With falling GDP and house prices, Spanish banks have been running the risk of failure. Indeed, the Spanish government has already had to agree to bail out Spain’s fourth biggest bank, Bankia.
On Saturday 9 June, at a crisis conference call, eurozone finance ministers agreed to lend the Spanish government up to €100 billion to provide credit to Spanish banks. The Spanish government is commissioning independent audits of the banks and, in the light of that, will specify just how much it needs to borrow.
Details of the nature of the loans will be made clear over the coming days, but they will funded either from the temporary rescue fund, the European Financial Stability Facility (EFSF), or from the new permanent fund that will replace it, the European Stability Mechanism (ESM).
But whilst the loans will remove the immediate pressure on Spanish banks, the underlying problems of the Spanish economy remain. Easy credit fuelled a property bubble which then burst. House prices have fallen by over 20% since the peak, and many Spanish people are in negative equity. Many construction companies have gone out of business.
What is more, the Spanish government is committed to reducing the budget deficit from 8.9% of GDP in 2011 to 5.3% in 2012 and 3% in 2013. To achieve this it has instituted tough austerity policies of government expenditure cuts and tax rises. (Click here for a link to a graph from the BBC of budget deficits in 18 EU countries.)
This has only aggravated the decline in GDP – at least in the short term. Spanish GDP is set to fall by around 2% this year and unemployment, at nearly 25% and rising, is the highest in Europe. Indeed the unemployment rate for those aged 15 to 25 is over 51%! This clearly has profound social and political consequences, with many young people seeing no prospect of gaining employment and thus feeling socially alienated. (For a PowerPoint of the above chart, click here.)
Markets on the Monday after the bailout was announced initially reacted positively. By the end of the day, however, the gains had been wiped out. Although no conditions were imposed on the Spanish government – the loan, although to the Spanish government, was to bail out the banks, not the government itself – worries remain that the Spanish economy is not set to recover for some time.
What is more, worries about other eurozone countries in difficulty have not gone away. Indeed, with the Spanish government being seen as having been dealt with more leniently than the Greek, Portuguese and Irish governments, investors are now worried that these countries may demand to renegotiate the terms of their bailout. And in the case of Greece, the Spanish bailout may make people more willing to vote in this coming Saturday’s election for parties that reject the Greek bailout terms. This may make it more likely that Greece will be forced to leave the euro, with all the chaos that is likely to ensue.
Webcasts and Podcasts
Spain: Simmering anger in Seville BBC News, Paul Mason (7/6/12)
Will Spain’s Bailout save Europe? CNBC Video, Martin Wolf (11/6/12)
Bailout boost evaporates Financial Times video, James Macintosh (11/6/12)
Spain’s bailout may not be enough Financial Times video, Nikki Tait (11/6/12)
Eurozone: ‘Italy will be next’ BBC Today Programme, Robert Peston (11/6/12)
Articles
Eurozone agrees to lend Spain up to 100 billion euros MSN Money, Jan Strupczewski and Julien Toyer (12/6/12)
Hurried Spanish banking bailout fails to calm market nerves Guardian, Giles Tremlett (11/6/12)
Fears that Spain’s bailout relief may be short-live Independent, Alasdair Fotheringham and Tom Bawden (11/6/12)
Spanish banks deal: Market concerns remain BBC News (11/6/12)
Q&A: Spanish bank deal BBC News (11/6/12)
Debt crisis: Market euphoria evaporates over Spain’s €100bn bank bailout The Telegraph, Emma Rowley and Bruno Waterfield (11/6/12)
Why bondholders are scared about Spain MarketWatch, Deborah Levine (11/6/12)
Krugman on another bank bailout Press-Telegram Paul Krugman (11/6/12)
Messy Spanish rescue BBC News, Robert Peston (10/6/12)
This latest euro fix will come apart in less than a month The Telegraph, Jeremy Warner (11/6/12)
The consequences of Spain’s bank rescue Financial Times, Gavyn Davies (10/6/12)
Buy on the summit, sell on the communiqué Financial Times, Alan Beattie (11/6/12)
The vicious euro circle keeps turning BBC News, Stephanie Flanders (12/6/12)
Spanish banks need up to 62bn euros BBC News (21/6/12)
Eurozone crisis explained BBC News (19/6/12)
Spain formally requests a bailout for its banks BBC News (25/6/12)
Documents and press releases
IMF Says Spain’s Core Financial System is Resilient, but Important Vulnerabilities Remain IMF Press Release (8/6/12)
Spain and the IMF IMF links to various documents including: Spain – Financial System Stability Assessment (8/6/12)
Eurogroup statement on Spain Eurozone Portal, The Eurogroup (9/6/12)
Questions
- How does the Spanish bailout differ from those for Greece, Irelend and Portugal?
- What are the likely implications for Spanish borrowing costs of the loans coming from the ESM?
- To what extent does the plan to bail out Spanish banks involve a moral hazard?
- What is likely to be the effect of the Spanish bailout on Greece, Ireland and Portugal?
- How bad is Spanish public-sector debt compared with other countries? What is the likely effect of the bailout on Spanish public-sector debt?
- What is meant by a banking union in the eurozone and how would it work? What would be the implication of a eurozone banking union for the UK?
No market is perfect and when the market mechanism fails to deliver an efficient allocation of resources, we say the market fails and hence there is justification for some government intervention. From a monopolist dominating an industry to a manufacturing firm pumping out pollution, there are countless examples of market failure.
The Guardian is creating a guide to climate change, covering areas from politics to economics. The problem of climate change has been well documented and this blog considers a particular issue – the case for climate change or the environment as a market failure. In many cases just one market failure can be identified, for example an externality or a missing market. However, one of the key problems with climate change is that there are several market failures: externalities in the form of pollution from greenhouse gases; poor information; minimal incentives; the problem of the environment as a common resource and the immobility of factors of production, to name a few. Each contributes towards a misallocation of resources and prevents the welfare of society from being maximised.
When a market fails, intervention is justified and economists argue for a variety of policies to tackle the above failures. In a first-best world, there is only one market failure to tackle, but in the case of the environment, policy must be designed carefully to take into account the fact that there are numerous failings of the free market. Second-best solutions are needed. Furthermore, as the problem of climate change will be felt by everyone, whether in a developed or a developing country, international attention is needed. The two articles below are part of the Guardian’s ultimate climate change guide and consider a huge range of economic issues relating to the problem of environmental market failure.
Why do economists describe climate change as a ‘market failure’? Guardian, Grantham Research Institute and Dunca Clark (21/5/12)
What is the economic cost of climate change? Guardian (16/2/11)
Questions
- What is meant by market failure?
- What are the market failures associated with the environment and climate change? In each case, explain how the issue causes an inefficient allocation of resources and thus causes the market to fail? You may find diagrams useful!
- What is meant by the first-best and second-best world?
- What does a second-best solution aim to do?
- Using diagrams to help your explanation, show how a tax on pollution will have an effect in a first best world, where the only market failure is a negative externality and in a second best world, where the firm in question is also a monopolist.
- What solutions are there to the problem of climate change? How effective are they likely to be?
- Does the need to tackle climate change require international co-operation? Can you use game theory to help your explanation?!
After weak Christmas trading, Tesco issued a profit warning – its first in 20 years. Following this, their shares fell in value by some £5bn, but this was met with an announcement of the creation of 20,000 jobs in the coming years, as part of a project to train staff, improve existing stores and open new ones. Yet, Tesco has reported another quarter of falling sales.
Trading times have been challenging and the fact that the UK’s biggest supermarket is struggling is only further evidence to support this. In the 13 weeks to the 26th May 2012, Tesco reported a decline in like-for-like sales of 1.5%. Although much of the £1bn investment in Tesco is yet to be spent, the fact that sales have fallen for a full year must be of concern, not only to its Chief Executive, but also to analysts considering the economic future for the UK.
Consumer confidence remains low and together with tight budgets, shoppers are continuing to be very cautious of any unnecessary spending. Part of Tesco’s recent drive to drum up sales has been better customer service and a continuing promotion war with the other supermarkets. This particular sector is highly competitive and money-off coupons and other such promotions plays a huge part in the competitive process. Whilst low prices are obviously crucial, this is one sector where non-price competition can be just as important.
Although Tesco sales in the UK have been nothing to shout about – the Chief Executive said their sales performance was ‘steady’ – its total global sales did increase by 2.2%. The Chief Executive, Mr Clarke said:
‘Internationally, like-for-like sales growth proved resilient, despite slowing economic growth in China…Against the backdrop of continued uncertainty in the eurozone, it is pleasing to see that our businesses have largely sustained their performance.’
A boost for UK sales did come with the Jubilee weekend and with the Olympics just round the corner, Tesco will be hoping for a stronger end to the year than their beginning. The following articles consider Tesco’s sales and the relative performance of the rest of the sector.
Tesco’s quarterly sales hit by ‘challenging’ trading BBC News (11/6/12)
Tesco UK arm notches up one year of falling sales Guardian, Zoe Wood (11/6/12)
Tesco upbeat despite new sales dip Independent, Peter Cripps (11/6/12)
Tesco sales seen lower in first quarter Reuters, James Davey(11/6/12)
The Week Ahead: Tesco set to admit it is losing ground to rivals Independent, Toby Green (11/6/12)
Tesco’s performance in the UK forecast to slip again Telegraph, Harry Wallop (10/6/12)
Tesco: What the analysts say Retail Week, Alex Lawson (11/6/12)
Supermarkets issue trading updates The Press Association (9/6/12)
The Week Ahead: Supermarkets prepare to give City food for thought Scotsman, Martin Flanagan (11/6/12)
Asda’s sales growth accelerates Reuters, James Davey (17/5/12)
Asda sales increase helped by Tesco Telegraph, Harry Wallop (18/5/12)
Tesco v. Sainsbury’s in trading update battle Manchester Evening News (11/6/12)
Sainsbury’s out-trades Tesco on UK food sales Independent, James Thompson (10/6/12)
Questions
- Using some examples, explain what is meant by non-price competition.
- Why has Tesco been losing ground to its competitors?
- Given the products that Tesco sells (largely necessities), why have sales been falling, despite household’s tight budgets?
- Into which market structure would you place the supermarket sector? Explain your answer by considering each of the assumptions behind the market structure you choose.
- Why have Tesco’s rivals been gaining ground on Tesco?
- How might this latest sales data affect Tesco’s share prices?
- Based on what the analysts are saying about the food sector, can we deduce anything about the future of the UK economy in the coming months?
Oil prices have been falling in recent months. By early June they had reached a 17-month low. The benchmark US crude price (the West Texas Intermediate price) fell to $83.2 at the beginning of the month, and Brent Crude (the North Sea reference price for refining into petrol) fell to $97.7 (see chart). (For a PowerPoint of the chart below, click here.)
At the same time various commodity prices have also been falling. The IMF all commodities price index has fallen by 7.2% over the past 12 months and by 6.2% in May alone. Some commodities have fallen much faster. In the 12 months to May 2012, natural gas fell by 44%, wheat by 25%, lamb by 37%, Arabica coffee by 36%, coconut oil by 45%, cotton by 47%, iron ore by 23% and tin by 29%.
Although part of the reason for the fall in the price of some commodities is increased supply, the main reason is weak world demand. And with continuing problems in the eurozone and a slowdown in China and the USA, commodity price weakness is likely to continue.
So is this good news? To the extent that commodity prices feed through into consumer prices and impact on the rate of inflation, then this is good news. As inflation falls, so central banks will be encouraged to make further cuts in interest rates (in the cases where they are not already at a minimum). For example, the Reserve Bank of Australia cut its cash rate last week from 3.75% to 3.5%. This follows on from a cut from 4.25% on 1 May. In cases where there is no further scope for interest rate cuts (e.g. the US Federal Reserve Bank, whose interest rate is between 0% and 0.25%), then the fall in inflation may encourage a further round of quantitative easing.
But falling commodity prices are also a reflection of bad news, namely the low economic growth of the world economy and fears of turmoil from a possible Greek exit from the euro.
Update
A day after this was written (9/6/12), a deal was agreed between eurozone ministers to provide support of up to €100 billion for Spanish banks. This helped to reduce pessimism about the world economy, at least temporarily. Stock markets rose and so too did oil prices, by around 1%. But if pessimism increases again, then the fall is likely to resume.
Articles
Oil prices hit a 17-month low on China slowdown fears BBC News (8/6/12)
Oil gives up gains without signs of Fed move BloombergBusinessweek, Sandy Shore (7/6/12)
Oil Heads for Longest Run of Weekly Losses in More Than 13 Years BloombergBusinessweek, (8/6/12)
Gold plunges as Bernanke gives no hint of stimulus Live5News(7/6/12)
Oil Price Tumbles Below $83 on Weak Economy Money News(8/6/12)
World food price index expected to fall for May Reuters(6/6/12)
Oil price losing streak continues Guardian, Julia Kollewe (8/6/12)
Data
Spot fuel prices US Energy Information Administration
Commodity Prices Index Mundi
Crude Oil Price Index Index Mundi
Questions
- Why have crude oil prices fallen to their lowest level for 17 months?
- How can the concepts of income elasticity of demand, price elasticity of supply and price elasticity of demand help to explain the magnitude of the fall in crude oil prices?
- Would a fall in inflation linked to a fall in commodity prices be a fall in cost-push or demand-pull inflation? Explain.
- What are the macroeconomic implications of the fall in crude oil prices?
- What factors are likely to have significant impact on crude oil prices in the coming months
- Why is it difficult to predict crude oil prices over the coming months?
If one person saves more, then it will increase that person’s consumption possibilities in the future. If, however, everyone saves more, and hence spends less, then businesses will earn less and are likely to respond by producing less if the decline in aggregate demand continues. Hence if a country saves more, people could be worse off. That’s the paradox of thrift.
There is considerable debate around the world at the moment about the desirability of austerity policies. The debate has become more intense with the worsening economic outlook in many European countries and with the election in France of François Hollande who rejects many of the austerity measures of his predecessor, Nicolas Sarkozy.
But can further stimulus be given to aggregate demand without causing a further worsening of countries’ public-sector debt positions and causing a fall in confidence in financial markets? And how would that impact on investment?
And in the meantime, as the economic outlook darkens, people are trying to save more, despite low interest rates. The paradox of thrift seems to be getting more acute. (Click here for a PowerPoint of the chart.)
Articles
How National Belt-Tightening Goes Awry New York Times, Robert J. Shiller (19/5/12)
Japan disease is spreading: High risk and low returns Firstpost (India), Vivek Kaul (17/5/12)
The Solution can not be More Debt Huffington Post, Jill Shaw Ruddock (29/5/12)
Crediting debt Breaking Views, Edward Hadas (30/5/12)
Green investments can overcome the paradox of thrift New Statesman, Dimitri Zenghelis (7/6/12)
Austerity has never worked Guardian, Ha-Joon Chang (4/6/12)
The False Choice Between Austerity And Growth Forbes (24/5/12)
It’s not a case of austerity v stimulus for Europe Guardian, Paul Haydon (1/6/12)
Data
UK households’ saving ratio: series NRJS ONS
Household saving rates for OECD countries StatExtracts: OECD
Questions
- Why may we be experiencing a paradox of thrift at the current time?
- What are the arguments for the use of fiscal and monetary policies to expand aggregate demand at the current time?
- What are the arguments against the use of fiscal and monetary policies to expand aggregate demand at the current time?
- Can economic growth be stimulated by a redistribution of aggregate demand and, if so, in what way?
- Can green investment overcome the paradox of thrift?
- To what extent are demand-side and supply-side policies (a) complementary; (b) contradictory? Or, to put the question another way, to what extent may policies to encourage growth in the long term damage growth in the short term and vice versa?
Details of the nature of the loans will be made clear over the coming days, but they will funded either from the temporary rescue fund, the European Financial Stability Facility (EFSF), or from the new permanent fund that will replace it, the European Stability Mechanism (ESM).
Markets on the Monday after the bailout was announced initially reacted positively. By the end of the day, however, the gains had been wiped out. Although no conditions were imposed on the Spanish government – the loan, although to the Spanish government, was to bail out the banks, not the government itself – worries remain that the Spanish economy is not set to recover for some time.
