In his speech to the Conservative Party conference, the Chancellor of the Exchequer, George Osborne, announced that from 2013 child benefit would not be paid to any household where one or both parents had a high enough income to pay tax at the 40% rate. This means that if either parent earns over £43,875, they will receive no child benefit for any of their children. If, however, neither parent pays tax at 40%, then they will continue to receive it for all their children. Thus if both parents each earned, say, £43,870, giving a total household income of £87,740, they would continue to receive child benefit.
Not surprisingly, people have claimed that it is very unfair to penalise households where one person earns just over the threshold and the other does not work or earns very little and not penalise households where both parents earn just below the threshold. So what are the justifications for this change? What are the implications for income distribution? And what are the effects on incentives? Are there any people who would be put off working? The following articles look at these questions.
Articles
How benefit cuts could affect you Guardian, Patrick Collinson and Mark King (5/10/10)
Q&A: Child benefit measures will be messy Financial Times, Nicholas Timmins (5/10/10)
Cameron Defends Cut in Child Benefits for Stay-at-Home Mothers Bloomberg Businessweek, Thomas Penny and Kitty Donaldson (5/10/10)
Three million families hit by child benefit axe Telegraph, Myra Butterworth (5/10/10)
George Osborne’s child benefit plans are characterised by unfairness Telegraph letters (5/10/10)
Child benefit: case study Telegraph, Harry Wallop (5/10/10)
Child benefit cuts ‘tough but necessary’ say ministers BBC News (4/10/10)
Child Benefit Changes – Should Parents Take a Pay Cut? Suite101, John Oyston (5/10/10)
No such thing as an easy reform BBC News blogs: Stephanomics, Stephanie Flanders (5/10/10)
Child benefit saga: Lessons to be learned BBC News blogs: Stephanomics, Stephanie Flanders (6/10/10)
Speech
Higher rate taxpayers to lose child benefits from 2013: extracts from speech BBC News, Nick Robinson (5/10/10)
Our tough but fair approach to welfare Conservative Party Conference Speech, George Osborne (4/10/10)
Data and information
Child Benefit: portal HMRC
Child Benefit rates HMRC
Income Tax, rates and allowances HMRC
Questions
- Assess the fairness arguments for not paying child benefit to any household where at least one person pays tax at the 40% rate.
- For a family with three children, how much extra would a parent earning £1 below the threshold have to earn to restore their disposable income to the level they started with?
- What incentive effects would result from the proposals? How might ‘rational’ parents respond if one parent now stays at home and the other works full time and earns over £43,870, but where both parents have equal earning potential?
- What income and substitution effects are there of the proposed changes?
- Discuss other ways in which child benefit could be reformed to achieve greater fairness and save the same amount of money.
- What are the arguments for and against tapering the reduction in child benefit as parents earn more?
With countries around the globe struggling to recover from recession, many seem to believe that the answer lies in a growth in exports. But how can this be achieved? A simple solution is to lower the exchange rate.
Under a pegged exchange rate, the currency could be devalued. Alternatively, if the country’s inflation is lower than that of other countries, merely leaving the exchange rate pegged at its current level will bring about a real devaluation (in purchasing-power parity terms).
Under a floating exchange rate, one answer would be to lower interest rates. This would involve open market operations to support the lower rate and that would increase the money supply. But with central banks’ interest rates at virtually zero, it is not possible to lower them further. In such circumstances a solution would be a deliberate policy of increasing the money supply through “quantitative easing”. For example, the USA is considering a second round of quantitative easing (known as “QE2”). This would tend to push down the exchange rate of the dollar.
But stimulating exports through devaluation or depreciation is a zero-sum game globally. If currency A depreciates against currency B, currency B necessarily appreciates against currency A. Country A’s gain in exports to Country B are an increase in imports for Country B. It is logically impossible for every currency in the world to depreciate! Yet depreciation is exactly the policy being pursued by countries such as Japan, South Korea and Taiwan, all of which have directly intervened in the currency markets to lower their exchange rates. And, in each case of course, other countries’ currencies have an equivalent appreciation against them.
Economists and politicians in the USA argue that the dollar is fundamentally over valued against the Chinese yuan (or ‘renminbi’ as it is sometimes called). They are calling on China to revalue by far more than the 2% increase since June 2010. But what if China refuses to do so? On 29 September the House of Representatives passed a bill giving the executive branch the authority to impose a wide range of tariffs on imports from China. The bill was passed with a huge majority of 348 to 79.
So is this the start of a trade war? Many in the USA argue that China is already waging such a war by giving subsidies to a wide range of exports. And that war is hotting up. China has just announced that it is imposing traiffs ranging from 50% to 104% on various poultry imports from the USA. And if it is a trade war, will there be any winners? The following articles investigate.
Global recovery’s weakness raises possibility of trade war Guardian, Larry Elliott (4/10/10)
Tension mounts as China and US trade insults over currency Independent, Stephen Foley (1/10/10)
Is the world in a trade war? Time Magazine blogs: The Curious Capitalist, Michael Schuman (29/9/10)
Trade War Is Here – and We’ve Disarmed The Huffington Post, Robert Kuttner (3/10/10)
US House Passes Anti-China Trade War Bill GlobalResearch.ca, Barry Grey (1/10/10)
Currencies the key to market’s next move BBC News, Jamie Robertson (3/10/10)
A Message for China New York Times (30/9/10)
Taking On China New York Times, Paul Krugman (30/9/10)
Krugman Makes Two Powerful Arguments Against “Taking on China” Wall Street Pit, Scott Sumner (2/10/10)
Why the U.S. can’t win a trade war with China The Globe and Mail (Canada), Carl Mortished (4/10/10)
China-Japan trade war looms CTV News (Canada), Mark MacKinnon (23/9/10)
IMF chief’s warning of currency war ‘real threat’ BBC News, interview with Dominique Strauss-Khan, head of the IMF (7/10/10)
Could disputes over currency levels lead to a depression? BBC World Service, interview with Robert Zoellick (8/10/10)
China stands firm over yuan move BBC News, Andrew Walker (9/10/10)
What to do about China’s currency? Washington Post (10/10/10)
How to stop a currency war The Economist (14/10/10)
What’s the currency war about? BBC News, Laurence Knight (23/10/10)
Nominally cheap or really dear? The Economist (4/11/10)
Questions
- Why are competitive devaluations globally a zero sum game while global trade wars are a negative sum game?
- What are the arguments for and against using tariffs as a means of stimulating recovery?
- Why has quantitative easing so far had a more discernible effect on asset prices than on the real economy?
- Do a search on “Smoot-Hawley Tariff Act” of 1930 and describe its impact on the global economy in the 1930s. Are there any parallels today?
- How is it possible for massive trade surpluses and deficits to persist and yet for individual countries’ exchange rates and overall balance of payments to be in equilibrium?
- Are global trade imbalances widening, and if so why?
- What would determine the size of the effect on the US balance of trade of an appreciation of the yuan?
If you are an Irish resident, you may be feeling very worried! As Irish debt levels reach new heights, the bill will once again fall on the tax payer. Irish government borrowing is almost 12% of GDP, but with two key banks requiring a bail out, government borrowing is expected to treble this figure to some 32% of GDP. The Anglo-Irish bank requires approximately £30 billion and Allied Irish also requires more cash. The Irish Finance Minister said:
‘The state has to downsize these institutions to prevent them becoming a systemic threat to the state itself.’
The Irish have already faced a round of austerity cuts and with the latest banking catastrophe, the next round is about to start. There are concerns that the Irish economy could move into a downward spiral, with more money being removed from the economy causing more people to lose their jobs, which will weaken public finances further and mean that more borrowing will then be required. It is hardly surprising to find a pessimistic mood on the streets of Ireland.
However, with a new interdependent world, this crisis will not only be felt by Ireland. The UK exports a large amount to Ireland – more than to Spain or Italy. With Irish tax-payers facing higher burdens and unemployment still relatively high, UK exporters may feel the squeeze. Other countries on the periphery of Europe, such as Portugal, Greece and even Spain are also feeling the pressure. There are concerns of a ‘two-speed Europe’. Below are some articles about the Irish crisis. Do a search and see if you can find any information on the problems in Greece, Spain or Portugal.
Ireland: a problem soon to be shared BBC News blogs, Stephanomics, Stephanie Flanders (30/9/10)
European recovery hope grows despite Ireland’s swelling deficit Guardian, Richard Wachman (30/9/10)
Ireland bank rescue spurs global debt concerns The World Today (ABC News), Peter Ryan (30/10/10)
Irish debt yields in new record despite better job data BBC News (28/9/10)
Euro Govt-bonds fall after overdone rally on Ireland, Spain Reuters (30/9/10)
Ireland’s love affair with masochism Telegraph, Jeremy Warner (30/9/10)
EU austerity drive country by country BBC News (30/9/10)
Anglo-Irish was ‘systemic threat’ BBC News (30/9/10)
Questions
- What do we mean by government borrowing?
- With such high levels of government debt, what would you expect to happen to interest rates on government debt? Explain your answer.
- When deciding whether or not to bail out the banks, what process could a government use?
- The Irish Finance Minister talks about the institutions becoming a ‘systemic threat’. What does he mean by this?
- Why might the UK economy suffer from the problems in Ireland?
- To what extent do you agree that there is a two-speed Europe, with the core economies, such as France and Germany making good economic progress, but the peripheral economies still suffering from the effects of recession?
- How might the situation in Ireland affect other members of Europe? Will there be an impact on the euro exchange rate?
Towards the end of each month the European Commission for Economic and Financial Affairs publishes its economic sentiment index for each EU country, including the UK, along with average scores for the EU and for the countries using the euro. September’s release showed sentiment in the UK amongst consumers and businesses to have weakened more than in any other EU country. The index fell from a score of 102.3 to 100.2, where 100 represents an equal number of optimistic and pessimistic responses.
In itself the score seems to suggest that there remains some degree of economic confidence here in the UK. So should we be concerned? Well, the direction of the sentiment index is very likely to be of some concern and something that policy-makers will be keeping a keen eye on. Furthemore, the direction of sentiment in the UK is contrary, perhaps surprisingly so you might think, to that in most EU countries. The EU-average score, for instance, rose from 103.1 to 103.4, its highest since March 2008. From this we can infer not only that more people in the survey are optimistic than pessimistic but also that sentiment is becoming more positive (slightly). In Germany the economic sentiment index rose between August and September from 111.2 to 113.2, its highest since February 1991, with sentiment rising across consumers and all sectors of business.
If we delve a little deeper into the UK sentiment figures we see that the weakening of economic confidence is greatest amongst retailers. To a large extent this reflects an erosion of the significant increase in sentiment reported by retailers in the summer months. It also appears to reflect something of a lagged response to the waning sentiment amongst consumers. The figures for consumer confidence showed a ‘bounce’ in confidence during the spring, but September’s consumer confidence level was the lowest since June 2009 when the economy was still in recession.
One of the tasks facing policy-makers and economists is to try to predict what these economic sentiment figures might mean for economic activity. In particular, to what extent do these figures have significance for the future decisions made by households and businesses? Surprisingly, relatively little column space is given to measures of confidence and to the EU’s Economic Sentiment Index in particular.
It’s probably fair to say too that, as economists, we are a long way from fully understanding the role that confidence plays in affecting individual behaviour or indeed the variables that impact on confidence. It was once suggested to me (Dean), for instance, that changes in UK consumer confidence might be closely related to changes in housing wealth. Further, we economists struggle to understand what these survey measures of economic confidence are actually capturing, since the surveys comprise a multitude of questions, which, in the case of consumers for instance, ask them to compare their current financial situation with that in the past as well as to predict how it will evolve over the coming months.
Despite our imperfect understanding of the role played by confidence and how we can measure it, there is considerable interest amongst policy-makers, economic think-tanks and economic forecasters. For example, earlier this week a statement following an IMF Mission to the UK indentified ‘sizeable’ downside risks to the UK economy’s recovery, including what it termed ‘the continued fragility of confidence’. Could the release just a few days later from the EU reporting a decline in economic sentiment in the UK be timely?
Articles
Eurozone optimism nears three-year high Financial Times, Ralph Atkins and David Oakley (29/9/10)
EU economic, business indicators improve again The Sofia Echo (29/9/10)
Eurozone Sept. economic sentiment strongest since 2008 RTT News (29/9/10)
EU September economic morale unexpectedly improves MarketNews.com (29/9/10)
Data
Business and Consumer Surveys The Directorate General for Economics and Financial Affairs, European Commission
Consumer Confidence Nationwide Building Society
Questions
- Do you think economic sentiment or economic confidence is a worthwhile concept for economists and policy-makers to analyse?
- Draw up a series of factors that you think might affect the economic sentiment amongst consumers. Are there any factors that might be peculiar to the UK? Then repeat the exercise for businesses.
- Why do you think there is a ‘fragility of confidence’ in the UK? What might explain the stronger confidence levels in other EU countries, such as Germany?
The growth in money supply is slowing. This is not surprising, given that the programme of quantitative easing, whereby the Bank of England injected an extra £200bn of (narrow) money into the banking system between March 2009 and February 2010, has come to an end.
Should we be worried about this? Has sufficient money been injected into the economy to sustain the recovery, especially as fiscal policy is about to be radically tightened (see the BBC’s Spending Review section of its website)? One person who thinks that the Bank of England should do more is Adam Posen, an external member of the Bank of England’s Monetary Policy Committee. In a speech on 28 September 2010, he argued that the UK was in danger of slipping into Japanese-style sluggish growth that could last many years. The reason is that capacity would be lost unless aggregate demand is increased sufficiently to bring the UK back up towards the potential level of output. Firms are unlikely to want to retain unused plant and equipment and underutilised skilled labour for very long. If they do start ‘disinvesting’ in this way, potential output will fall.
What, according to Adam Posen is the answer? With fiscal policy being tightened and with Bank rate as low as it can go, the only option is to increase money supply. But with CPI inflation at 3.1%, considerably above the target 2%, is there a danger that increasing the money supply will cause inflation to rise further? Not according to Posen, who sees inflation falling over the medium term.
Not surprisingly other economists and commentators disagree – including some of his colleagues on the MPC. The following articles look at the arguments on both sides. You will also find below a link to the speech and to money supply data. There is also a link to the latest Bank of England inflation and GDP forecasts.
Articles
Posen calls for QE to be resumed Financial Times, Chris Giles (28/9/10)
Weak lending data fuel debate on QE Financial Times, Norma Cohen (29/9/10)
Bank of England’s Adam Posen calls for more quantitative easing Telegraph, Philip Aldrick and Emma Rowley (29/9/10)
Posen pleads for new stimulus to save economy and democracy Independent, Sean O’Grady (29/9/10)
Bring back the usury laws Independent, Hamish McRae (29/9/10)
Rocking the boat on the MPC BBC News blogs, Stephanomics, Stephanie Flanders (28/9/10)
A Response to Adam Posen The Source, Alen Mattich (28/9/10)
Adam Posen is posing the Bank of England a tricky question Guardian, Nils Pratley (28/9/10)
UK economy: optimists vs. pessimists FT blogs, Chris Giles (29/9/10)
What should the Bank of England do next? BBC Today Programme, Stephanie Flanders and John Redwood (1/10/10)
Interest rates will rise, predicts former Bank of England deputy governor Guardian, Dan Milmo (4/10/10)
UK interest rates on hold at record low of 0.5% BBC News (7/10/10)
Speech
The Case for Doing More Speech to the Hull and Humber Chamber of Commerce, Industry and Shipping, Adam Posen (28/9/10)
Data
Money supply data
Money and Lending (Statistical Interactive Database) Bank of England
Bank of England Inflation and GDP forecasts
Inflation and GDP forecasts (Inflation Report) Bank of England
Questions
- Summarise Adam Posen’s arguments for a further round of quantitative easing.
- How may changes in aggregate demand affect a country’s potential (as well as actual) output?
- What are the similarities and differences between the UK now and Japan over the past two decades?
- Describe what has been happening to the various components of money supply over the past few months.
- What might suggest that the Bank of England was wrong in believing that the trend rate of growth was about 2.75%?
- What are the moral arguments about personal and state borrowing? Should we begin the ‘long retreat from the never-never society’?
- Analyse the arguments against a further round of quantitative easing.