With the majority of developed countries now moving out of recession, many people will think the worst is over. But for some countries and some people, there may be worse to come. The single currency in the eurozone was introduced in 1999 and in December 2009, the eurozone saw its highest level of unemployment at 10%. There are now 23 million people unemployed across the 16 countries that make up the eurozone and many of those people reside in Spain, where unemployment has reached a 12-year high of 18.8% and is even expected to reach 20%.
Interest rates in the eurozone and in the UK have been maintained at 1% and 0.5% respectively, and inflation has seen a rise in both places. Whilst in the eurozone inflation remains well below the inflation target, in the UK there has been a rapid rise to 2.9% to December 2009 (see Too much of a push from costs but no pull from demand)
While Spain is suffering from mass unemployment, Greece is struggling with the burden of a huge budget deficit. The former European Central Bank Chief Economist, Otmar Issing, has said that any bailout of Greece would severely damage the Monetary Union and “The Greek disease will spread”. With concern that Greece will not be able to service its debt, there is speculation that the country will be forced out of the currency bloc. However, the chair of the single currency area’s finance ministers said that Greece will not leave the eurozone and does not believe that a state of bankruptcy exists.
So, what’s behind rising unemployment, rising inflation and rising budget deficits and how are they likely to affect the eurozone’s recovery?
Eurozone inflation rises to 0.9% BBC News (15/1/10)
Unemployment sector remains beat in Eurozone pressuring price levels FX Street (29/1/10)
greek bailout would hurt Eurozone – Germany’s Issing Reuters (29/1/10)
Eurozone unemployment rate hits 10% BBC News (29/1/10)
Greece will not go bust or leave Eurozone Reuters, Michele Sinner (27/1/10)
Eurozone unemployment hits 10% AFP (29/1/10)
New rise in German job loss total BBC News (28/1/10)
Spain unemployment nears 12 year high Interactive Investor (29/1/10)
Questions
- How do we define unemployment? What type of unemployment is being experienced in the eurozone?
- Why do you think unemployment levels have risen in the eurozone and in Spain in particular? Illustrate this on a diagram.
- What are the costs of unemployment for (a) the individual (b) governments and (c) society?
- What explanation can be given for rising levels of both unemployment and inflation?
- Inflation in the eurozone increased to 0.9%. What are the factors behind this? Illustrate the effects on a diagram.
- Greece’s forecast budget deficit for 2009 is 12.7% of GDP, but Greece has said it will reduce it to 8.7% of GDP. How does the Greek government intend to do this and what are the likely problems it will face?
- Why could bailing out Greece hurt the eurozone?
It’s not just the roads in the UK that were frozen, as the Bank of England unsurprisingly decided to keep interest rates frozen at 0.5%. Furthermore, many economists do not expect to see interest rates increase for some time. Roger Bootle has predicted that rates could stay low for up to 5 years and this will contribute to a continuing weak pound and spell further trouble for importers and their customers.
The Bank of England also left its money-creation programme of ‘quantitative easing’ unchanged, but next month it will have to decide whether to extend quantitative easing beyond the limits of £200 billion that it set back in November.
Whilst we are supposedly beginning our economic recovery – with 2009 quarter 4 figures showing the first rise in output since the first quarter of 2008 – its strength remains questionable. Indeed, the rise in output in the last three months of 2009 was a mere 0.1%. So how important are interest rates in helping to sustain the recovery? Can they really pull us out of the recession by remaining at just 0.5%? Read the articles below which look at freezing interest rates and quantitative easing.
FTSE unaffected by interest rate decision In the News (7/1/10)
Freeze on UK interest rates BBC News (7/1/10)
Bank of England may raise interest rates as soon as March, leading economist predicts Telegraph (7/1/10)
Interest rates and quantitative easing on hold Guardian, Larry Elliott (7/1/10)
Bank of England extends quantitative easing by £25bn – but is it enough? Guardian, Larry Elliott (5/11/10)
Questions for QE BBC News blogs, Stephanomics, Stephanie Flanders (7/1/10)
Interest rates could stay low for 5 years, says Bootle BBC News (7/1/10)
Questions
- How do low interest rates contribute to a weak pound? How does this affect exporters and importers?
- What is quantitative easing? Should the QE programme be extended? What are the arguments for and against this in terms of economic recovery and public debt?
- How much of an impact do you think the recession will have on government policy over the next few months?
- Explain the transmission mechanisms by which changes in interest rates affect the goods market.
- If the Bank of England were not independent, what do you think would be happening to interest rates?
President Obama has proposed a major reform of the US banking system. This follows on from the proposed levy to be imposed on banks’ assets announced a few days ago (see “We want our money back and we’re going to get it”).
There are two elements to the new proposals. The first is to limit the size of banks’ market share. Currently, banks’ deposits are not permitted to exceed 10% of total retail deposits in the USA. This 10% limit would be extended to cover wholesale deposits and other liabilities. The idea is to reduce concentration and increase competition. At present the largest four banks hold over half the total assets of banks in the USA.
The second element involves separating casino banking from retail banking. This would be achieved by barring retail banks from owning or investing in private equity or hedge funds or from engaging in ‘proprietary trading operations’. As the second BBC article below states:
Proprietary trading involves a firm making bets on financial markets with its own money, rather just than carrying out a trade for a client in which only the client’s money is at risk.
This comes close to restoring the Glass-Steagall Act, which was repealed in 1999. The Act, which was passed in 1933 in the wake of the 1929 Wall Street cash and the subsequent Great Depression, separated commercial banking and investment banking. It was designed to prevent customers’ deposits being exposed to the riskier activities of investment banking.
What have been the reactions to President Obama’s announcement? Are these reactions justified? Will the proposals prevent another banking crisis and credit crunch? The following articles explore these questions.
Obama hammers the banks Financial Times, Tom Braithwaite and Francesco Guerrera (22/1/10)
Obama pushes new bank regulation (including video) BBC News (21/1/10)
Q&A: Obama’s bank curbs BBC News, Martin Webber (21/1/10)
Obama announces dramatic crackdown on Wall Street banks (including video) Guardian, Jill Treanor (21/1/10)
Barack Obama bank reforms: Trying to fix a broker society Telegraph, Louise Armitstead and Helia Ebrahimi (23/1/10)
Glass-Steagall lite The Economist (22/1/10)
Obama’s Plan Finally Attacks “Too Big to Fail” The Huffington Post, Neil K. Shenai (21/1/10)
Obama Sizes Handcuffs For Banks Forbes, Liz Moyer (21/1/10)
Obama’s Showdown With Wall Street Forbes, Richard Murphy (22/1/10)
President Obama shows the way Independent (23/1/10)
Wall Street’s $26m lobbyists gear up to fight Obama banks reform The Observer, Andrew Clark (24/1/10)
Obama’s drawn first blood – now it’s the UK’s turn The Observer, Ruth Sunderland (24/1/10)
Gordon Brown to push for ‘Tobin tax’ after Wall Street crackdown Guardian, Larry Elliott and Jill Treanor (22/1/10)
Myners: UK does not need to copy Obama banking reforms Guardian, Andrew Clark, Jill Treanor, Paul Owen (22/1/10)
Debate on London’s banking system The Observer, Will Hutton and Boris Johnson (24/1/10)
What Obama’s bank reforms really mean BBC News blogs, Peston’s Picks, Robert Peston (22/1/10)
Davos 2010: Central bankers seethe behind closed doors BBC News, Tim Weber (29/1/10)
Questions
- What are the arguments for and against separating retail banking from the more risky elements of investment banking?
- Should banks be allowed to fail? Explain your answer and whether it is necessary to distinguish different types of banks.
- Would putting a limit on the market share of banks prevent them from achieving full economies of scale?
- Why did banking shares fall after President Obama’s announcement? Was this a ‘good sign’ or a ‘bad sign’?
- What is meant by the ‘broker-dealer’ function of banks? Explain each of the specific types of broker-dealer function.
- Compare recent UK measures to control banks with those in the USA.
With banks around the world revealing massive profits and huge bonuses, governments are getting increasingly uneasy that their bailouts have lined the pockets of bank executives. Not surprisingly voters are demanding that bankers should not be rewarded for their reckless behaviour. After all, it was taxpayers’ money that prevented many banks going bankrupt during the credit crunch.
Banks, of course, seek to justify the bonuses. If you don’t pay large bonuses, they maintain, then senior staff will leave and profits will suffer. It’s nothing to do with ‘morality’, they claim. It’s the market. ‘If you don’t pay the market rate, then executives will leave and take higher-paid jobs elsewhere.’
So are governments calling this bluff? In his pre-Budget report in December, the UK’s Chancellor of the Exchequer, Alistair Darling, announced a 50% tax on bank bonuses over £25,000. This was followed by an announcement by Nicholas Sarkozy that the French government would impose a similar 50% tax on bonuses over €27,500.
Then in mid January, President Obama proposed a tax on financial institutions with balance sheets above $50 billion. This would be levied at a rate of 0.15 percent of certain assets. But this was not a tax on bank bonuses, as favoured by the British and French governments, nor a tax on financial transactions – a type of Tobin tax – as favoured by Angela Merkel (see Tobin or not Tobin: the tax proposal that keeps reappearing). Nevertheless, it was another way of recouping for the taxpayer some of the money used to rescue banks and prevent a banking collapse.
So is this payback time for bankers, or will it simply be bank shareholders that suffer? And why can banks pay such large bonuses in the face of so much public hostility? The following articles explore the issues.
To leave or not to leave: the supertax question Financial Times, Patrick Jenkins and Kate Burgess (9/1/10)
French tax to raise €360m Financial Times, Scheherazade Daneshkhu and Ben Hall (13/1/10)
Oversized bank bonuses: classic case of overcharging The Business Times (Singapore), Anthony Rowley (15/1/10)
Obama vows to recoup ‘every dime’ taxpayers lent banks Belfast Telegraph (15/1/10)
Obama outlines $117bn bank levy (including video) BBC News (14/1/10)
Obama lays out his proposal to tax big US banks Sydney Morning Herald, Jackie Calmes (16/1/10)
Obama’s bank tax will only work if there’s a master plan in place Telegraph, Tracy Corrigan (14/1/10)
Turning the tables The Economist (14/1/10)
Obama’s bigger rod for banks BBC News, Peston’s Picks, Robert Peston (14/1/10)
Will Obama’s tax go global? BBC News, Peston’s Picks, Robert Peston (15/1/10)
Darling: I won’t do an Obama and tax the banks Scotsman, Eddie Barnes (16/1/10)
Obama tax is only the beginning of the banking Blitz Telegraph, Edmund Conway (15/1/10)
Bank taxes edge closer to the real target Guardian, Dan Roberts (15/1/10)
Questions
- Compare the incentive effects on bankers of the British, French and US measures discussed in the articles.
- Why does the ‘market’ result in high bank bonuses? Where does economic power lie in the market?
- Assume that you hold shares in Bank A. Would you welcome (a) high bonuses for executives of Bank A; (b) a tax on bank bonuses; (c) a ceiling on bank bonuses; (d) a tax on certain bank assets? Explain.
- What insights can game theory provide for the likely success in clawing back bank bonuses without doing damage to the economy?
- Consider whether Obama’s tax will “go global”.
Most businesses have suffered over the past year or so. Profits and sales have fallen, as the UK (and global) economy suffered from a recession that’s seen UK interest rates at 0.5%, unemployment rising and public debt at unprecedented levels. Christmas trading always sees a boost in sales and that’s just what’s happened for many businesses. Shoppers have responded to the doom and gloom of the past year by spending and making up for a hard year. Phrases such as “I decided to treat myself” became common on the news as reporters travelled to shopping centres across the UK. However, shops such as M&S and Next have warned that attempts by the government to reduce the public deficit could derail the consumer recovery.
These positive stories, whilst true, are a useful tool to help boost consumer confidence and keep expectations positive for the coming months. However, there are warnings that these figures shouldn’t be taken out of context. The economy is still in trouble and public debt has reached almost 60% of GDP. With cuts in government spending and rises in taxation expected, how much confidence should be taken from these positive signs in the retail sector? Only time will tell.
Online powers Shop Direct sales Financial Times, Esther Bintliff (6/1/10)
Poundland, House of Fraser and Co-op see sales rise BBC News (11/1/10)
Links of London see buoyant festive sales Telegraph, James Hall (5/1/10)
John Lewis reports bumper Christmas trading Retail Week, Jennifer Creevy (5/1/10)
New Look expects to build on strong Christmas London Evening Standard (7/1/10)
Christmas trade booming in City Star News Group, Alex de Vos (7/1/10)
Record trading for Cash Generator Manchester Evening News (7/1/10)
Sainsbury’s hails ‘strong’ Christmas trading BBC News (7/1/10)
Cautious M&S reports strong Christmas trade Times Online, Marcus Leroux and Robert Lindsay (6/1/10)
Asda reports ‘solid’ Christmas trading Guardian (6/1/10)
Questions
- Why are expectations important for the future of the British economy? Are the expectations rational or adaptive or a combination of the two?
- Are high Christmas sales really a sign that the economy is recovering? Discuss both sides of the argument. Will high sales now have an adverse effect on future trade in the UK?
- How will expected cuts in government spending affect sales in the retail sector?
- Tax rises are a possibility. How will this affect consumers and sales in the coming year? Think about the circular flow of income.
- If interest rates are increased in the coming months, trace through the likely effects in the goods market.