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?
Is this a problem you find when you go shopping? Maybe that’s because the shop that sells it has closed. A report by the Local Data Company has revealed that one in eight shops stand empty on Britain’s high streets, after the recession saw vacancies shoot up by 24% in the second half of 2009. The number of empty town-centre shops climbed to 17,880 in the second half of 2009, equivalent to 12% of the 149,000 shops covered by the research.
Margate in Kent and Wolverhampton in the Midlands were two of the worst-hit areas, where vacant shops stood at 27% and 24% respectively. Take a stroll down a high street in almost any city or town in the UK and you are bound to see ‘Shop for let’. We’ve seen Woolworths and Borders close down and Threshers’ parent company collapse. But these stores have largely remained empty.
Empty houses have also been a problem as the number of repossessions increases. Statistics show an average of 126 people a day were thrown out of their homes in 2009. What is the explanation behind this?
An obvious answer is the recession. As shops felt the strain of low demand, some were simply unable to cope and they shut down as a result. At the same time, new firms were reluctant to take the risk and enter the market during an economic downturn – and who can blame them?
However, are there other reasons why Britain’s high streets are seeing more and more empty shops? The following articles look at the reshaping of our high streets and some of the explanations behind it.
Empty Shops
Shops ‘empty due to recession’ The Press Association (11/2/10)
UK recession has left one in eight shops empty Telegraph, Graham Ruddick (11/2/10)
Bradford second worse for empty shop premises Telegraph and Argus, Will Kilner (11/2/10)
25% of town shops now empty Express and Star (11/2/10)
British town centres in crisis, conference told Reuters, Sinead Cruise (10/2/10)
Empty shop numbers continue to rise in UK Property Week, Laura Chesters (10/2/10)
Empty shops caused by more than recession Startups (12/2/10)
Empty Homes
Buy-to-let: Landlords blow as tenants struggle to pay Telegraph (11/2/10)
Housing Minister says repossession is the ‘best thing’ for homeowners Telegraph, Myra Butterworth (11/2/10)
Home repossessions at highest since 1995 This is Money (11/2/10)
Questions
- What are the main factors behind the high number of empty shops? Use a demand and supply diagram to illustrate these factors.
- In the Startups Article, the BRC Director says: “High street shops are often battling big bills for business rates and rents, parking and access difficulties, as well as failure to manage and invest in the area.” Illustrate this on a diagram and explain how this effect has contributed to empty shops.
- To what extent is more internet shopping the main cause of the problem? Why is it cheaper to run a business via the internet than on a high street?
- Why have some cities and towns been more affected than others?
- Is there a link between empty shops and repossessions?
- What more could the government and local councils do to try to encourage businesses to set up on the high street?
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.