The eurozone has been suffering from deflation: that is, negative inflation. But, the latest data show an increase in the rate of inflation in April from 0% to 0.3%. This is still a very low rate, with a return to deflation remaining a possibility (though perhaps unlikely); but certainly an improvement.
The eurozone economy has been stagnant for some time but the actions of the European Central Bank (ECB) finally appear to be working. Prices across the eurozone have risen, including services up by 1.3%, food and drink up by 1.2% and energy prices, albeit still falling, but at a slower rate. All of this has helped to push the annual inflation rate above 0%. For many, this increase was bigger than expected. Howard Archer, Chief European Economist at HIS Global Insight said:
“Renewed dips into deflation for the eurozone are looking increasingly unlikely with the risks diluted by a firming in oil prices from their January lows, the weakness of the euro and improved eurozone economic activity.”
Economic policy in the eurozone has focused on stimulating the economy, with interest rates remaining low and a €1.1 trillion bond-buying programme by the ECB. But, why is deflation such a concern? We know that one of the main macroeconomic objectives of a nation is low and stable inflation. If prices are low (or even falling) is it really as bad as economists and policy-makers suggest?
The problem of deflation occurs when people expect prices to continue falling and thus delay spending on durables, hoping to get the products cheaper later on. As such, consumption falls and this puts downward pressure on aggregate demand. This decision by consumers to put off spending will cause aggregate demand to shift to the left, thus pushing national income down, creating higher unemployment and adding to problems of economic stagnation. If this expectation continues, then so will the inward shifts in AD. In the eurozone, this has been a key problem, but it now appears that aggregate demand has stopped falling and is now slowly recovering, together with the economy.
It is important to note how interdependent all aspects of an economy are. The euro responded as news of better inflation data emerged, together with expectations of a Greek deal being reached. Enrique Diaz-Alvarez, chief risk officer at Ebury said:
“The move [rise in euro] got going with the big upside surprise in eurozone inflation data — especially core inflation, which bounced up from 0.6 per cent to 0.9 per cent. This is exactly what the ECB wants to see, as it is proof that QE is having the desired effect and removes the threat of deflation in the eurozone from the foreseeable future.”
One of the key factors that has kept inflation down in the eurozone (and also the UK) is falling oil prices. It is for this reason that many have been suggesting that this type of deflation is not bad deflation. With oil prices recovering, the general price level will also recover and so economies will follow suit. The following articles consider the fortunes of the eurozone.
Eurozone inflation shouldn’t shift ECB’s QE focus Wall Street Journal, Richard Barley (2/6/15)
Eurozone deflation threat recedes Financial Times, Claire Jones (2/6/15)
Eurozone inflation rate rises to 0.3% in May BBC News (2/6/15)
Eurozone back to inflation as May prices beat forecast Reuters, Jan Strupczewski (2/6/15)
Boost for ECB as Eurozone prices turn positive in May Guardian, Phillip Inman (2/6/15)
Eurozone inflation higher than expected due to quantitative easing International Business Times, Bauke Schram (2/6/15)
Euro lifted by Greek deal hopes and firmer inflation data Financial Times, Roger Blitz and Michael Hunter (2/6/15)
Questions
- What is the difference between the 0.3% and 0.9% figures quoted for inflation in the eurozone?
- What is deflation and why is it such a concern?
- Illustrate the impact of falling consumer demand in an AD/AS diagram.
- How has the ECB’s QE policy helped to tackle the problem of deflation? Do you think that this programme needs to continue or now the economy has begun to improve, should the programme end?
- To what extent is the economic stagnation in the eurozone a cause for concern to countries such as the UK and USA? Explain your answer.
- Why has the euro risen, following news of this positive inflation data?
John Nash was one of the pioneers of game theory and in 1994 was awarded the Nobel prize in economics for his work in this field. He was also the subject of the 2001 film, A beautiful mind, where the young John Nash was played by Russell Crowe, for which he won an Oscar.
Tragically, John Nash and his wife were killed in a car crash on May 23: he was 86 years old. Since his death there have been many tributes paid to him and his work.
As a student of economics you will almost certainly have studied the concept of a Nash equilibrium: a situation where everyone makes their best choice, given the choices of the other ‘players’ in a ‘game’. But a Nash equilibrium is not in the collective best interests of the participants in a non-cooperative game.
This is a very different concept of equilibrium from the simple equilibrium in a perfectly competitive market. In fact, in the complex world of strategic decision making, where firms are constantly looking at their rivals’ behaviour and possible reactions to their own behaviour, there are all sorts of Nash equilibria which are clearly sub-optimal. Competition may be highly destructive.
The following obituaries look at Nash’s contribution to the development of economics. As the Bloomberg article states:
The game theory concepts that Nash’s math[s] brought to the field were a true paradigm shift in economics. Macroeconomists, who continue to use the old Walrasian notion of equilibrium typically engage in hand-waving about how the macroeconomy is too big for strategic interactions to matter. But most of the economics profession has gradually shifted toward Nash equilibrium. The 2014 Nobel winner, Jean Tirole, is emblematic of the new economics. And many of the biggest successes in applied economics, like the auctions that power Google’s advertising, rely on Nash’s technique.
Do we owe him as much as Adam Smith?
Articles
Death of John Nash and His Beautiful Ideas Bloomberg, Noah Smith (26/5/15)
John Nash, economist and mathematician, 1928–2015 Financial Times, Ferdinando Giugliano (25/5/15)
Obituary: John Nash: Lost and found The Economist (28/5/15)
Remembering John Nash: Finding equations to explain the world The Economist (28/5/15)
John F. Nash Jr., Math Genius Defined by a ‘Beautiful Mind,’ Dies at 86 New York Times, Erica Goode (24/5/15)
Explaining a Cornerstone of Game Theory: John Nash’s Equilibrium New York Times, Kenneth Chang (24/5/15)
John Nash’s Indelible Contribution To Economic Analysis Forbes, Jon Hartley (25/5/15)
John Nash’s ground-breaking contributions to maths BBC News, John Moriarty (24/5/15)
From the archives: Nash’s Nobel prize The Economist (24/5/15)
A beautiful strategy: John Nash’s ‘game theory’ explained Hindustan Times, Gaurav Choudhury (25/5/15)
Interview with John Nash
Interview with John Nash Nobelprize.org (Sept 2004)
Questions
- What is meant by the ‘prisoners’ dilemma’? How is this a demonstration of a sub-optimal Nash equilibrium in a non-cooperative game?
- Why is it difficult to predict the outcome of a non-cooperative game?
- Give some examples of non-cooperative games played by companies competing with each other.
- Give some examples of non-cooperative games played by nations competing with each other.
- Why do competition authorities try to prevent cooperation between businesses?
- Why may a cooperative equilibrium between firms be an unstable one?
As we saw in the blog post The UK’s poor productivity record, the UK’s productivity, as measured by output per hour worked, has grown much slower than in other major developed countries since the financial crisis. In fact, output per hour is lower now than in 2008. In France and Germany it is around 3 per higher than in 2008; in Japan it is nearly 6% higher; in the USA it is over 8% higher; and in Ireland it is 12% higher.
The chart below shows international comparisons of labour productivity from 2000 to 2014. (Click here for a PowerPoint of the chart.)
And it is not just labour productivity that has fallen in the UK. Total factor productivity of labour and capital combined has also fallen. This reflects the fall in business investment after the financial crisis and, more recently, meeting the demand for extra output by employing more labour rather than by investing in extra capital.
In his first major speech since the election, the Chancellor of the Exchequer, George Osborne, told the CBI that the government was intent on tackling the problem of low and stagnant productivity. This would require investment in infrastructure, such as high-speed rail, better roads, superfast broadband and a new runway in the south east. It would require investment in education, training and research; it would involve cutting red tape for business; it would require making it easier for both parents in a family to work by cutting the cost of childcare. The details of the government’s policies would be made clear in the soon-to-be published Productivity Plan.
But how much difference can the government make? Are there intractable problems that will prove virtually impossible to overcome? How much, indeed, can a government do, however much it would like to? The articles explore the issues.
Articles
Will George Osborne’s productivity plan help make Britain a world-beater? The Guardian, Larry Elliott (24/5/15)
UK productivity has stayed stubbornly low for years. Dare we hope for better? The Guardian (24/5/15)
Joseph Stiglitz: ‘GDP per capita in the UK is lower than it was before the crisis. That is not a success’ The Observer, Anthony Andrew (24/5/15)
Osborne says low productivity key economic challenge BBC News (20/5/15)
Solving the productivity puzzle BBC News, Duncan Weldon (20/4/15)
Osborne faces up to productivity challenge BBC News, Robert Peston (20/5/15)
Osborne makes priority of boosting UK productivity Financial Times, George Parker (20/5/15)
The Bank of England is living in cloud-cuckoo land on wages Independent, David Blanchflower (18/5/14)
Cameron’s Plan Hasn’t Cracked Productivity Slump Flagged by BOE Bloomberg, Jill Ward (14/5/15)
To solve Britain’s productivity puzzle, try asking the workers The Conversation, Stephen Wood (29/6/15)
Report
Inflation Report: Chapter 3, Output and Supply Bank of England (May 2015)
Questions
- Define (a) labour productivity; (b) capital productivity; (c) total factor productivity.
- Why has the UK experienced lower productivity than other developed countries?
- Why may the UK’s lower unemployment than other countries in the post-recession period be the direct consequence of lower productivity growth?
- For what reasons might it be difficult for the government to achieve a significant increase in UK productivity?
- How might demand-side policy negatively impact on the supply-side policies that the government might adopt to increase productivity?
- How might the period up to and beyond the referendum in the UK on continuing EU membership impact on productivity?
- How might poor productivity be tackled?
The period from the end of the Second World War until the financial crisis of 2007–8 was one of increasing globalisation. World trade rose considerably faster than world GDP. The average annual growth in world GDP from 1950 to 2007 was 4.2%; the average annual growth in world merchandise exports was 6.7%.
And there were other ways in which the world was becoming increasingly interconnected. Cross-border financial flows grew strongly, especially in the 1990s and up to 2007. In the early 1990s, global cross-border capital flows were around 4% of world annual GDP; by 2007, they had risen to over 20%. The increasing spread of multinational corporations, improvements in transport, greater international movement of labour and improved communications were all factors that contributed to a deepening of globalisation.
But have things begun to change? Have we entered into an era of ‘deglobalisation’? Certainly some indicators would suggest this. In the three years 2012–14, world exports grew more slowly than world GDP. Global cross-border financial flows remain at about one-third of their 2007 peak. Increased banking regulations are making it harder for financial institutions to engage in international speculative activities.
What is more, with political turmoil in many countries, multinational corporations are more cautious about investing in such markets. Many countries are seeking to contain immigration. Fears of global instability are encouraging many firms to look inwards. After more than 13 years, settlement of the Doha round of international trade negotiations still seems a long way off. Protectionist measures abound, often amount to giving favourable treatment to domestic firms.
The Observer article considers whether the process of increased globalisation is now dead. Or will better banking regulations ultimately encourage capital flows to grow again; and will the inexorable march of technological progress give international trade and investment a renewed boost? Will lower energy and commodity prices help to reboot the global economy? Will the ‘Great Recession’ have resulted in what turns out to be merely a blip in the continued integration of the global economy? Is it, as the Huffington Post article states, that ‘globalization has a gravitational pull that is hard to resist’? See what the articles and speech have to say and what they conclude.
Articles
Borders are closing and banks are in retreat. Is globalisation dead? The Observer, Heather Stewart (23/5/15)
Is Globalization Finally Dead? Huffington Post, Peter Hall (6/5/14)
Speech
Financial “deglobalization”?: capital flows, banks, and the Beatles Bank of England, Kristin Forbes (18/11/14)
Questions
- Define globalisation.
- How does globalisation affect the distribution of income (a) between countries; (b) within countries?
- Why has the Doha round of trade negotiations stalled?
- Examine the factors that might be leading to deglobalisation.
- What are the implications of banking deglobalisation for the UK?
- Are protectionist measures always undesirable in terms of increasing global GDP?
- What forces of globalisation are hard to resist?
You may be used to these types of blogs by now … On my commute to work on the 18th May, I listened to Start the Week on BBC radio 4 and happened upon a fascinating discussion on inequality.
Of those discussing the issue, one certainly needs no introduction: Joseph Stiglitz, a prominent economist, author and commentator on economics, in particular on inequality. He was joined by Steve Hilton, who has worked for David Cameron for many years in providing advice on a range of issues, including inequality and strategy and has written on existing institutions and their effectiveness. The final panellist was Masha Gessen, who has written extensively on Russia and in particular on the journey of the infamous Boston Bomber.
Though the discussion covers a variety of areas relevant to economics, one key area that is addressed is inequality and the policies that are being used to address the causes and the symptoms. You can access the 45-minute discussion at the link below.
Joseph Stiglitz and Steve Hilton on inequality BBC Radio 4 (18/5/15)
Questions
- How would you measure inequality?
- Why is it important to distinguish between the causes and symptoms of poverty when designing government policy?
- To what extent do you believe that education is an essential requirement for growth and development?
- Why has inequality grown in some of the most developed nations?
- How is it possible that inequality in the developed world has grown, while global inequality has fallen?
- Why does the report argue that the reforms they suggest would help boost growth?
- Do you agree that existing institutions are not suitable for society today?
It is important to note how interdependent all aspects of an economy are. The euro responded as news of better inflation data emerged, together with expectations of a Greek deal being reached. Enrique Diaz-Alvarez, chief risk officer at Ebury said:
