The Greek economy is suffering. In April 2010, a €45 billion bailout package was agreed between Greece and the IMF and the EU. This was increased to €110 billion in May 2011. (The bailout loans expire in 2013.) In return for the loans, Greece agreed to tough austerity measures, involving tax increases, clamping down on tax evasion and government expenditure cuts. These measures have succeeded in cutting the deficit by 5 percentage points, but it still stood at 10.5% of GDP in 2010. Public-sector debt rose from 127% of GDP in 2009 to 143% in 2010. The market cost of borrowing on two-year government bonds currently stands at 23% per annum – a sign of a serious lack of confidence by investors in Greece’s ability to repay the loans.
The austerity measures have brought great hardship. Unemployment has soared. In February 2011, it reached 15.9%; in February last year it was 12.1%. According to the IMF’s World Economic Outlook (Table A2), Greek real GDP fell by 2.0% in 2009, by 4.5% in 2010 and is forecast to fall by 3.0% in 2011. But with GDP falling, this brings automatic fiscal stabilisers into play: lower incomes mean lower income tax revenues; lower expenditure means lower VAT revenue; higher unemployment means that more people claim unemployment-related benefits. This all makes it harder to meet the deficit reduction targets through discretionary tax rises and government expenditure cuts and makes it even more important to cut down on tax evasion. But, of course, the more taxes rise and the more government expenditure is cut, the more this suppresses aggregate demand. The austerity measures have thus worsened the recession.
On May 9, the ratings agency Standard & Poor’s downgraded Greece’s rating to B (15 points below the top rating of AAA and 6 points into ‘junk’ territory). It now has the lowest rating in Europe along with Belarus.
Worries have been growing that Greece might be forced to default on some its debt, or choose to do so. This would probably mean an extension of repayment periods. In other words, bondholders would be paid back in full but at a later date. This has been referred to as ‘debt re-profiling’. This could cause a renewed loss of confidence, not only in the Greek economy, but also in banks that are major lenders to Greece and which would be exposed in the case of default or restructuring.
The IMF and the ECB have been quick to stress that Greece can continue to manage its debt and that, if necessary, another loan might be negotiated. Anticipations are that Greece could indeed ask for a further bailout. But is this the answer? Or would it be better if Greece sought a restructuring of its debt? The following webcasts and podcasts consider the issue.
Webcasts and podcasts
Greece may need second financial bail-out BBC News, Stephanie Flanders (11/5/11)
Greece needs revised bail-out Financial Times Global Economy Webcasts, Luke Templeman and Vincent Boland (9/5/11)
Why Greece must stick to the plan Financial Times Global Economy Webcasts, Ralph Atkins, Frankfurt Bureau Chief, talks to Jurgen Stark (11/5/11)
Will Greece need more money? BBC News, Matina Stevis (9/5/11)
Economists debate Greek crisis BBC News, Thomas Mayer and David McWilliam (9/5/11)
Greece at ‘a very difficult stage’ BBC Today Programme, Stephanie Flanders and Vassilis Xenakis (11/5/11)
The Business podcast: PPI scandal and Greece’s debt crisis Guardian Podcast, Aditya Chakrabortty (11/5/11) (listen to last part of podcast, from 19:20)
Greece: Eurozone ministers discuss terms of second bailout BBC News, Nigel Cassidy (16/5/11)
Greece dominates eurozone talks in Brussels BBC News, Matthew Price (17/5/11)
Articles
S&P moves to cut Greek credit rating Financial Times, Richard Milne, Tracy Alloway and Ralph Atkins (9/5/11)
One Year After the Bailout, Greece is Still Hurting Time Magazine, Joanna Kakissis (12/5/11)
What price a Greek haircut? BBC News blogs: Peston’s Picks, Robert Peston (10/5/11)
What is debt ‘reprofiling’? BBC News, Laurence Knight (17/5/11)
Reprofiling: Greece’s restructuring-lite Channel 4 News, Faisal Islam (17/5/11)
Questions
- What are the arguments for and against tough austerity measures for Greece and other eurozone countries with high deficits, such as Portugal and Ireland?
- Should Greece seek a restructuring of its debts?
- What is a ‘haircut’ and is this a suitable form of restructuring?
- What are the arguments for and against a default, or partical default, by the Greek government on its debt?
- Is it in the intesests of European banks to offer a further bailout to Greece?
- What should be the role of the IMF in the current situation in Greece?
Each month the Monetary Policy Committee of the Bank of England meets to set Bank Rate – the Bank’s repo rate, which has a direct impact on short-term interest rates and an indirect effect on other interest rates, such as mortgage rates and bond yields. Ever since March 2009, Bank Rate has been 0.5%. So each month the MPC has met and decided to do nothing! The latest meeting on 4 and 5 May was no exception.
And it is not just the Bank of England. The Fed in the USA has kept interest rates at between 0 and 0.25% ever since December 2008. The ECB had maintained its main interest rate at 1% for two years from May 2009. Then last month (April) it raised the rate to 1.25%, only to keep it unchanged at that level at its meeting on 5 May.
So is all this ‘doing nothing’ on interest rates (or very little in the case of the ECB) a sign that the economies of the UK, the USA and the eurozone are all ticking along nicely? Are they in the ‘goldilocks’ state of being neither too hot (i.e. too much demand and excessive inflation) or too cold (i.e. too little demand and low growth, or even recession)? Or does the apparent inaction on interest rates mask deep concerns and divisions within the decision-making bodies?
The three central banks’ prime concern may be inflation, but they are also concerned about the rate of economic growth. If inflation is forecast to be above target and growth to be unsustainably high, then central banks will clearly want to raise interest rates. If inflation is forecast to be below target and economic growth is forecast to be low or negative, then central banks will clearly want to reduce interest rates.
But what if inflation is above target and will probably remain so and, at the same time, growth is low and perhaps falling? What should the central bank do then? Should it raise interest rates or lower them? This is the dilemma facing central banks today. With soaring commodity prices (albeit with a temporary fall in early May) and the economic recovery stalling or proceeding painfully slowly, perhaps keeping interest rates where they are is the best option – an ‘active’ decision, but not an easy one!
Articles
Central Banks Leave Rates Unchanged News on News (8/5/11)
European Central Bank set for a bumpy ride City A.M., Guy Johnson (9/5/11)
Euro Tumbles Most Against Dollar Since January on Rate Signal; Yen Climbs Bloomberg, Allison Bennett and Catarina Saraiva (7/5/11)
Rates outlook Financial Times, Elaine Moore (6/5/11)
Interest rates on hold amid fears economy is stalling Independent, Sean Farrell (6/5/11)
The decision to hold back on increasing interest rates may turn out to be wrong Independent, Hamish McRae (6/5/11)
Bank of England: Inflation threat from fuel bills BBC News. Hugh Pym (11/5/11)
Andrew Sentance loses last battle over interest rates Guardian, Heather Stewart (5/5/11)
Interest rates: what the experts say Guardian (5/5/11)
King’s Defense of Record-Low Rates in U.K. Is Bolstered by Economic Data Bloomberg, Svenja O’Donnell (5/5/11)
BoE holds rates: reaction The Telegraph, Joost Beaumont, Abn Amro (5/5/11)
UK interest rates kept on hold at 0.5% BBC News (5/5/11)
Bank of England Signals Rate Increase This Year as Inflation Accelerates Bloomberg, Svenja O’Donnel (11/5/11)
ECB: Clearing the way for an Italian hawk? BBC News blogs: Stephanomics, Stephanie Flanders (5/5/11)
Ben and the Fed’s excellent adventure BBC News blogs: Stephanomics, Stephanie Flanders (27/4/11)
Inflation up. Growth down. Uncertainty everywhere BBC News blogs: Stephanomics, Stephanie Flanders (11/5/11)
Inflation report: analysts expecting a rate rise are wide of the mark Guardian, Larry Elliott (11/5/11)
May’s Inflation Report – three key graphs The Telegraph, Andrew Lilico (11/5/11)
The Errors Of The Inflation Hawks, Part I Business Insider, John Carney (9/5/11)
Errors of Inflation Hawks, Part II CNBC, John Carney (9/5/11)
Data and information
Inflation Report Bank of England
Inflation Report Press Conference Webcast Bank of England (11/5/11)
Monetary Policy ECB
ECB Interest Rates ECB
Monetary Policy Federal Reserve
US interest rates Federal Reserve
Questions
- Why is it exceptionally difficult at the current time for central banks to “get it right” in setting interest rates?
- What are the arguments for (a) raising interest rates; (b) keeping interest rates the same and also embarking on another round of quantitative easing?
- Should central banks respond to rapidly rising commodity prices by raising interest rates?
- Why is inflation in the UK currently around 2 percentage points above the target?
- What is likely to happen to inflation in the coming months and why?
- Explain the following comment by John Carney in the final article above: “To put it differently, the textbook money multiplier doesn’t exist anymore. This means that Fed attempts to juice the economy by raising the quantity of reserves—the basic effect of quantitative easing—are bound to fail.”.
- What has been the recent relationship in the UK between (a) growth in the monetary base and growth in broad money; (b) growth in the monetary base and inflation and economic growth?
Despite better economic growth in the first quarter of 2011, confidence remains low and according to Halifax, this has contributed to a decline in house prices from March to April by 1.4% to give their lowest average price since July 2009. Halifax has blamed this steady decline on a lack of confidence and the uncertain economic climate. However, despite this latest decline, Halifax have suggested that the trend may be coming to an end. Martin Ellis, from Halifax had this to say:
“Signs of a modest tightening in housing market conditions, a relatively low burden of servicing mortgage debt and an increase in the number of people in employment are all likely to be providing support for house prices, curbing the pace of decline. There are signs that house sales are stabilising, albeit at a level lower than the historical average.”
There are many factors that contribute towards house prices: the number of properties on the market, the number of buyers, the availability of mortgages and finance, interest rates and the future economic climate. How these factors change will have a crucial influence on the future house price trend. The following articles consider the causes and likely consequences of this latest housing market data.
House prices fall at fastest rate in 18 months Telegraph (9/5/11)
House prices ‘fell by 1.4% in April’ the Halifax says BBC News (9/5/11)
House prices post biggest fall in 1-1 ½ years Reuters, Fiona Shaikh (9/5/11)
House prices dive to a two-year low Independent, Nicky Burridge (9/5/11)
UK housing market remains weak Wall Street Journal, Jason Douglas (9/5/11)
U.K April house prices fall most in seven months, Halifax says Bloomberg, Svenja O’Donnell (9/5/11)
Questions
- What are the main causes behind this decline in house prices?
- The articles talk about the volatility of house prices over recent months. What is the explanation for this?
- If interest rates are increased by the MPC, is it more or less likely to cause house prices to decline further? Explain your answer.
- Why dies Martin Ellis, of Halifax, believe that the decline in house prices might reverse this year?
- How does the housing market affect the wider UK economy? Is these latest data likely to jeopardise the fragile recovery?
According to the first estimates by the Office for National Statistics, real UK GDP rose by 0.5% in the first quarter of 2011. In the House of Commons, David Cameron claimed that “it’s clearly a success the economy is growing”, while Ed Balls, Shadow Chancellor, countered this by stating that the economy “flat-lined in the last six months with no growth at all”.
So who is right? According to the statistics both are, in the sense that the economy grew by 0.5% in the first quarter of 2011 after shrinking by 0.5% in the fourth quarter of 2010. But what bigger picture do the figures paint? Is the economy now in recovery mode? Or is the fact that growth is so small a sign that the economy is still fragile? Could it easily dip back into recession as the tax increases and government expenditure cuts begin to bite?
And what of the policy implications? Do the latest figures make a rise in Bank Rate more or less likely in the near future? And how will the figures impact on confidence? Are they more or less likely to stimulate investment? Will consumers feel more confident that recovery is under way and their jobs are therefore more secure?
The following articles assess the situation and look ahead at the prospects for the UK economy.
Articles
UK economy ‘on a plateau’ as 0.5pc GDP rise disappoints The Telegraph, Emma Rowley and Philip Aldrick (28/4/11)
GDP figures: Cameron accused of complacency over economy Guardian, Hélène Mulholland (27/4/11)
Low growth figure suggests economy is stagnating – at best Independent, Sean O’Grady (28/4/11)
A matter of interpretation but nobody’s happy at the latest news Scotsman, Terry Murden (28/4/11)
UK economy grows by 0.5% in first quarter of 2011 BBC News (27/4/11)
Britain ‘on the edge of a double dip recession’ The Telegraph, Philip Aldrick (27/4/11)
British GDP grows by 0.5 per cent Channel 4 News, Faisal Islam (27/4/11)
GDP: Slow but not stagnant BBC News blogs: Stephanomics, Stephanie Flanders (27/4/11)
GDP figures: Despite meagre growth, we must hold our nerve The Telegraph (27/4/11)
The economic gamble looks ever more reckless Independent (28/4/11)
If George Osborne thinks this is the road to recovery, he needs a new satnav Guardian, Heather Stewart (27/4/11)
GDP figures: the verdict Guardian, Michael Burke, Eamonn Butler, Frances O’Grady, Ian Brinkley (27/4/11)
UK GDP grows 0.5pc: reaction The Telegraph, various commentators (27/4/11)
Data
GDP growth ONS
GDP preliminary estimates ONS
Forecasts for Output, Prices and Jobs The Economist
Forecasts for the UK economy: a comparison of independent forecasts HM Treasury
Questions
- What are the causes of short-term economic growth?
- Why has UK growth been lower than that of most other developed economies?
- What are the arguments for and against the government using fiscal policy at the current time to increase aggregate demand?
- Why has the construction sector performed so badly while the manufacturing sector has performed relatively well?
- How might the growth figures impact on consumer and business confidence? Why is this difficult to predict?
- What impact are the growth figures likely to have on interest rate decisions by the Bank of England’s Monetary Policy Committee?
As the new tax year begins, many changes are taking place. In order to cut the large budget deficit, sacrifices have to be made by all. The tax and benefit changes could make households worse off by some £2bn this year – definitely not good news for those households already feeling the squeeze. However, the Coalition say that the poorest households will be made better off relative to the rich.
Personal allowance is increasing by £1,000, which is expected to benefit £800,000 people who will no longer pay any tax. At the same time, the 40% tax bracket is being reduced from £43,875 to £42,475, which will bring another 750,000 people into this higher tax bracket, bringing in much needed revenue for the government. Employee’s national insurance contributions will rise by 1% and according to Credit Action, this will leave households £200 worse off per year. Benefits do rise with inflation, but they are to be indexed against the CPI rather than the RPI. The RPI is usually higher and hence benefits will not increase by as much, again leaving some people worse off. Child benefit will be frozen for all and will then be removed for higher rate tax payers from 2013. According to the Treasury, it is the top 10% of households who will lose the most from these needed changes. However, as Justine Greening, the Economic Secretary to the Treasury said:
‘Labour left behind a complete mess with no plan to deal with it, apart from to run up more debts for the next generation to pay off.’
In order to cut the deficit, which stands at an estimated £146bn, spending must fall and tax revenue for the government must rise. The government argues that if cuts are not made today, even higher cuts will be necessary in the future and this will harm the poorest even more. Whilst the Treasury have accepted that there was a ‘marginal loss’ across the population, it is the highest earning households that will suffer the most.
Wednesday of woe as the taxman bites: Changes could leave you £600 worse off Daily Mail, Becky Barrow (6/4/11)
Benefit cuts: Labour warns of ‘Black Wednesday’ BBC News (6/4/11)
Tax and benefit changes: row over financial impact BBC News (6/4/11)
Black Wednesday will hig millions in tax changes and cuts Metro, John Higginson (5/4/11)
Taxman to take extra £750 from families this year Scotsman, Tom Peterkin and Jeff Salway (6/4/11)
Tax and welfare changes will hit women and children hardest, says Ed Balls Guardian, Helene Mullholland, Polly Curtis and Larry Elliott (6/4/11)
Black Wednesday for millions of British families Telegraph (6/4/11)
Majority of households ‘better off’ The Press Association (6/4/11)
Questions
- Where does the term ‘Black Wednesday’ come from?
- What is the likely impact of the 1% rise in NICs? Think about the income and substitution effects. Can you illustrate the effect using indifference analysis?
- Why are Labour arguing that women and children will be hit the hardest and the coalition arguing that it is the highest income households who will lose the most? Can both parties be right?
- What are the arguments (a) for and (b) against bringing in tax and benefit changes today rather than in a few years?
- How might these changes affect the economic recovery?
- Is it equitable that child benefit should eventually be removed from those paying the higher rates of income tax?
- Why has the government indexed benefit payments to rise in line with the CPI rather than the RPI?