Many economists argue that the most effective policy for dealing with climate change is carbon pricing. This reduces greenhouse gas (GHG) emissions in a way that minimises the costs to the economy.
For the policy to work effectively it is important that the price per tonne of CO2 equivalent (CO2e) does not vary with the activity that causes the emissions. In other words, whether you drive a car, heat your house using gas or travel by air, the GHGs you create need to be priced at a unified rate.
Governments can introduce carbon pricing in two different ways – cap-and-trade schemes and carbon taxes.
With a cap-and-trade policy, emission allowances are either issued or sold to the organisations covered by the scheme. They must accumulate enough of these allowances to match the actual level of emissions they produce or pay a large fine. After the initial allocation, allowances can be bought and sold in a secondary market and prices can be quite volatile.
With a carbon tax, the government directly sets the price of GHGs through the tax rate but has less control over the quantity of emissions.
Policy in the UK
The UK Emissions Trading Scheme – an example of a cap-and-trade scheme – clearly places a price on GHG emissions. As this price is determined by market forces it can vary on a daily basis. The scheme applies to electricity generation and other energy-intensive industries that account for approximately 30 per cent of all emissions.
Although the UK does not have a specific carbon tax, it does have a number of different taxes that have an impact on the environment. Some of these have stated environmental objectives (e.g. the Climate Change Levy) while the main rationale for others is to raise revenue (fuel duty).
The tax rates are typically set on the output or consumption of the good rather than on emissions. For example, the Climate Change Levy applies to businesses’ use of electricity, gas and coal rather than the emissions the energy generates. Fuel duty depends on the amount of petrol consumed rather than the emissions the burning of that fuel generates. Clearly, emissions will tend to rise in proportion to the consumption/production of the good, but the relationship will not be precise.
The structure of VAT also influences emissions. The standard rate of VAT in the UK is 20 per cent. However, a lower level is applied to some goods/services that produce significant emissions. For example, the rate on household consumption of gas is 5 per cent while commercial passenger flights are zero rated. These lower tax rates are an implicit subsidy for the people who consume these goods/services. It makes them cheaper relative to the price of other goods.
Impact of the policies
Researchers from the Institute for Fiscal Studies have recently tried to analyse the impact of this complex range of policies on the price of carbon. The results indicate wide variations depending on the activity that causes the emissions.
One of the most significant differences is between gas and electricity. For example, non-energy-intensive businesses pay a price of £229.10 per tonne of CO2e from electricity generation but only £30.50 per tonne from burning gas. The response to the incentives this creates is unsurprising. One of the biggest contributing factors to the fall in territorial emissions in the UK has come from the decarbonisation of electricity supply: i.e. the switch away from coal-fired generation.
The impact of government policy on UK households creates quite perverse incentives. Because of the lower rates of VAT, families receive an implicit subsidy of £24 per tonne CO2e when they use gas to heat their homes. When they use electricity, the source of energy that generates less emissions, they face a positive price of £137 per tonne of CO2e. Once again, the response to these incentives is unsurprising. Household emissions only fell by a relatively small amount between 1990 and 2018 because of the continued use of gas for heating and cooking.
Unsurprisingly many commentators have referred to carbon pricing in the UK as a confusing mess and have called for a unified rate across all activities to minimise the costs to the economy. Another important issue is the level at which a new unified rate is set. Some research by the Department for Business, Energy and Industrial Strategy suggests that the figure would have to be set between £122 and £36 per tonne of CO2e in order for the UK to reach its target of net zero emissions by 2050.
A higher unified rate would also create another problem – the distributional impact. Poorer households spend a much greater share of their income on electricity, heating and food and so would be disproportionately affected by the policy. For the policy to be politically acceptable, the government will need to find an effective way to compensate these groups.
Articles
Report
Questions
- Outline the difference between territorial and consumption emissions.
- Using the concepts of rivalry and excludability, explain why GHGs and the climate change they cause are an example of market failure.
- Discuss the main differences between cap-and trade schemes and carbon emission taxes.
- Explain why a unified carbon price would minimise the costs to the economy of reducing the level of GHG emissions.
- Discuss some of the potential limitations of introducing carbon pricing and explain why some countries are considering the implementation of a Carbon Border Adjustment mechanism.
Inflation has surged worldwide as countries have come out of their COVID-19 lockdowns. The increases in prices combined with supply-chain problems has raised questions of what will happen to future prices and whether it will feed further inflation cycles.
Inflation targeting
Inflation is a key contributor to instability in an economy. It measures the rate of increases in prices over a given period of time and indicates what will happen to the cost of living for households. Because of its importance, many central banks aim to keep inflation low and steady by setting a target. The Bank of England, the Federal Reserve, and the European Central Bank all aim to keep inflation low at a target rate of 2 per cent.
Inflation-rate targeting has been successfully practised in a growing number of countries over the past few decades. However, measures to combat rising inflation typically contract the economy through reducing real aggregate demand (or at least its rate of growth). This is a concern when the economy is not experiencing a strong economic performance.
Current outlook
Globally, rising inflation is causing concern as a surge in demand has been confronted by supply bottlenecks and rising prices of energy and raw materials. As the world emerges from the COVID-19 lockdowns, global financial markets have been affected in recent months by concerns around inflation. They have also been affected by the prospect of major central banks around the world being forced into the early removal of pandemic support measures, such as quantitative easing, before the economic recovery from the coronavirus is complete.
The Chief Economist at the Bank of England has warned that UK inflation is likely to rise ‘close to or even slightly above 5 per cent’ early next year, as he said the central bank would have a ‘live’ decision on whether to raise interest rates at its November meeting. Although consumer price inflation dipped to 3.1 per cent in September, the Bank of England has forecast it to exceed 4 per cent by the end of the year, 2 percentage points higher than its target. UK banks and building societies have already started to increase mortgage rates in response to rising inflation, signalling an end to the era of ultra-low borrowing costs and piling further pressure on household finances.
In the USA, shortages throughout the supply chains on which corporate America depends are also causing concern. These issues are translating into widespread inflationary pressure, disrupting operations and forcing companies to raise prices for customers. Pressure on every link in the supply chain, from factory closures triggered by COVID-19 outbreaks to trouble finding enough staff to unload trucks, is rippling across sectors, intensifying questions about the threat that inflation poses to robust consumer spending and rebounding corporate earnings. Reflecting concern over weaker levels of global economic growth despite rising inflationary pressures, US figures published at the end of October showed the world’s largest economy added just 194 000 jobs in September, far fewer than expected.
There are also fears raised over high levels of corporate debt, including in China at the embattled property developer Evergrande, where worries over its ability to keep up with debt payments have rippled through global markets. There are major concerns that Evergrande could pose risks to the wider property sector, with potential spill-overs internationally. However, it is argued that the British banking system has been shown in stress tests to be resilient to a severe economic downturn in China and Hong Kong.
Central bank responses
The sharpest consumer-price increases in years have evoked different responses from central banks. Many have raised interest rates, but two that haven’t are the most prominent in the global economy: the Federal Reserve and the European Central Bank. These differences in responses reflect differing opinions as to whether current price increases will feed further inflation cycles or simply peter out. For those large central banks, they are somewhat relying on households keeping faith in their track record of keeping inflation low. There is also an expectation that there are enough underutilised workers to ensure that wage inflation is kept low.
However, other monetary authorities worry that they have not yet earned the record of keeping inflation low and are concerned about the risk of wage inflation. In addition, in poorer countries there is a larger share of spending that goes on essentials such as food and energy. These have seen some of the highest price increases, so policy makers are going to be keen to stamp down on the inflation.
The Federal Reserve is expected to announce that it will start phasing out its $120bn monthly bond-buying programme (quantitative easing) as it confronts more pronounced price pressures and predictions that interest rates will be lifted next year. However, no adjustments are expected to be made to the Fed’s main policy rate, which is tethered near zero. Whilst financial markets are betting on an rise in Bank Rate by the Bank of England as early as next month, spurred by comments from Governor Andrew Bailey in mid-October that the central bank would ‘have to act’ to keep a lid on inflation.
Outlook for the UK
The Bank of England’s Chief Economist, Huw Pill, has warned that high rates of inflation could last longer than expected, due to severe supply shortages and rising household energy bills. He said inflationary pressures were still likely to prove temporary and would fall back over time as the economy adjusted after disruption caused by COVID and Brexit. However, he warned there were growing risks that elevated levels of inflation could persist next year.
The looming rise in borrowing costs for homeowners will add further pressure to family finances already stretched by higher energy bills and surging inflation. According to the Institute for Fiscal Studies, it is expected that households will face years of stagnating living standards, with predictions showing that households would on average be paying £3000 more each year in taxes by 2024/25, with the biggest impact felt by higher earners.
Investors are also reacting to concerns and have pulled $9.4bn out of UK-focused equity funds this year after hopes that a COVID-19 vaccination drive will fuel a vigorous economic recovery were overshadowed by questions about slow growth and high inflation. It is suggested that there is a general sense of caution about the UK when it comes to investing globally, driven by monetary, fiscal and trade uncertainties.
Given all the elements contributing to this outlook, The IMF has forecast that the UK will recover more slowly from the shocks of coronavirus than other G7 nations, with economic output in 2024 still 3 per cent below its pre-pandemic levels. Financial markets are predicting the Bank of England will lift interest rates as soon as the next MPC meeting. And while supply-chain bottlenecks and rising commodity prices are a global trend, the Bank’s hawkish stance has increased the possibility of a sharper slowdown in Britain than other developed markets, some analysts have said.
What next?
Some of the major central banks are poised to take centre stage when announcing their next monetary action, as it will reveal if they share the alarm about surging inflation that has gripped investors. Markets are betting that the Bank of England will begin raising interest rates, with Bank Rate expected to rise to around 1.25 per cent by the end of next year (from the current 0.1 per cent).
It is thought that the Fed will not raise interest rates just yet but will do so in the near future. Markets, businesses, and households globally will be waiting on the monetary decisions of all countries, as these decisions will shape the trajectory of the global economy over the next few years.
Articles
- Three Days Will Reveal Global Alert Level on Inflation: Eco Week
Bloomberg, Molly Smith and Craig Stirling (31/10/21)
- Inflation watch: Global food prices hit 10-year high
Al Jazeera (4/11/21)
- Fed sings the ‘transitory’ inflation refrain, unveils bond-buying ‘taper’
ReutersHoward Schneider and Ann Saphir (3/11/21)
- BoE chief economist warns UK inflation likely to hit 5%
Financial Times, Chris Giles (21/10/21)
- Inflation pressure now ‘brutal’ because of supply squeeze, US companies say
Financial Times, Andrew Edgecliffe-Johnson, Matthew Rocco, Obey Manayiti and Claire Bushey (23/10/21)
- Rising inflation could trigger global sell-off that would harm UK, says Bank
The Guardian, Richard Partington (8/10/21)
- Bank of England chief economist warns high inflation rates may persist in 2022
The Guardian, Richard Partington (7/10/21)
- Bank of England surprises markets by holding rates at record lows
CNBC, Elliot Smith (4/11/21)
Bank of England resists pressure to raise interest rates as inflation spike loomsSky News, Ed Conway (4/11/21)
Forecasts and commentary
Questions
- What is the definition of inflation?
- How is inflation measured?
- Using a diagram to aid your answers, discuss the difference between cost-push and demand-pull inflation.
- What are the demand-side and cost-side causes of the current rising inflation?
- Explain the impact an increase in interest rates has on the economy.
The UK government has made much of its spending commitments in the UK Budget and Spending Review delivered on 27 October 2021. Spending on transport infrastructure, green energy and health care figured prominently. The government claimed that these were to help achieve its objectives of economic growth, carbon reduction and ‘levelling up’. This means that government expenditure will be around 42% of GDP for the five years from 2022 (from 1988 to 2000 it averaged 36%). Although it temporarily rose to 52% in 2020/21, this was the result of supporting the economy through the pandemic. But does this mean that the government is now a ‘Keynesian’ one?
When the economy is in recession, as was the case in 2020 with the effects of the pandemic, increased government expenditure financed by borrowing rather than taxation is the classic Keynesian remedy to boost aggregate demand and close the output gap. The increased injection of spending works through the multiplier process to raise equilibrium national income and reduce unemployment.
But is this the objective of the extra spending announced in October 2021? To answer this, it is important to look at forecasts for the state of the economy with no change in government policy and at the balance of government expenditure and taxation resulting from the Budget. The first chart shows public sector net borrowing from 2006/7 and forecast to 2026/7. The green and red lines from 2021/22 onwards give the PSNB forecasts with and without the October 2021 measures.
As you can see, there was a large increase in the PSNB in 2020/21, reflecting the government’s measures to support firms and workers during the pandemic. (Click here for a PowerPoint of the chart.) This was very much a Keynesian response, where a large budget deficit was necessary to support aggregate demand. It was also to protect the supply side of the economy by enabling firms to survive.
But could the October 2021 announcements also be seen as a Keynesian response to the macroeconomic situation? If we redraw Chart 1, focusing just on the forecast period and adjust the vertical scale, we can see that the measures have a net effect of increasing the PSNB and thus acting as a stimulus to aggregate demand. (Click here for a PowerPoint of the chart.) The figures are shown in the following table, which shows the totals from Table 5.1 in the Autumn Budget and Spending Review 2021 document:
Effects of Spending Review and Budget 2021 on PSNB (+ = increase in PSNB)
At first sight, it would seem that the Budget was mildly expansionary. To see how much so, the Office for Budget Responsibility (OBR) measures the ‘fiscal stance’ using the ‘cyclically adjusted primary deficit (CAPD)’. This is PSNB minus interest payments and minus expenditures and tax revenues that fluctuate with the cycle and which therefore act as automatic stabilisers. The OBR’s forecast of the CAPD shows it to be expansionary, but decreasing over time. In 2021/22, there is forecast to be a net injection of around 3.2% (excluding ‘virus-related’ support), falling to 2.7% in 2022/23 and then gradually to around 0.6% by 2026/27. So it does seem that fiscal policy remains expansionary throughout the period, but less and less so.
But this alone does not make it ‘Keynesian’. A Keynesian Budget would be one that uses fiscal policy to adjust aggregate demand (AD) according to whether AD is forecast to be deficient or excessive without the Budget measures. To operate a Keynesian Budget, it would be necessary to forecast the output gap without any policy measures. If was forecast to be negative (a deficiency of demand, with equilibrium output below the potential level), then an expansionary policy should be pursued by raising government expenditure, cutting taxes or some combination of the two. If it was forecast to be positive (an excess demand, with equilibrium output above the potential level), then a contractionary/deflationary policy should be pursued by cutting government expenditure, raising taxes or some combination of the two.
So what is the forecast for the output gap? The OBR states that, after being negative in 2020
(–0.4% of potential GDP), it has risen substantially to 0.9% in 2021 with the rapid bounce back from the pandemic. But it is forecast to remain positive, albeit declining, until reaching zero in 2025. This is illustrated in Chart 3. (Click here for a PowerPoint of the chart.) So fiscal policy remains mildly expansionary until 2025, after having provided a considerable stimulus in 2021.
This is not normally what a Keynesian economist would recommend. Fiscal policy should be designed to achieve a zero output gap. With the output gap being substantially positive in 2021, there is a problem of excess demand. This can be seen in supply-chain difficulties and labour shortages in certain areas and higher inflation, with CPI inflation predicted by the OBR to rise to 4.4 per cent in 2022. The combination of higher prices, the rise in national insurance from April 2022 by 1.25 percentage points and the freezing of income tax personal allowances will squeeze living standards. And the cancelling of the £20 per week uplift to Universal Credit and no increase in its rate for the unemployed will put particular pressure on some of the poorest people.
The government is hoping that the rise in government expenditure will have beneficial supply-side effects and increase potential national income. The aim is to create a high-wage, high-skilled, high-productivity economy though investment in innovation, infrastructure and skills. As the OBR states, ‘The rebounding economy has provided the Chancellor with a Budget windfall that he has added to with tax rises that lift the tax burden to its highest since the early 1950s’.
It remains to be seen whether the extra spending on education, training, infrastructure and R&D will be sufficient to achieve the long-term growth the Chancellor is seeking. The OBR is forecasting very modest growth into the longer term when the bounce back has worked through. Real GDP is forecast to grow on average by just 1.5% per year from 2024 to 2026. What is more, the OBR sees permanent scarring effects of around 2% of GDP from the pandemic and around 4% of GDP from Brexit.
Articles
Analysis
Documents
Data
Questions
- What do you understand by ‘fiscal stance’?
- What are ‘automatic fiscal stabilisers? How might they affect GDP over the next few years?
- If the government had chosen to pursue a zero output gap from 2022/23 onwards, how would this have affected the balance between total government expenditure and taxation in the 2021 Budget and Spending Review?
- Provide a critique of the Budget from the left.
- Provide a critique of the budget from the right.
- Was this a ‘Green Budget’?
- Is the Budget following the ‘golden rule’ of fiscal policy?
- Look through Table 5.1 in the Budget and Spending Review document (linked below). Which of the measures will have the most substantial effect on aggregate demand?
The development of open-source software and blockchain technology has enabled people to ‘hack’ capitalism – to present and provide alternatives to traditional modes of production, consumption and exchange. This has enabled more effective markets in second-hand products, new environmentally-friendly technologies and by-products that otherwise would have been negative externalities. Cryptocurrencies are increasingly providing the medium of exchange in such markets.
In a BBC podcast, Hacking Capitalism, Leo Johnson, head of PwC’s Disruption Practice and younger brother of Boris Johnson, argues that various changes to the way capitalism operates can make it much more effective in improving the lives of everyone, including those left behind in the current world. The changes can help address the failings of capitalism, such as climate change, environmental destruction, poverty and inequality, corruption, a reinforcement of economic and political power and the lack of general access to capital. And these changes are already taking place around the world and could lead to a new ‘golden age’ for capitalism.
The changes are built on new attitudes and new technologies. New attitudes include regarding nature and the land as living resources that need respect. This would involve moving away from monocultures and deforestation and, with appropriate technologies (old and new), could lead to greater output, greater equality within agriculture and increased carbon absorption. The podcast gives examples from the developing and developed world of successful moves towards smaller-scale and more diversified agriculture that are much more sustainable. The rise in farmers’ markets provides an important mechanism to drive both demand and supply.
In the current model of capitalism there are many barriers to prevent the poor from benefiting from the system. As the podcast states, there are some 2 billion people across the world with no access to finance, 2.6 billion without access to sanitation, 1.2 billion without access to power – a set of barriers that stops capitalism from unlocking the skills and productivity of the many.
These problems were made worse by the response to the financial crisis of 2007–8, when governments chose to save the existing model of capitalism by propping up financial markets through quantitative easing, which massively inflated asset prices and aggravated the problem of inequality. They missed the opportunity of creating money to invest in alternative technologies and infrastructure.
New technology is the key to developing this new fairer, more sustainable model of capitalism. Such technologies could be developed (and are being in many cases) by co-operative, open-source methods. Many people, through these methods, could contribute to the development of products and their adaptation to meet different needs. The barriers of intellectual property rights are by-passed.
New technologies that allow easy rental or sharing of equipment (such as tractors) by poor farmers can transform lives and massively increase productivity. So too can the development of cryptocurrencies to allow access to finance for small farmers and businesses. This is particularly important in countries where access to traditional finance is restricted and/or where the currency is not stable with high inflation rates.
Blockchain technology can also help to drive second-hand markets by providing greater transparency and thereby cut waste. Manufacturers could take a stake in such markets through a process of certification or transfer.
A final hack is one that can directly tackle the problem of externalities – one of the greatest weaknesses of conventional capitalism. New technologies can support ways of rewarding people for reducing external costs, such as paying indigenous people for protecting the land or forests. Carbon markets have been developed in recent years. Perhaps the best example is the European Emissions Trading Scheme (EMS). But so far they have been developed in isolation. If the revenues generated could go directly to those involved in environmental protection, this would help further to internalise the externalities. The podcasts gives an example of a technology used in the Amazon to identify the environmental benefits of protecting rain forests that can then be used to allow reliable payments to the indigenous people though blockchain currencies.
Podcast
Questions
- What are the main reasons why capitalism has led to such great inequality?
- What do you understand by ‘hacking’ capitalism?
- How is open-source software relevant to the development of technology that can have broad benefits across society?
- Does the current model of capitalism encourage a self-centred approach to life?
- How might blockchain technology help in the development of a more inclusive and fairer form of capitalism?
- How might farmers’ co-operatives encourage rural development?
- What are the political obstacles to the developments considered in the podcast?
To make a sensible comparison of one year’s national income generated from the production of goods and services with another we need to take inflation into account. Changes in inflation-adjusted GDP represent changes in the volume of production of a country’s goods and services: in other words, the real value of goods and services. We revisit the blog written back in April 2019, prior the pandemic, to show how changes in real GDP evidence what we may refer to as the twin characteristics of economic growth: positive long-term growth but with fluctuating short-term rates of growth.
Real and nominal GDP
The nominal or current-price estimate for UK Gross Domestic Product in 2020 is £2.156 trillion. It is the value of output produced within the country in 2020. This was a fall of 4.4 per cent on the £2.255 trillion recorded in 2019. These values make no adjustment for inflation and therefore reflect the prices of output that were prevailing at the time.
Chart 1 shows current-price estimates of GDP from 1950 when the value of GDP was estimated at £12.7 billion. The increase to £2.156 trillion in 2020 amounts to a proportionate increase of almost 170 times, a figure that rises to 211 times if we compare the 1950 value with the latest IMF estimate for 2025 of £2.689 trillion. However, if we want to make a more meaningful comparison of the country’s national income by looking at the longer-term increase in the volume of production, we need to adjust for inflation. (Click here to download a PowerPoint copy of the chart.)
Long-term growth in real GDP
If we measure GDP at constant prices, we eliminate the effect of inflation. To construct a constant-price series for GDP a process known as chain-linking is used. This involves taking consecutive pairs of years, e.g. 2020 and 2021, and estimating what GDP would be in the most recent year (in this case, 2021) if the previous year’s prices (i.e. 2020) had continued to prevail. By calculating the percentage change from the previous year’s GDP value we have an estimate of the volume change. If this is repeated for other pairs of years, we have a series of percentage changes that capture the volume changes from year-to-year. Finally, a reference year is chosen and the percentage changes are applied backwards and forwards from the nominal GDP value for the reference year – the volume changes forwards and backwards from this point.
In effect, a real GDP series creates a quantity measure in monetary terms. Chart 1 shows GDP at constant 2019 prices (real GDP) alongside GDP at current prices (nominal GDP). Consider first the real GDP numbers for 1950 and 2020. GDP in 1950 at 2019 prices was £410.1 billion. This is higher than the current-price value because prices in 2019 (the reference year) were higher than those in 1950. Meanwhile, GDP in 2020 when measured at 2019 prices was £2.037 trillion. This constant-price value is smaller than the corresponding current-price value because prices in 2019 where lower than those in 2020.
Between 1950 and 2020 real GDP increased 5.0 times. If we extend the period to 2025, again using the latest IMF estimates, the increase is 5.9 times. Because we have removed the effect of inflation, the real growth figure is much lower than the nominal growth figure. Crucially, what we are left with is an indicator of the long-term growth in the volume of the economy’s output and hence an increase in national income that is backed up by an increase in production. Whereas nominal growth rates are affected both by changes in volumes and prices, real growth rates reflect only changes in volumes.
The upward trajectory observed in constant-price GDP is therefore evidence of positive longer-term growth. This is one of the twin characteristics of growth.
Short-term fluctuations in the growth of real GDP
The second characteristic is fluctuations in the rate of growth from period to period. We can see this second characteristic more clearly by plotting the percentage change in real GDP from year to year.
Chart 2 shows the annual rate of growth in real GDP each year since 1950. From it, we see the inherent instability that is a key characteristic of the macroeconomic environment. This instability is, of course, mirrored in the output path of real GDP in Chart 1, but the annual rates of growth show the instability more clearly. We can readily see the impact on national output of the global financial crisis and the global health emergency.
In 2009, constant-price GDP in the UK fell by 4.25 per cent. Then, in 2020, constant-price GDP and, hence, the volume of national output fell by 9.7 per cent, as compared to a 4.4 per cent fall in current-price GDP that we identified earlier. These global, ‘once-in-a-generation’ shocks are stark examples of the instability that characterises economies and which generate the ‘ups and downs’ in an economy’s output path, known more simply as ‘the business cycle’. (Click here to download a PowerPoint copy of the chart.)
Determinants of long-and short-term growth
The twin characteristics of growth can be seen simultaneously by combining the output path captured by the levels of real GDP with the annual rates of growth. This is shown in Chart 3. The longer-term growth seen in the economy’s output path is generally argued to be driven by the quantity and quality of the economy’s resources, and their effectiveness when combined in production. In other words, it is the supply-side that determines the trajectory of the output path over the longer term. (Click here to download a PowerPoint copy of the chart.)
However, the fluctuations we observe in short-term growth rates tend to reflect impulses that affect the ability and or willingness of producers to supply (supply-side shocks) and purchasers to consume (demand-side shocks). These impulses are then propagated and their effects, therefore, transmitted through the economy.
Effects of the pandemic
The pandemic is unusual in that the health intervention measures employed by governments around the world resulted in simultaneous negative aggregate demand and aggregate supply shocks. Economists were particularly concerned that the magnitude of these impulses and their propagation had the potential to generate scarring effects and hence negative hysteresis effects. The concern was that these would affect the level of real GDP in the medium-to-longer term and, hence, the vertical position of the output path, as well as the longer-term rate of growth and, hence, the steepness of the output path.
The extent of these scarring effects continues to be debated. The ability of businesses and workers to adapt their practices, the extraordinary fiscal and monetary measures that were undertaken in many countries, and the roll-out of vaccines programmes, especially in advanced economies, have helped to mitigate some of these effects. For example, the latest IMF forecasts for output in the USA in 2024 are over 2 per cent higher than those made back in October 2019.
Scarring effects are, however, thought to be an ongoing issue in the UK. The IMF is now expecting output in the UK to be nearly 3 per cent lower than it originally forecast back in October 2019. Therefore, whilst UK output is set to recover, scarring effects on the UK economy will mean that the output path traced out by real GDP will remain, at least in the medium term, vertically lower than was expected before the pandemic.
Data and Reports
Articles
Questions
- What do you understand by the term ‘macroeconomic environment’? What data could be used to describe the macroeconomic environment?
- When a country experiences positive rates of inflation, which is higher: nominal economic growth or real economic growth?
- Does an increase in nominal GDP mean a country’s production has increased? Explain your answer.
- Does a decrease in nominal GDP mean a country’s production has decreased? Explain your answer.
- Why does a change in the growth of real GDP allow us to focus on what has happened to the volume of production?
- What does the concept of the ‘business cycle’ have to do with real rates of economic growth?
- When would falls in real GDP be classified as a recession?
- Distinguish between the concepts of ‘short-term growth rates’ and ‘longer-term growth’.
- What do you understand by the term hysteresis? By what means can hysteresis effects be generated?
- Discuss the proposition that the pandemic could have a positive effect on longer-term growth rates because of the ways that people and business have had to adapt.