Category: Essential Economics for Business: Ch 10

Economics, but not as we know it. As the introduction to this programme on BBC radio 4 suggests, there has been criticism and concern about the way in which we think about economics. About, how it’s taught; the lessons we learn and whether we need to have a re-think. Tomas Sedlacek is a Czech economist and has a different way of thinking about this subject.

Humanomics is certainly a new way of thinking about economics and considering how it links and can be applied to a wide range of areas: the Bible; movies such as Fight Club and the Matrix. This 30 minute discussion between Evan Davies and Tomas Sedlacek provides some interesting insights and thoughts on some of the current challenges facing this subject and some novel insights into how we could change our thinking.

Tomas Sedlacek: The Economics of Good and Evil BBC Radio 4 (25/01/16)

Questions

  1. How do we define and measure value? Is this always possible? Can you think of some things where we cannot assign prices or numbers to values?
  2. How could economics be relevant Adam and Eve?
  3. Think about the marriage market. How would you apply the model of demand and supply to this most unusual of markets?
  4. What insights does Tomas Sedlacek provide about the ancient business cycle and this might affect our thinking about debt and assets?
  5. Do you think that refugees are of benefit to a country? If you don’t think they are of benefit, does this mean that countries should not accept them?
  6. If we did find out that corruption or crime and terrorism were of benefit to the GDP of a country, would you encourage it? Or would you place the morality issue above the actual figure of contribution?

The Chinese economy was, for some time, the beacon of the world economy, posting strong growth and giving a much needed boost to demand in other countries. However, the weakening Chinese economy is now causing serious concerns around the world and not least in China itself.

China’s stock market on Monday 11th January closed down 5.3%, with the Hong Kong Index down by 2.8%. These falls suggest a continuing downward trajectory this week, following the 10% decline on Chinese markets last week. Today, further falls were caused, at least in part, by uncertainty over the direction of the Chinese currency, the yuan. Volatility in the currency is expected to continue with ongoing depreciation pressures and adding to this is continuing concerns about deflation.

The barrage of bad news on key economic indicators may well mean significant intervention by Chinese authorities to try to avoid its slowest growth in 25 years. However, there are also concerns about China’s ability to manage its economic policy, given recent events. IG’s Angus Nicholson said:

“Global markets are still in the grips of China fears, and it is uncertain whether the Chinese government can do enough to reassure global investors.”

Similar sentiments were echoed by Paul Mackel, head of emerging markets FX research at HSBC:

“Different signals about foreign exchange policy have wrong-footed market participants and we are wary in believing that an immediate calmness will soon emerge.”

Perhaps key to turning this downward trend on its head, will be the Chinese consumers. With a traditionally larger saving ratio than many Western economies, it may be that this ‘cushion’ will give growth a boost, through the contribution of consumer spending. As we know, aggregate demand comprises consumption, investment, government spending and net exports (AD = C + I + G + XM). Consumer spending (C) increased from 50.2% in 2014 to 58.4% in 2015, according to HIS Global Insight. A similar increase for 2016 would certainly be welcome.

As oil prices continue to fall and concerns remain over China’s weak economic data, we may well soon begin to see just how interdependent the world has become. Many economists suggest that we are now closer to the start of the next recession than we are to the end of the last one and this latest turmoil on Chinese stock markets may do little to allay the fears that the world economy may once again be heading for a crash. The following articles consider the Chinese turmoil.

Free lunch: China’s weakest link Financial Times, Martin Sandbu (11/01/16)
China’s stocks start the week with sharp losses BBC News (11/01/16)
China shares fall 5% to hit-three-month low The Guardian (11/01/16)
China’s resilient shoppers face fresh test from market headwinds Bloomberg (11/01/16)
China shares head lower again on price data Sky News (11/01/16)
U.S., European shares slip as China, oil woes continue Reuters, Lewis Krauskopf (11/01/16)
U.S. stocks drop as oil tumbles again Wall Street Journal (11/01/16)
China escalates emergency stock market intervention The Telegraph, Mehreen Kahn (05/01/16)

Questions

  1. How are prices and values determined on the stock market?
  2. Share prices in China have been falling significantly since the start of 2016. Has it been caused by demand or supply-side factors? Use a demand and supply diagram to illustrate this.
  3. Why has the volatility of the Chinese currency added further downward pressure to Chinese stock markets?
  4. With the expected increase in consumer spending in China, how will this affect AD? Use a diagram to explain your answer and using this, outline what we might expect to happen to economic growth and unemployment in China.
  5. Why are there serious concerns about the weak level of inflation in China? Surely low prices are good for exports.
  6. Should the world economy be concerned if China’s economy does continue to slow?
  7. To what extent are oil prices an important factor in determining the future trajectory of the world economy?

Sales during the weeks leading up to Christmas often make a significant contribution to retailers’ profits. For many consumers, it is a time to spend money on food, presents and decorations and this often means increased borrowing.

Data indicate that borrowing by consumers in the lead-up to Christmas increased by the biggest amount for almost 8 years: a figure of £1.5 billion. As a result, there were likely to have been many happy families at Christmas, with lots of gifts being exchanged. But what does this mean for the New Year? There are concerns about the increase we will see in consumer debt throughout 2016 and the number of borrowers who will, perhaps, be unable to repay their debts.

Could this significant increase in borrowing be a signal that we haven’t learnt from our past? This article from BBC News considers the borrowing data and their implications.

Borrowing jumped ahead of Christmas, Bank of England says BBC News, Brian Milligan (4/01/16)

Questions

  1. Is borrowing good or bad for the economy? Explain your answer.
  2. If borrowing is good for the economy, why are there concerns about the current level of borrowing?
  3. How will this higher level of borrowing affect aggregate demand? Use an AD/AS diagram to explain the impact this will have.
  4. Could this higher level of borrowing affect unemployment and inflation? In what ways?
  5. If interest rates had been higher, do you think the level of consumer borrowing would have been lower?

To what extent does history repeat itself? Minsky’s Financial Instability Hypothesis infers that credit cycles are fairly inevitable. We have seem them in the past and we will see them in the future. Human beings are subject to emotion, to irrational exuberance and to a large dose of forgetfulness! To what extent do the latest UK credit numbers suggest that we might be embarking on another credit binge? Are the credit data consistent with evidence of another credit cycle?

Chart 1 shows the stocks of debt acquired by households and private non-financial corporations from MFIs (Monetary Financial Institutions). The scale of debt accumulation in the late 1980s and again from the mid 1990s up to the financial crisis of the late 2000s is stark. At the start of 1985 the UK household sector had debts to MFIs of around £140 billion. By the start of 2009 this had hit £1.29 trillion. Meanwhile, private non-financial corporations saw their debts to MFIs rise from around £45 billion to over £500 billion. (Click here to download a PowerPoint of the chart.)

The path of debt at the start of the 2010s is consistent with a story of consolidation. Financially-distressed households, private non-financial corporations and, of course, MFIs themselves meant that corrective action was needed to repair their balance sheets. The demand for and supply of additional credit waned. Debt accumulation largely ceased and, in fact, debt numbers fell. This trend continues today for private non-financial corporations. But, for households debt accumulation resumed in the middle of 2013. At the end of the third quarter of 2015 the household sector had debt obligations to MFIs of £1.246 trillion.

Chart 2 focuses on flows rather stocks. It allows us to see the accumulation of new credit (i.e. less repayments of debt). What is even more apparent from this chart is the evidence of cycles in credit. The growth in new credit during the 2000s is stark as is the subsequent squeeze on credit that followed.

The question that follows is what path are we now on? Clearly flows of credit to households are again on the rise. In part, this is driven by the rebound in the UK housing market. But, in fact there is a more rapid increase in consumer credit, i.e. unsecured debt. (Click here to download a PowerPoint of the chart.)

Chart 3 shows the flows of consumer credit from MFIs and other credit providers. Again, we see the marked evidence of cycles. In the year to the end of Q1 of 2015 net consumer credit flows amounted to £22.8 billion, the highest figure since the 12-month period up to the end of Q3 of 2005. Click here to download a PowerPoint of the chart.)

While it might be a little early to say that another Minsky cycle is well under way, policymakers will be keeping a keen eye on credit patterns. Is history repeating itself?

Articles

Average UK mortgage debt rises to £85,000 The Guardian, Phillip Inman (15/12/15)
Consumer spending rise troubles Bank of England The Guardian, Heather Stewart (24/11/15)
Recovery ‘too reliant on consumer debt’ as BCC downgrades forecast The Guardian, Heather Stewart (9/12/15)
BCC: UK Growth Too Reliant On Consumer Debt Sky News (9/12/15)
Interest rates will stay low for longer – but household debt is a worry, says BoE The Telegraph, Szu Ping Chan (24/11/15)
IMF: UK’s economic performance ‘very strong’, but risks remain BBC News (11/12/15)

Data

Bankstats (Monetary and Financial Statistics) – Latest Tables Bank of England
Statistical Interactive Database Bank of England

Questions

  1. How can the financial system affect the economy’s business cycle?
  2. What does it mean if households or firms are financially distressed? What responses might they take to this distress and what might the economic consequences be?
  3. How would you measure the net worth (or wealth) of an individual or a firm? What factors might affect their net worth?
  4. How might uncertainty affect spending and saving by households and businesses?
  5. What does it mean if bank lending is pro-cyclical?
  6. Why might lending be pro-cyclical?
  7. Are there measures that policymakers can take to reduce the likelihood that flows of credit become too excessive?

As we saw in the blog post Down down deeper and down, or a new Status Quo?, for many countries there is now a negative rate of interest on bank deposits in the central bank. In other words, banks are being charged to keep liquidity in central banks. Indeed, in some countries the central bank even provides liquidity to banks at negative rates. In other words, banks are paid to borrow!

But, by definition, holding cash (in a safe or under the mattress) pays a zero interest rate. So why would people save in a bank at negative interest rates if they could get a zero rate simply by holding cash? And why would banks not borrow money from the central bank, if borrowing rates are negative, hold it as cash and earn the interest from the central bank?

These questions are addressed in the article below from The Economist. It argues that to swap reserves for cash is costly to banks and that this cost is likely to exceed the interest they have to pay. In other words, there is not a zero bound to central bank interest rates, either for deposits or for the provision of liquidity; and this reflects rational behaviour.

But does the same apply to individuals? Would it not be rational for banks to charge customers to deposit money (a negative interest rate)? Indeed, there is already a form of negative interest rate on many current accounts; i.e. the monthly or annual charge to keep the account open. But would it also make sense for banks to offer negative interest rates on loans? In other words, would it ever make sense for banks to pay people to borrow?

Read the folowing article and then try answering the questions.

Article

Bankers v mattresses The Economist (28/11.15)

Central bank repo rates/base rates
Central banks – summary of current interest rates global-rates.com
Worldwide Central Bank Rates CentralBankRates

Questions

  1. What is a central bank’s ‘repo rate’. Is it the same as (a) its overnight lending rate; (b) its discount rate?
  2. Why are the Swedish and Swiss central banks charging negative interest rates when lending money to banks?
  3. What effect are such negative rates likely to have on (a) banks’ cash holdings; (b) banks’ lending to customers?
  4. Why are many central banks (including the ECB) charging banks to deposit money with them? Why do banks continue to make such deposits when interest rates are negative?
  5. Would banks ever lend to customers at negative rates of interest? Explain why or why not.
  6. Would banks ever offer negative rates of interest on savings accounts? Explain why or why not.
  7. How do expectations about exchange rate movements affect banks willingness to hold deposits with the central bank?
  8. What are the arguments for and against abolishing cash altogether?