Would you like to be a millionaire? Of course you would – who wouldn’t, right? Actually the answer to this question may be more complicated than you might think (see for instance Sgroi et al (2017) on the economics of happiness: see linked article below), but, generally speaking, most people would answer positively to this question.
What if I told you, however, that you could become a millionaire (actually, scratch that – think big – make that “trillionaire”) overnight and be deeply unhappy about it? If you don’t believe me see what happened to Zimbabwe 10 years ago, when irresponsible money printing and fiscal easing drove the country’s economy to staggering hyperinflation (see the blogs A remnant of hyperinflation in Zimbabwe and Fancy a hundred trillion dollar note?. At the peak of the crisis, prices were increasing by a factor of 130 each year. I have in my office a 100 trillion Zimbabwean dollar note (see below) which I show in my lectures when I talk about hyperinflation to my first year Economics for Business students (if you are one of them, make sure not to miss it next February at UEA!). How much is this 100 trillion note worth? Nothing (except, may be, for collectors). It has been withdrawn from circulation as it ended up not even being worth the cost of the paper on which it was printed.
The Zimbabwean economy managed to pull itself out of this spiral of economic death, partly by informally replacing its hyperinflationary currency with the US greenback, and partly by keeping its fiscal spending under control and reverting to more sane economic policy making. That lasted until 2013, after which the government launched a Zimbabwean digital currency (known as “Zollar”) that had a nominal value set equal to a US dollar; and forced its exporters to exchange their greenbacks for Zollars. It then started spending these USD to finance a very ambitious and unsustainable programme of fiscal expansion.
The Economist published yesterday a story that shows the results of this policy – wild price increases and empty supermarket shelves are both back. According to the newspaper’s report:
At a supermarket in Harare, Zimbabwe’s capital, the finance minister is staring aghast at a pack of nappies. ‘This is absolutely ridiculous!’, exclaims Mthuli Ncube. ‘$49!’ A manager says it cost $23 two weeks ago, before pointing out other eye-watering items such as $20 Coco Pops. […] Over the past two weeks zollars have been trading at as little as 17 cents to the dollar. The devaluation has led to a surge in prices—and not just in imported goods like nappies. Football fans attending the Zimbabwe v Democratic Republic of Congo game on October 16th were shocked to learn that ticket prices had doubled on match day.
How long will it take for the 100 trillion Zollar to make its appearance again? We shall find out. I am sure Zimbabweans will be less than thrilled!
Articles and Report
- A fist full of zollars: Zimbabwe’s shops are empty and prices are soaring
The Economist (28/10/18)
- Shelves Empty as Specter of Hyperinflation Stalks Zimbabwe
Bloomberg, Paul Wallace, Godfrey Marawanyika and Desmond Kumbuka (12/10/18)
- imbabwe currency crisis: No cash, no bread, no KFC
BBC News, Andrew Harding (12/10/18)
- Hyperinflation in Zimbabwe: money demand, seigniorage and aid shocks
Journal of Applied Economics, Tara McIndoe-Calder (Volume 50, Issue 15, 18/9/17)
- Understanding Happiness
A CAGE Policy Report: Social Market Foundation, Daniel Sgroi, Thomas Hills, Gus O’Donnell, Andrew Oswald and Eugenio Proto (January 2017)
- Using an AS/AD diagram, explain the concept of hyperinflation. How can irresponsible fiscal policy-making lead to hyperinflation?
- What are the effects of hyperinflation on the people who live in the affected countries? Search the web for examples and case studies, and use them to support your answer.
- Once it has started, what policies can be used to fight hyperinflation? Use examples to support your answer.
- How does speculation affect hyperinflation?
Economic journalists, commentators and politicians have been examining the possible economic effects of a Yes vote in the Scottish independence referendum on 18 September. For an economist, there are two main categories of difficulty in examining the consequences. The first is the positive question of what precisely will be the consequences. The second is the normative question of whether the likely effects will be desirable or undesirable and how much so.
The first question is largely one of ‘known unknowns’. This rather strange term was used in 2002 by Donald Rumsfeld, US Secretary of Defense, in the context of intelligence about Iraq. The problem is a general one about forecasting the future. We may know the types of thing that are likely happen, but the magnitude of the outcome cannot be precisely known because there are so many unknowable things that can influence it.
Here are some known issues of Scottish independence, but with unknown consequences (at least in precisely quantifiable terms). The list is certainly not exhaustive and you could probably add more questions yourself to the list.
|Will independence result in lower or higher economic growth in the short and long term?
|Will there be a currency union, with Scotland and the rest of the UK sharing the pound and a central bank? Or will Scotland merely use the pound outside a currency union? Would it prefer to have its own currency or join the euro over the longer term?
|What will happen to the sterling exchange rate with the dollar, the euro and various other countries?
|How will businesses react? Will independence encourage greater inward investment in Scotland or will there be a net capital outflow? And either way, what will be the magnitude of the effect?
|How will assets, such as oil, be shared between Scotland and the rest of the UK? And how will national debt be apportioned?
|How big will the transition costs be of moving to an independent Scotland?
|How will independence impact on Scottish trade (a) with countries outside the UK and (b) with the rest of the UK?
|What will happen about Scotland’s membership of the EU? Will other EU countries, such as Spain (because of its concerns about independence movements in Catalonia and the Basque country), attempt to block Scotland remaining in or rejoining the EU?
|What will happen to tax rates in Scotland, with the new Scottish government free to set its own tax rates?
|What will be the consequences for Scottish pensions and the Scottish pensions industry?
|What will happen to the distribution of income in Scotland? How might Scottish governments behave in terms of income redistribution and what will be its consequences on output and growth?
Of course, just because the effects cannot be known with certainty, attempts are constantly being made to quantify the outcomes in the light of the best information available at the time. These are refined as circumstances change and newer data become available.
But forecasts also depend on the assumptions made about the post-referendum decisions of politicians in Scotland, the rest of the UK and in major trading partner countries. It also depends on assumptions about the reactions of businesses. Not surprisingly, both sides of the debate make assumptions favourable to their own case.
Then there is the second category of question. Even if you could quantify the effects, just how desirable would they be? The issue here is one of the weightings given to the various costs and benefits. How would you weight distributional consequences, given that some people will gain or lose more than others? What social discount rate would you apply to future costs and benefits?
Then there are the normative and largely unquantifiable costs and benefits. How would you assess the desirability of political consequences, such as greater independence in decision-making or the break-up of a union dating back over 300 years? But these questions about nationhood are crucial issues for many of the voters.
Scottish Independence would have Broad Impact on UK Economy NBC News, Catherine Boyle (9/9/14)
Scottish independence: the economic implications The Guardian, Angela Monaghan (7/9/14)
Scottish vote: Experts warn of potential economic impact BBC News, Matthew Wall (9/9/14)
The economics of Scottish independence: A messy divorce The Economist (21/2/14)
Dispute over economic impact of Scottish independence Financial Times, Mure Dickie, Jonathan Guthrie and John Aglionby (28/5/14)
10 economic benefits for a wealthier independent Scotland Michael Gray (6/3/14)
Scottish independence, UK dependency New Economics Foundation (NEF), James Meadway (4/9/14)
Scottish Jobs and the World Economy Scottish Economy Watch, Brian Ashcroft (25/8/14)
Scottish yes vote: what happens to the pound in your pocket? Channel 4 News (9/9/14)
What price Scottish independence? BBC News, Robert Peston (12/9/14)
What price Scottish independence? BBC News, Robert Peston (7/9/14)
Economists can’t tell Scots how to vote BBC News, Robert Peston (16/9/14)
Books and Reports
The Economic Consequences of Scottish Independence Scottish Economic Society and Helmut Schmidt Universität, David Bell, David Eiser and Klaus B Beckmann (eds) (August 2014)
The potential implications of independence for businesses in Scotland Oxford Economics, Weir (April 2014)
- What is a currency union? What implications would there be for Scotland being in a currency union with the rest of the UK?
- If you could measure the effects of independence over the next ten years, would you treat £1m of benefits or costs occurring in ten years’ time the same as £1m of benefits and costs occurring next year? Explain.
- Is it inevitable that events occurring in the future will at best be known unknowns?
- If you make a statement that something will occur in the future and you turn out to be wrong, was your statement a positive one or a normative one?
- What would be the likely effects of Scottish independence on the current account of the balance of payments (a) for Scotland; (b) for the rest if the UK?
- How does inequality in Scotland compare with that in the rest of the UK and in other countries? Why might Scottish independence lead to a reduction in inequality? (See the chapter on inequality in the book above edited by David Bell, David Eiser and Klaus B Beckmann.)
- One of the problems in assessing the arguments for a Yes vote is uncertainty over what would happen if there was a majority voting No. What might happen in terms of further devolution in the case of a No vote?
- Why is there uncertainty over the amount of national debt that would exist in Scotland if it became independent?
The exchange rate for sterling is determined in much the same way as the price of goods – by the interaction of demand and supply.
When factors change that cause residents abroad to want to hold more or fewer pounds, the demand curve for sterling will shift. If, instead, factors change that cause UK residents to want to buy more or less foreign currency, then the supply curve of sterling will shift. It is these two curves that determine the equilibrium exchange rate of sterling.
There are concerns at the moment that sterling is about to reach a peak, with expectations that the pound will weaken throughout 2013. But is a weakening exchange rate good or bad for the UK?
With lower exchange rates, exports become relatively more competitive. This should lead to an increase in the demand for UK products from abroad. As exports are a component of aggregate demand, any increase in exports will lead to the AD curve shifting to the right and thus help to stimulate a growth in national output. Indeed, throughout the financial crisis, the value of the pound did fall (see chart above: click here for a PowerPoint) and this led to the total value of UK exports increasing significantly. However, the volume of UK exports actually fell. This suggests that whilst UK exporters gained in terms of profitability, they have not seen much of an increase in their overall sales and hence their market share.
Therefore, while UK exporters may gain from a low exchange rate, what does it mean for UK consumers? If a low exchange rate cuts the prices of UK goods abroad, it will do the opposite for the prices of imported goods in the UK. Many goods that UK consumers buy are from abroad and, with a weak pound, foreign prices become relatively higher. This means that the living standards of UK consumers will be adversely affected by a weak pound, as any imported goods buy will now cost more.
It’s not just the UK that is facing questions over its exchange rate. Jean-Claude Junker described the euro as being ‘dangerously high’ and suggested that the strength or over-valuation of the exchange rate was holding the eurozone back from economic recovery. So far the ECB hasn’t done anything to steer its currency, despite many other countries, including Japan and Norway having already taken action to bring their currencies down. Mario Draghi, the ECB’s president, however, said that ‘both the real and the effective exchange rate of the euro are at their long-term average’ and thus the current value of the euro is not a major cause for concern.
So, whatever your view about intervening in the market to steer your currency, there will be winners and losers. Now that countries are so interdependent, any changes in the exchange rate will have huge implications for countries across the world. Perhaps this is why forecasting currency fluctuations can be so challenging. The following articles consider changes in the exchange rate and the impact this might have.
A pounding for sterling in 2013? BBC News, Stephanomics, Stephanie Flanders (17/1/13)
UK drawn into global currency wars as slump deepens Telegraph, Ambrose Evans-Pritchard (16/1/13)
Foreign currency exchange rate predictions for GBP EUR, Forecasts for USD and NZD Currency News, Tim Boyer (15/1/13)
Euro still looking for inspiration, Yen firm Reuters (16/1/13)
Daily summary on USD, EUR, JPY, GBP, AUD, CAD and NZD International Business Times, Roger Baettig (16/1/13)
UK inflation bonds surge on Index as pound falls versus euro Bloomberg, Business News, Lucy Meakin (10/1/13)
- Which factors will cause an increase in the demand for sterling? Which factors will cause a fall in the supply of sterling?
- In the article by Stephanie Flanders from the BBC, loose monetary policy is mentioned as something which is likely to continue. What does this mean and how will this affect the exchange rate?
- Explain the interest- and exchange-rate transmission mechanisms, using diagrams to help your answer.
- If sterling continues to weaken, how might this affect economic growth in the UK? Will there be any multiplier effect?
- What is the difference between the volume and value of exports? How does this relate to profit margins?
- Why are there suggestions that the euro is over-valued? Should European Finance Ministers be concerned?
- Should governments or central banks intervene in foreign exchange markets?
- If all countries seek to weaken their currencies in order to make their exports more competitive, why is this a zero-sum game?
It doesn’t seem that long ago when Greece was in the news regarding its deficit and need for bailing out. Back then, countries such as Spain, Portugal and Ireland were being mentioned as the next countries which might require financial assistance from the EU. It is now the Irish economy that is in trouble, even though the Irish government has not yet requested any financial help. The EU, however, is ‘ready to act’.
The Irish economy experienced an extremely strong boom, but they also suffered from the biggest recession in the developed world, with national income falling by over 20% since 2007. Savers are withdrawing their money; property prices continue to collapse; and banks needed bailing out. Austerity measures have already been implemented – tax rises and spending cuts equal to 5% of GDP took place, but it has still not been enough to stabilise the economy’s finances. All of these problems have contributed to a large and unsustainable budget deficit and a significant lack of funding and that’s where the EU and possibly the IMF come in.
If the Irish economy continues to decline and experiences a financial crisis, the UK would probably be one of the first to step in and offer finance. As our closest neighbour and an important trading partner, the collapse of the Irish economy would adversely affect the UK. A significant proportion of our exports go to the Irish economy and, with Irish taxpayers facing troubled times, UK exporting companies may be the ones to suffer.
One thing that this crisis has done is to provide eurosceptics with an opportunity to argue their case and blame the euro for the collapse of Ireland. With one monetary policy, the Irish economy is tied in to the interest rates set by the ECB and low interest rates fuelled the then booming economy. The common currency also increased capital flows from central European countries, such as Germany, to peripheral countries, such as Ireland, Spain and Portugal. In themselves, capital flows aren’t a problem, but when they are used to fund property bubbles and not productive investments, adverse effects are inevitable, as Ireland found to its detriment.
As prices collapsed and banks simply ran out of money, the government stepped in and rescued not only the depositors of Irish banks, but also their bondholders. Unable to devalue their currency, as it’s the euro, the Irish economy was unable to boost exports and hence aggregate demand and in turn economic growth. Although, the Irish government has not requested any financial help, as the French Finance Minister commented about a potential bailout: “Is it six months or a few days away? I’d say it’s closer to days.” The following articles look at this developing situation in Europe.
EU plays down Irish republic bail-out talks BBC News (17/11/10)
Ireland bailout: the European politicians who will decide Telegraph, Phillip Aldrick (17/11/10)
Don’t blame the Euro for Ireland’s mess Financial Times, Phillipe Legrain (17/11/10)
Britain signals intention to help Ireland in debt crisis New York Times, James Kanter and Steven Erlanger (17/11/10)
Ireland will take aid if ‘bank issue is too big’ Irish Times, Jason Michael (17/11/10)
Irish junior party says partnership strained Reuters (17/11/10)
Ireland resists humiliating bail-out as UK pledges £7 billion Telegraph, Bruno Waterfield (17/11/10)
Markets stable as Ireland bailout looms Associated Press (17/11/10)
The implausible in pursuit of the indefensible? BBC News blogs, Stephanomics, Stephanie Flanders (16/11/10)
Ireland bailout worth ‘tens of billions’ of euros, says central bank governor Guardian, Julia Kollewe and Lisa O’Carroll (18/11/10)
The stages of Ireland’s grief BBC News blogs, Stephanomics, Stephanie Flanders (18/11/10)
Q&A: Irish Republic finances BBC News (19/11/10)
Could Spain and Portugal be next to accept bail-outs? BBC News, Gavin Hewitt (19/11/10)
- Why will the UK be affected by the collapse of the Irish economy?
- If Ireland were not a member of the eurozone, would the country be any better off? How might a floating exchange rate boost growth?
- The Financial Times article talks about the euro not being to blame for the Irish problems, saying that ‘tight fiscal policy’ should have been used. What does this mean?
- Why is the housing market so important to any nation?
- What are the arguments (a) for and (b) against the euro? Would Ireland benefit from leaving the euro?
- Should the UK government intervene to help Ireland? What are the key factors that will influence this decision? What about the EU – should Ireland ask for help? Should the EU give help?
- Austerity measures have already been implemented, but what other actions could the Irish economy take to increase competitiveness?
One of the key problems faced by all countries over the past three years has been a lack of consumer demand. Firms face demand from a number of sources and when the domestic economy is struggling and domestic demand is weak, a key source of demand will be from abroad. By this, we are of course referring to exports. However, it was not just one country that plunged into recession: the global economy was affected. So, when one country was suffering from a weak domestic market, it turned to its export market and hence to other countries for demand. However, with these economies also suffering from recession, the export market was unable to offer any significant help. In order to boost exports, governments have tried to make their export markets more competitive and one method is to cut the value of the currency. Japan, South Korea, Thailand, Columbia and Taiwan are just some of the countries using this strategy.
Following these interventions, the Brazilian finance minister has commented that a new trade war has begun. Speaking to a group of industrial leaders in Sao Paulo, Mr. Mantega said:
‘We’re in the midst of an international currency war. This threatens us because it takes away our competitiveness.’
As more and more governments intervene in the currency market in a bid to boost exports, those refraining from intervening will suffer. Furthermore, interest rates throughout the developed world have remained low, as central banks continue their attempts to boost economics. However, this has led vast amounts of money to be transferred into countries, such as Brazil, where there is a better supply of high-yield assets. This has worsened the state of affairs in Brazil, as the Brazilian currency is now thought to be the most heavily over-valued currency in the world. This adversely affects Brazil’s export market and its trade balance. The following articles look at the lastest developments in this new ‘war’.
Currencty ‘war’ warning from Brazil’s finance minister BBC News (28/9/10)
Brazil warns of world currency war Telegraph (28/9/10)
Brazil warns of world currency ‘war’ Associated Press (28/9/10)
Brazil defends exporters in global currency battle Reuters (15/9/10)
Kan defends Japan’s intervention in the currency markets Associated Press (25/9/10)
US and China are still playing currency Kabuki Business Insider, Dian L. Chu (21/9/10)
How to stop a currency war The Economist (14/10/10)
What’s the currency war about? BBC News, Laurence Knight (23/10/10)
Exchange rate data
Exchange rate X-rates.com
Statistical Interactive Database – interest and exchange rates data Bank of England
Currencies BBC News
Currency converter Yahoo Finance
- Demand for a firm’s products comes from many sources. What are they? Illustrate this on a diagram.
- Why is a weak currency good for the export market?
- How will a country’s trade balance be affected by the value of its currency?
- Explain the process by which investors putting money into high-yield assets in countries like Brazil leads to currency appreciation.
- What are the options open to a government if it wants to devalue its currency? What are the advantages and disadvantages of each method?