intervention be required?
Should economists have foreseen the credit crunch? A few were warning of an overheated world economy with excessive credit and risk taking. Most economists prior to 2007/8, however, were predicting a continuation of steady economic growth. Inflation targeting, fiscal rules and increasingly flexible markets were the ingredients of this continuing prosperity. And then the crash happened!
So why did so few people see the downturn coming? Were the models used by economists fundamentally flawed, or was it simply a question of poor assumptions or poor data? Do we need a new way of modelling the economy, or is it simply a question of updating theories from the past? Should, for example, models become much more Keynesian? Should we abandon the new classical approach of assuming that markets are essentially good at pricing in risk and that herd behaviour will not be seriously destabilising?
The following podcast looks at these issues. “Aditya Chakrabortty’s joined in the studio by the Guardian’s economics editor Larry Elliott, as well as Roger Bootle, the managing director of Capital Economics, and political economist and John Maynard Keynes biographer Robert Skidelsky. Also in the podcast, we hear from Nobel prize-winning economist, Elinor Ostrom, Freakonomics author Steven Levitt, and UN advisor and developmental economist Daniel Gay.”
The Business: A crisis of economics Guardian podcast (25/11/09)
See also the following news items from the Sloman Economics news site:
Keynes is dead; long live Keynes (3/10/09)
Learning from history (3/10/09)
Macroeconomics – Crisis or what? (6/8/09)
The changing battle grounds of economics (27/7/09)
Repeat of the Great Depression – or learning the lessons from the past? (23/6/09)
Animal spirits (30/4/09)
Keynes – do we need him more than ever? (26/10/08)
Questions
- Why did most economists fail to predict the credit crunch and subsequent recession? Was it a problem with the models that were used or the data that was put into these models, or both?
- What was the Washington consensus? To what extent did this consensus contribute to the current recession?
- What is meant by systemic risk? How does this influence the usefulness of ‘micro’ financial models?
- What particular market failures were responsible for the credit crunch?
- What is meant by ‘rational behaviour’? Is it reasonable to assume that people are rational?
- Is macroeconomics too theoretical or too mathematical (or both)? If you think it is, how can macroeconomics be reformed to improve its explanatory and predictive power?
- Does a ‘really good economist’ need to have a good grounding in a range of social sciences and in economic history?