With the majority of developed countries now moving out of recession, many people will think the worst is over. But for some countries and some people, there may be worse to come. The single currency in the eurozone was introduced in 1999 and in December 2009, the eurozone saw its highest level of unemployment at 10%. There are now 23 million people unemployed across the 16 countries that make up the eurozone and many of those people reside in Spain, where unemployment has reached a 12-year high of 18.8% and is even expected to reach 20%.
Interest rates in the eurozone and in the UK have been maintained at 1% and 0.5% respectively, and inflation has seen a rise in both places. Whilst in the eurozone inflation remains well below the inflation target, in the UK there has been a rapid rise to 2.9% to December 2009 (see Too much of a push from costs but no pull from demand)
While Spain is suffering from mass unemployment, Greece is struggling with the burden of a huge budget deficit. The former European Central Bank Chief Economist, Otmar Issing, has said that any bailout of Greece would severely damage the Monetary Union and “The Greek disease will spread”. With concern that Greece will not be able to service its debt, there is speculation that the country will be forced out of the currency bloc. However, the chair of the single currency area’s finance ministers said that Greece will not leave the eurozone and does not believe that a state of bankruptcy exists.
So, what’s behind rising unemployment, rising inflation and rising budget deficits and how are they likely to affect the eurozone’s recovery?
Eurozone inflation rises to 0.9% BBC News (15/1/10)
Unemployment sector remains beat in Eurozone pressuring price levels FX Street (29/1/10)
greek bailout would hurt Eurozone – Germany’s Issing Reuters (29/1/10)
Eurozone unemployment rate hits 10% BBC News (29/1/10)
Greece will not go bust or leave Eurozone Reuters, Michele Sinner (27/1/10)
Eurozone unemployment hits 10% AFP (29/1/10)
New rise in German job loss total BBC News (28/1/10)
Spain unemployment nears 12 year high Interactive Investor (29/1/10)
Questions
- How do we define unemployment? What type of unemployment is being experienced in the eurozone?
- Why do you think unemployment levels have risen in the eurozone and in Spain in particular? Illustrate this on a diagram.
- What are the costs of unemployment for (a) the individual (b) governments and (c) society?
- What explanation can be given for rising levels of both unemployment and inflation?
- Inflation in the eurozone increased to 0.9%. What are the factors behind this? Illustrate the effects on a diagram.
- Greece’s forecast budget deficit for 2009 is 12.7% of GDP, but Greece has said it will reduce it to 8.7% of GDP. How does the Greek government intend to do this and what are the likely problems it will face?
- Why could bailing out Greece hurt the eurozone?
Inflation’s rising again! After a year of falling inflation, with CPI inflation being below the Bank of England’s target of 2% since June 2009, inflation began rising again in October 2009 and then shot up in December. In the year to November 2009, CPI inflation was 1.9%. In the year to December it had risen to 2.9% – well above the 2% target. As the National Statistics article states, however:
This record increase is due to a number of exceptional events that took place in December 2008:
the reduction in the standard rate of Value Added Tax (VAT) to 15 per cent from 17.5 per cent
sharp falls in the price of oil
pre-Christmas sales as a result of the economic downturn
These exceptional events led to the CPI falling by 0.4 per cent between November and December 2008 (a record fall between these two months). The CPI increase between November and December 2009 of 0.6 per cent is far more typical (the CPI increased by 0.6 per cent between November and December in both 2006 and 2007). These exceptional events also affected the change in the RPI annual rate.
So what should the Bank of England do? 2.9% is well above the target of 2%. So should the Monetary Policy Committee raise interest rates at its next meeting? The answer is no. Although inflation is above target, the Bank of England is concerned with predicted inflation in 24 months’ time. Almost certainly, the rate of inflation will fall back as the special factors, such as the increase in VAT back to 17.5% and earlier falls in VAT and oil prices, fall out of the annual data.
What is more, the sudden rise in CPI inflation is almost entirely due to cost-push factors, not demand-pull ones. Rises in costs have a dampening effect on demand. Raising interest rates in these circumstances would further dampen demand – the last thing you want to do as the economy is beginning a fragile recovery from recession.
The Bank of England’s policy recognises that the prime determinant of inflation over the medium term is aggregate demand relative to potential output. For this reason it doesn’t respond to temporary supply-side (cost) shocks.
Avoid false alarm over UK inflation Financial Times (20/1/10)
Oh dear. Inflation is back again Telegraph, Jeremy Warner (19/1/10)
Mervyn King confident on inflation target Times Online, Grainne Gilmore (19/1/10)
How should we remember 2009? As the year the Bank of England’s inflation target died Telegraph, Jeremy Warner (20/1/10)
An embarrassing bungee-jump The Economist (21/1/10)
Priced in BBC News, Stephanomics, Stephanie Flanders’ blog (19/1/10)
This MPC is not fit for purpose New Statesman, David Blanchflower (21/1/10)
Jobs joy takes sting out of inflation misery Sunday Times, David Smith (24/1/10)
For CPI inflation data, see Consumer Prices Index (CPI) National Statistics
Questions
- For what reasons might inflation be expected to fall back to 2% later in the year?
- Does the rise in inflation to 2.9% put pressure on the Bank of England’s Monetary Policy Committee (MPC) to raise interest rates? Explain why or why not.
- What factors is the MPC likely to consider at its February meeting when deciding whether or not to embark on a further round of quantitative easing?
- What effects has the depreciation of sterling had on inflation? Explain whether this effect is likely to continue and what account of it should be taken by the MPC when setting interest rates.
- What is meant by ‘core inflation’? Why did this rise to 2.8% in December 2009?
- What is the role of expectations in determining (a) inflation and (b) real GDP in 24 months’ time?
- Why, according to David Blanchflower, is the MPC not ‘fit for purpose’?