Rising inflation: not normally a cause for celebration, but that’s not the case for Japan. Having been subject to the spectre of deflation for many years, the 22-year high for the CPI at 2.7% is a welcome figure, even it is slightly lower than expected. This surge in prices is partly the result of a growth in domestic demand and a sign, therefore, that output will expand in response to the rise in demand.
The Japanese economy has experienced largely stagnant growth for two decades and a key cause has been falling prices. Although consumers like bargains, this has been problematic for this large economy. Deflation creates continuously falling prices and this means consumers hold back from purchasing durable goods, preferring to wait until prices have fallen further.
In the blog, Japan’s recovery, we looked at inflation data showing Japanese consumer prices growing at a faster rate than expected. This ‘positive’ trend has continued.
When it comes to inflation, expectations are crucial. If people think prices will rise in the future, they are more likely to buy now to get the lower price. This can therefore help to stimulate aggregate demand and it is this that has been the target for Japan. Part of the growth in the CPI is down to the sales tax rise from 5% to 8%. This was the first time in 17 years that the sales tax had increased. Further increases in it are expected in 2015. There were concerns about the impact of this rise, based on the depression that followed the last rise back in 1997, but so far the signs seem good.
Monetary easing was a key component in ending the downward trajectory of the Japanese economy and, following the sales tax rise, many believe that another round of monetary easing may be needed to counter the effects and create further growth in the economy and in the CPI. As the Bank of Japan Governor said:
There are various ways to adjust policy. We will decide what among these measures is appropriate depending on economic and price developments at the time … For now, we can say Japan is making steady progress toward achieving 2 per cent inflation.
One of the ‘three arrows‘ of the government’s policy has been to boost government spending, which should directly increase aggregate demand. Furthermore, with signs of the CPI rising, consumers may be encouraged to spend more, giving a much needed boost to consumption. The economy is certainly not out of the woods, but appears to be on the right path. The following articles consider the Japanese economy.
Japan CPI rises less than expected Wall Street Journal, Takashi Nakamichi (25/4/14)
Japan inflation may beat BOJ forecast Reuters, Leika Kihara (22/4/14)
Tokyo consumer price growth at 22-year high BBC News (25/4/14)
Japan inflation quickens to over 5-year high, output rebounds Reuters, Leika Kihara and Stanley White (31/1/14)
Japan’s consumer inflation set to reach five-year high Guardian (18/4/14)
Tokyo inflation hits 22-year high, inching toward BOJ goal Reuters, Tetsushi Kajimoto and Leika Kihara (25/4/14)
Tokyo’s core CPI got 2.7% lift in April from tax hike The Japan Times (25/4/14)
Is Japan winning the war against deflation? CNBC, Ansuya Harjani (25/4/14)
Questions
- Why is deflation a problem?
- Using an AD/AS diagram, illustrate the problem of expectations and how this contributes to stagnant growth.
- Use the same diagram to explain how expectations of rising prices can help to boost AD.
- Why is the sales tax expected to reduce growth?
- Why is another round of monetary easing expected?
- What government policies would you recommend to a government faced with stagnant growth and falling prices?
Unemployment and employment are concepts that are often talked about in the media. Indeed, the 7% unemployment target referred to by the Governor of the Bank of England has been a constant feature of recent headlines. However, rather than targeting an unemployment rate of 7%, George Osborne has now called for ‘full employment’ and believes that tax and welfare changes are key to meeting this objective.
Reducing the unemployment rate is a key macroeconomic objective and the costs of unemployment are well-documented. There are obviously big costs to the individual and his/her family, including lower income, dependency, stress and potential health effects. There are also costs to the government: lower income tax revenues, potentially lower revenues from VAT through reduced consumer expenditure and the possibility of higher benefit payments. There are other more ‘economic’ costs, namely an inefficient use of resources. Unemployment represents a cost to the economy, as we are operating below full capacity and we therefore see a waste of resources. It is for this reason that ‘full employment’ is being targeted.
Traditional economic theory suggests that there is a trade-off between unemployment and inflation, illustrated by the well-known Phillips curve. In the past, governments have been willing to sacrifice unemployment for the purpose of reducing inflation. There have also been attempts to boost the economy and create jobs through increased borrowing. However, George Osborne has said:
Unemployment is never a price worth paying, but artificial jobs paid for with borrowed money doesn’t work either.
A figure representing full employment hasn’t been mentioned, so it remains unclear what level of unemployment would be acceptable, as despite the name ‘full employment’, this doesn’t mean that everyone has a job. There are several definitions of full employment, in both an economic and political context. In the period of reconstruction after the Second World War, William Beveridge, architect of the welfare state, defined full employment as where 3% of people would be unemployed.
In more recent times, other definitions have been given. In the era of monetarism in the 1970s, the term ‘natural rate of unemployment’ was used to define the unemployment rate to which economies tend in the long run – after inflationary expectations have adjusted. Keynesians use the term the ‘non-accelerating-inflation rate of unemployment (NAIRU)’, where unemployment is confined to equilibrium unemployment and where there is no excess or deficiency of aggregate demand. Both the natural rate and the NAIRU relate to the rate of unemployment at which the long-run Phillips curve is vertical.
In its Economic and Fiscal Outlook of March 2013, the Office for Budget Responsibility estimated the UK’s NAIRU to be 5.4%. George Osborne has not specified a particular rate. Rather, his speech refers to creating the ‘highest employment rate of any of the world’s leading economies’. He said the ambition was to make the UK:
…the best place in the world to create a job; to get a job; to keep a job; to be helped to look for another job if you lose one…A modern approach to full employment means backing business. It means cutting the tax on jobs and reforming welfare.
Therefore, while it appears that there is no target figure for unemployment, it seems that a new Conservative objective will be to focus on sustainable job creation and eliminate disequilibrium unemployment. This represents a move very much into Labour territory. Meeting the objective will be no easy task, given the past few years and such high levels of youth unemployment, as Labour were quick to point out, but the unemployment figures are certainly moving in the right direction. The following articles consider the objective of full employment.
Articles
Britain’s Osborne changes tone on economy with “full employment” target Reuters, William James (31/3/14)
George Osborne commits to ‘fight for full employment’ BBC News (including video) (1/4/14)
What does full employment mean? The Guardian (1/4/14)
What is full employment? The Telegraph, Peter Dominiczak (31/3/14)
’Jobs matter’, says George Osborne as he aims for full employment Independent, Andrew Grice (31/3/14)
Liam Bynre: Labour would aim for ‘full employment’ BBC News (17/5/13)
Osborne pledges full employment for UK Sky News (31/3/14)
Osborne commits to full employment as election looms Bloomberg, Svenja O’Donnell (31/3/14)
Whatever happened to full employment? BBC News, Tom de Castella and Caroline McClatchey (13/10/11)
Questions
- What is meant by full employment?
- Is it a good idea to target zero unemployment?
- Using a diagram, illustrate the difference between disequilibrium and equilibrium unemployment?
- How can full employment be achieved?
- What are the costs of unemployment?
- Use a diagram to illustrate the natural rate of unemployment and explain what it means in terms of the relationship between unemployment and inflation.
Globalisation has led to an increasingly interdependent world, with companies based in one country often dependent on a market abroad. In recent years, it is the rapid growth of countries like China that has led to growth in the size of the markets for many products. With incomes rising in emerging countries, demand for many products has been growing, but in the past year, the trend for Prada has ended and seems to be reversing.
As the market in China matures and growth of demand in Europe slows, Prada has seen its shares fall by the largest margin since June last year.
Prada is a well-known luxury brand. The products it sells are relatively expensive and hence its products are likely to have an income elasticity of demand well above +1. With changes in China and Europe, Prada expects its growth in sales to January 2015 will be ‘low single-digit’ – less than the 7% figure recorded for the last financial year.
This lower growth in same-store sales is likely to continue the following year as well. Add on to this the lower-than-expected profits, which missed analysts’ forecasts, and you have a prime example of a brand that is suffering because of its customer base and the economic times.
Prada isn’t alone in suffering from economic conditions and, relative to its European counterparts, is expected to have higher growth in sales and profits in the next 12 months – at 11.5% and 14.8% respectively. This is according to a survey by Thomson Reuters.
Prada has exploited high demand by Chinese consumers, but has recently been affected by the strength of the euro. A strong euro means that the Italian-based Prada is struggling with exports, which only adds to its problems. As economic growth picks up in China and as other emerging economies begin to experience more rapid economic growth, the fortunes of this luxury-retailer may change once more. However, with volatile economic times still around in many countries, the future of many retailers selling high-end products to higher income customers will remain uncertain. The following articles consider the fortunes of Prada.
Prada shares fall sharply after China luxury warning BBC News (3/4/14)
Prada falls after forecasting slowing luxury sales growth Bloomberg, Andrew Roberts and Vinicy Chan (3/4/14)
Prada profits squeezed by weakness in Europe and crackdown in China The Guardian (2/4/14)
Prada bets on men to accelerate sales growth Reuters, Isla Binnie (2/4/14)
Prada misses full year profit forecast Independent, Laura Chesters (2/4/14)
Questions
- How can we define a luxury product?
- Explain the main factors which have led to a decline in the demand for Prada products over the past 12 months.
- Using a diagram, illustrate what is meant by a strong euro and how this affects export demand.
- What business strategies are Prada expected to adopt to reverse their fortunes?
- Using a diagram, explain the factors that have caused Prada share prices to decline.
In August 2012, the ECB president, Mario Draghi, said that the ECB would ‘do whatever it takes‘ to hold the single currency together and support the weaker economies, such as Greece, Portugal and Spain. At the same time, he announced the introduction of outright monetary purchases (OMTs), which would involve purchasing eurozone countries’ bonds in the secondary markets. There were no limits specified to such purchases, but they would be sterilised by the sale of other assets. In other words, they would not increase the eurozone money supply. But despite the fanfare when OMTs were announced, they have never been used.
Today, the eurozone economy is struggling to grow. The average annual growth rate across the eurozone is a mere 0.5%, albeit up from the negative rates up to 2013 Q3. GDP is still over 2% below the peak in 2008. Inflation is currently standing at 0.8%, well below the 2% target. The ECB’s interest rate (‘main refinancing operations rate’) is 0.25%.
The recovery is hindered by a strong euro. As the chart shows, the euro has been appreciating against the dollar. The euro exchange rate index has also been rising. This has made it harder for the eurozone countries to export.
So what can the ECB do to stimulate the eurozone economy? Other central banks, such as the Bank of England, the US Federal Reserve and the Bank of Japan have all had substantial programmes of quantitative easing. The ECB has not. Perhaps OMTs could be used without sterilisation. The problem here is that there are no eurozone bonds issued by the ECB and hence none that could be purchased, only the bonds of individual member countries. Buying bonds of weaker countries in the eurozone would be seen as favouring these countries and might create a moral hazard.
Reducing interest rates is hardly an option given that they are at virtually zero already. And expansionary fiscal policy in the weaker countries has been ruled out by having to stick to the bailout conditions for these countries, which require the pursuit of austerity policies.
One possibility would be to intervene in the foreign currency market by buying US and other countries’ bonds. This would drive down the euro and provide a stimulus to exports. This option is considered in the Jeffrey Frankel article.
Articles
Why the European Central Bank should buy American The Guardian, Jeffrey Frankel (13/3/14)
Draghi holds course in face of deflation threat Reuters, Paul Carrel and Leika Kihara (13/3/14)
ECB’s Draghi: Strong Euro Pulling Down Euro Zone Inflation Wall Street Journal, Christopher Lawton and Todd Buell (13/3/14)
Draghi Bolstering Guidance Seen as Convincing on Rates Bloomberg, Jeff Black and Andre Tartar (13/3/14)
ECB president Mario Draghi counters euro upswing Financial Times, Claire Jones (13/3/14)
Turning Japanese? Euro zone exporters must hope not Reuters, Neal Kimberley (14/3/14)
Prospect of ECB QE drives eurozone bond rally Financial Times, Laurence Mutkin (12/3/14)
Data
Statistical Data Warehouse ECB
Winter forecast 2014 – EU economy: recovery gaining ground European Commission: Economic and Financial Affairs DG
AMECO online European Commission: Economic and Financial Affairs DG
Questions
- Why is the ECB generally opposed to quantitative easing of the type used by other central banks?
- What is meant by ‘sterilisation’? Why does sterilisation prevent OMTs being classed as a form of quantitative easing?
- Would it be possible for OMTs to be used without sterilisation in such as way as to avoid a moral hazard for the highly indebted eurozone countries?
- Is the eurozone in danger of experiencing deflation?
- What are the dangers of deflation?
- Why does the ECB not cut its main refinancing rate below zero?
- If the ECB buys US bonds, what effect would this have on the euro/dollar exchange rate?
- Would purchasing US bonds affect the eurozone money supply? Explain.
- What other means are there of the ECB stimulating the eurozone economy? How effective would they be likely to be?
While much of the UK is struggling to recover from recession, the London economy is growing strongly. This is reflected in strong investment, a growth in jobs and rapidly rising house prices.
There are considerable external economies of scale for businesses locating in London. There is a pool of trained labour and complementary companies providing inputs and services are located in close proximity. Firms create positive externalities to the benefit of other firms in the same industry or allied industries.
London is a magnet for entrepreneurs and highly qualified people. Innovative ideas and business opportunities flow from both business dealings and social interactions. As Boris Johnson says in the podcast, “It’s like a cyclotron on bright people… People who meet each other and spark off each other, and that’s when you get the explosion of innovation.”
Then there is a regional multiplier effect. As the London economy grows, so people move to London, thereby increasing consumption and stimulating further production and further employment. Firms may choose to relocate to London to take advantage of its buoyant economy. There is also an accelerator effect as a booming London encourages increased investment in the capital, further stimulating economic growth.
But the movement of labour and capital to London can dampen recovery in other parts of the economy and create a growing divide between London and other parts of the UK, such as the north of England.
The podcast examines ‘agglomeration‘ in London and how company success breeds success of other companies. It also looks at some of the downsides.
Podcast
Boris Johnson: London is cyclotron on bright people BBC Today Programme, Evan Davis (3/3/14)
Articles
London will always win over the rest of the UK The Telegraph, Alwyn Turner (2/3/14)
Evan Davis’s Mind The Gap – the view from Manchester The Guardian, Helen Pidd (4/3/14)
London incubating a new economy London Evening Standard, Phil Cooper (Founder of Kippsy.com) (10/2/14)
Reports and data
London Analysis, Small and Large Firms in London, 2001 to 2012 ONS (8/8/13)
Regional Labour Market Statistics, February 2014 ONS (19/2/14)
London Indicators from Labour Market Statistics (11 Excel worksheets) ONS (19/2/14)
Annual Business Survey, 2011 Regional Results ONS (25/7/13)
Economies of agglomeration Wikipedia
Questions
- Distinguish between internal and external economies of scale.
- Why is London such an attractive location for companies?
- Are there any external diseconomies of scale from locating in London?
- In what ways does the expansion of London (a) help and (b) hinder growth in the rest of the UK?
- Examine the labour statistics (in the links above) for London and the rest of the UK and describe and explain the differences.
Rising inflation: not normally a cause for celebration, but that’s not the case for Japan. Having been subject to the spectre of deflation for many years, the 22-year high for the CPI at 2.7% is a welcome figure, even it is slightly lower than expected. This surge in prices is partly the result of a growth in domestic demand and a sign, therefore, that output will expand in response to the rise in demand.
