The Brazilian economy is an emerging superpower (see A tale of two cities), but even its growth slowed in the second quarter of the year, although the economy still appears to be growing above capacity. In reaction to that latest economic data, the central bank slashed interest rates by 50 basis points to 12%. The Central Bank said:
‘Reviewing the international scenario, the monetary policy committee considers that there has been a substantial deterioration, backed up, for example, by large and widespread reductions to the growth forecasts of the main economic regions.’
Rates had previously been hiked up 5 times in the year to tackle rising inflation, which has been some way above its inflation target. Such tightening policies have become commonplace in many emerging economies to prevent overheating. However, following this reversal of policy, questions have been raised about the independence of the central bank, as some politicians have recently been calling for a cut in rates, including President Rousseff himself. As Tony Volpon at Nomura Securities said:
‘They gave in to political pressure. The costs will likely be much higher inflation and a deterioration of central bank credibility…It has damaged the inflation-targeting regime.’
Many believe the rate cut is premature and the last thing the economy needs given the inflationary pressures it’s been facing. Huge spending cuts have been announced to bring inflation back under control, together with the previous rate rises, so this cut in interest rates to stimulate growth is likely to put more pressure on costs and prices. Only time will tell exactly how effective or problematic this new direction of monetary policy will be.
Brazil’s growth slows despite resilient consumers Reuters, Brian Ellsworth and Brad Haynes (2/9/11)
Brail in surprise interest rate cut to 12% BBC News (1/9/11)
Rousseffl’s ‘Risky’ rate cut means boosting Brazil GDP outweighs inflation Bloomberg, Arnaldo Galvao and Alexander Ragir (2/9/11)
Brazil makes unexpected interest rate cut Financial Times, Samantha Pearson (1/9/11)
Brazil rate cut stirs inflation, political concerns Reuters (1/9/11)
Questions
- What is the relationship between the macroeconomic objectives of inflation and economic growth?
- Why are there concerns that the recent reduction in the interest rate may worsen inflation? Do you think that a decision has been made to sacrifice Brazil’s inflation-targeting regime to protect its economic growth?
- Why are there questions over the independence of the central bank and how will this affect its credibility? What are the arguments for central bank independence?
- Growth in Brazil, although lower this year, still remains very strong. Why has the Brazilian economy been able to continue its strong growth, despite worsening economic conditions worldwide?
- What type of inflation are emerging economies experiencing? Explain how continuous hikes in interest rates have aimed to bring it back under control.
- What is meant by overheating? How will the central bank’s past and current policies contribute towards it?
The growing interdependence of economies has never been more true than over the past few years. The credit crunch began in the US and gradually spread to the rest of the world. As the saying goes, ‘when America sneezes, the world catches a cold’. The US economy is the largest in the world and with such a close relationship to the UK, its economic situation is critical. GDP growth in the first quarter was a mere 0.4% and in the second quarter, it was revised down from the US Commerce Department’s original estimate of 1.3% to just 1%. This was attributed to weaker growth in business inventories, a fall in exports and less spending from the state and local governments. Personal consumption expenditure and exports did rise, but the increase in the former was hardly noticeable (0.4%) and in both cases, the second quarter increase was significantly down on that in the first quarter.
With GDP growth remaining low, there’s not much better news when it comes to US unemployment, which remained at 9.1% from July. It was expected that a further 70,000 jobs would be created in August, but the latest figures suggest that no new jobs were created. It seems that the data on growth and the components of aggregate demand are enough to bring consumer and investor confidence down. Virginie Maisonneuve said:
‘Companies that are overall doing OK are hesitating to hire and invest further, creating some fragility for the economy… We will need some help from the Fed and the government to avoid a recession.’
President Obama is due to make a speech in which he will outline a new plan to boost economic growth. Crucial to this will be restoring confidence, as without it, businesses will not invest, consumers will save rather than spend, jobs will not be created and growth will remain sluggish. This will do nothing to help the still weak economies of Europe. Indeed, following news of the US job situation, stock markets across the world fell, as fears of recession set in. The Dow Jones opened 2% down, the FTSE 100 ended 2.3% down (although this was also affected by a weakening in the construction sector), markets in Germany, France and Spain were down by over 3% and in Italy by over 4%.
US GDP revised down to 1pc in second quarter as growth stalls Telegraph (26/8/11)
US economy: no new jobs added in August BBC News (2/9/11)
Jobs data confirm US growth fears Financial Times, Robin Harding and Johanna Kassel (2/9/11)
Markets fall on weak U jobs data BBC News (2/9/11)
FTSE falls after weak US jobs data The Press Association (2/9/11)
European stocks knocked by dire US jobs data Reuters (2/9/11)
Fears over US economy cause world market route Economic Times (2/9/11)
FTSE 100 extends losses after poor US non farm payroll figures Guardian (2/9/11)
Questions
- What is aggregate demand? Which component is the biggest engine of growth for an economy?
- Why did markets decline following the data on US jobs?
- Why is the economic situation in America so important to the economic recovery of other countries across Europe?
- Why are there suggestions that the US is underestimating its inflation?
- Why is the US economic data for the second quarter of 2011 so much worse than that of the first quarter? What could have caused this downturn?
- What action could the government and the Fed take to boost confidence in the US economy and stimulate economic growth? Can any of this be done without causing inflation?
I found myself singing this morning which I have to admit is not the most pleasant experience for those in ear-shot. I was singing to the tune of ‘love is all around us’. But rather than the words of the song performed by the Troggs in the late 1960s and by Wet Wet Wet in the 1990s, I found myself singing ‘debt is all around us’. It could easily have been the sub-conscious effect of the headlines relating to government debt (also known as national debt). But, actually it was the effect of having looked at my latest credit card statement and noting the impact that my summer holiday had had on my financial position! Relaxation, so it seems, doesn’t come cheap. With this in mind, I have just taken a look at the latest bank of England figures on British household debt. You can do the same by going to the Bank of England’s statistical release lending to individuals.
The latest figures reveal that at the end of June 2011 households in Britain had a stock of debt of £1.451 trillion. Now this is a big number – not far short of the economy’s annual Gross Domestic Product. But, interestingly, this is its lowest level in three years. Indeed, over the past twelve months the stock of household debt has fallen by £6 billion. This is the result of the sector’s repayment of unsecured debt, such as credit card debt and overdrafts. The stock of unsecured debt has fallen by £8.2 billion or 3.8% over the past year to stand at £209.7 billion.
The remaining £1.241 trillion of household debt is secured debt which is debt secured against property. The stock of secured debt has risen by £2.16 billion over the last 12 months, but this equates to a rise of less than 0.2%. In fact, further evidence from the Bank of England reveals that households are not only looking to reduce their exposure to unsecured debt but to pay off mortgage debt too. You might wonder how this might be occurring given that the stock of mortgage debt has risen, albeit only slightly. The answer lies in the growth of housing investment relative to that of mortgage debt. Housing investment relates, in the main, to the purchase of brand new homes and to major home improvements. As our population grows and the housing stock expands and as we spend money on improving our existing housing stock we acquire more mortgage debt. Bank of England figures show that housing investment has been greater than new secured lending. Consequently, the additions to the stock of lending have been less than housing investment. This gives rise to negative housing equity withdrawal, i.e. negative HEW.
The Bank of England estimates that in Q1 of 2011 there was an increase in housing equity of £5.8 billion. Negative housing equity withdrawal (HEW), an injection of housing equity, has occurred every quarter since Q2 2008. Since then, the UK household sector has injected some £63.7 billion of housing equity. The opportunity cost of this injection is that by increasing equity in property households are using money that could have been used for consumption or for purchasing financial assets. The extent of this negative HEW over the past 12 quarters has been the equivalent to 2.2% of disposable income.
While my credit card may have ballooned this month, it would appear that the household sector is looking to reduce its debt exposure. I will be looking to do likewise!
Articles
Housing injection goes on BBC News (4/7/11)
Personal insolvencies rise Independent, Philip Whiterow (5/8/11)
Mortgage boom as homeowners cash in an try reduce debts Independent, Simeon Read (5/7/11)
Homeowners inject £5.8 billion of equity into property in first quarter Telegraph, Emma Rowley (5/7/11)
Housing equity injection continues Guardian, Hilary Osborne (4/7/11)
Data
Lending to individuals statistical release Bank of England
Housing equity withdrawal (HEW) statistical release Bank of England
Questions
- Illustrate with examples what is meant by secured and unsecured debt.
- What factors might help to explain the longer-term growth in secured and unsecured debt over recent decades?
- What factors might help to explain the more recent patterns in secured and unsecured debt?
- What do you understand by the term housing equity withdrawal?
- What is meant by negative HEW?
- What factors might help to explain the negative HEW observed for the past twelve quarters?
- What implications might there be for economic growth of negative housing equity withdrawal (HEW)?
There is no bigger purchase than a house. Ask most individuals who have at some point in their life purchased a house and they will tell you about the considerable time they devoted to making the decision to purchase. It’s not like rushing to a supermarket and purchasing a kilo of sugar. The decision to purchase a property is not taken lightly: the mood music has to be right. Consumer confidence is therefore an important ingredient for an active housing market. The latest mortgage approval data from the Bank of England suggest the music is not right!
April’s mortgage approval numbers continue to demonstrate the on-going fragility of the UK housing market and, in turn, of British households. April saw 45,166 mortgages approved for house purchase. What makes this figure particularly noteworthy is that it is the lowest level recorded in the month of April since the Bank of England figures started back in 1993. It is also 9% lower than April 2010. Some commentators have argued that the number of public holidays in April contributed to the fall in activity. But, 138,756 approvals over the period from February to April was 4.3% lower than over the corresponding period last year. This would suggest that we can’t lay the blame for low levels of mortgage approvals solely on hot cross buns and Kate Middleton!
The weakness in mortgage approvals data has been regular news for some time. Over the past two years the number of approvals per month has been close to 50K compared to about 89K over the past ten years. What makes the latest figures troubling is that there is no indication of recovery any time soon. Rather, the figures show that housing demand may be weakening yet again. If we exclude December’s low of 42,772, when housing market activity was hit by the harsh winter conditions, April’s figure is the lowest since March 2009.
The weakness in the demand for housing can in large part be attributed to the poor mood music: economic growth remains fragile, average real incomes have been declining and unemployment levels are expected to rise over the coming months. Furthermore, households are naturally reluctant to purchase property is they think house prices may fall further. All in all, we can expect the weakness in housing demand to persist for some time. The question seems to be one of just how weak housing demand will be. The next few months promise to be very interesting to say the least. Keep listening to the music!
Articles
UK mortgage approvals hit record low in April Telegraph, Emma Rowley and Harry Wilson (2/6/11)
Mortgage approvals fall to record April low Guardian, Mark King (1/6/11)
Mortgage approvals fall to two-year low Financial Times, Norma Cohen (1/6/11)
Mortgage approvals hit new low, Bank of England reports BBC News (1/6/11)
UK mortgage approvals drop to lowest in four months on lower confidence Bloomberg, Scott Hamilton (1/6/11) )
Pound drops on weak UK manufacturing PMI and mortgage approvals data RTT News (6/1/11)
Data
Mortgage approval numbers and other lending data are available from the Bank of England’s statistics publication, Monetary and Financial Statistics (Bankstats) (See Table A5.4.)
Questions
- How sensitive do you think mortgage approval numbers are likely to be both current and future economic conditions?
- Are there any other types of purchases which households make which you might expect to be especially sensitive to economic conditions?
- Is it just the weakness in the demand for housing which explains the current low levels of mortgage approvals? Explain your answer
- Do weak mortgage approval numbers mean that we should expect house prices to fall in the months ahead? Use demand and supply diagrams to help explain your answer.
The International Monetary Fund consists of 187 countries and is concerned with its members’ economic health. It promotes co-operation, economic stability and is also there to lend to those countries facing difficulties. The role of the IMF as a lender has come into question, as critics argue that the conditions placed on loans to countries can cause more problems than they solve, as the cause of the problems is not always identified. However, despite the criticisms and the current charges facing the former IMF Chief, the International Monetary Fund continues to play an important role in the global economic environment.
Many countries have used IMF credit and over the past two decades it has predominantly been the transition and the emerging market economies that have demanded the IMF’s resources. Whilst its lending did drop off in the mid 2000s, the global financial crisis of 2008/09 saw an increase in the demand for IMF funds from emerging economies to some $60 billion. In May 2010, we saw the IMF together with the EU put together a rescue package for Greece and it is now the turn of Egypt. The uprisings in Egypt put the stability of the economy in jeopardy, as investment declined, tax revenues decreased and the usually buoyant tourist industry started to struggle. Despite the efforts of the government to stabilise the economy, it remains short of cash and the IMF looks set to agree a loan deal of $3 billion (£1.8 billion). Egypt would have five years to repay the loan at an interest rate of 1.5%, after a three year ‘grace period’.
Other countries to receive loans include Ireland, Belarus, the Ukraine and Iceland, the latter of which owes the IMF $2,828.67 per person of its population. The UK has used the IMF back in 1976 and it may be something to look out for, depending on how our recovery continues. The following articles look at the IMF and its role in promoting global financial stability.
Articles
IMF to lend Egypt $3 bn: Ministry Associated Press (6/5/11)
IMF agrees $3bn financing deal with Egypt BBC News (5/6/11)
Timeline: Greece’s debt crisis Reuters (5/6/11)
Egypt strikes $3bn IMF deal to ‘re-launch’ economy Guardian, Jack Shenker (5/6/11)
The IMF versus the Arab Spring Guardian, Austin Mackell (25/5/11)
EU/IMF/ECB statement on Greek bailout Reuters (3/6/11)
Belarus wins $3 billion loan from Russia-led fund, still seeks IMF’s help Bloomberg, Scott Rose and Daryna Krasnolutska (4/6/11)
IMF frees up $225mn for Iceland Associated Press (4/6/11)
IMF loan: which country owes the most? Guardian (24/5/11)
International Monetary Fund
International Monetary Fund Homepage
IMF outlines $3 billion support for Egypt International Monetary Fund, IMF Survey Online (5/6/11)
Questions
- What is the role of the IMF and how is it financed?
- What are the objectives of the loans to countries such as Greece, Iceland and Egypt?
- What other countries has the IMF lent to and what are the conditions that have been placed on these loans?
- What has been the impact on the Egyptian economy of the uprisings? Think about all the industries that have been affected and the wider impacts.
- Can you find any examples of circumstances in which the conditions of an IMF loan have made problems worse for the recipient?
- Why are the conditions of the IMF loan to Egypt favourable and how will the loan help the economy?
- Look at the trend in IMF lending. What factors explain the peak and troughs? In particular, what is the explanation for the incresae in lending during the financial crisis?