The recession caused a large rise in unemployment in many countries. In the USA the rise has been particularly steep, where unemployment now stands at 14.5 million, or 9.8% of the labour force. Unemployment has continued to rise despite renewed growth in the US economy, where the latest annual real GDP growth is 2.6% (measured in Q3 2010). The rise in unemployment has been blamed on ‘sticky wages’ – i.e. the reluctance of wage rates to fall.
But are wages genuinely sticky as far as the average worker is concerned? They may be in many specific jobs with specific employers, but many workers made redundant then find work in different jobs at lower rates of pay. For them, their wage has fallen, even if particular jobs are paying the same as before.
So what are the consequences of this? Does the willingness of workers to accept lower paid jobs mean that the labour market is flexible and that people will thus price themselves into work? If so, why is employment still rising? Or does a reduction in real wages for many people dampen spending and hence aggregate demand, thereby reducing the demand for labour? If so, why is GDP rising?
The following articles look at the apparent stickiness of wages and the implications for the labour market and the macroeconomy.
Articles
Downturn’s Ugly Trademark: Steep, Lasting Drop in Wages Wall Street Journal, Sudeep Reddy (11/1/11)
The Causes of Unemployment Seeking Alpha, Brad DeLong (13/1/11)
Sticky, sticky wages The Economist blogs: Free Exchange, R.A. (11/1/11)
The Causes of Unemployment New York Times blogs: Wonkish, Paul Krugman (16/1/11)
America’s union-bashing backlash Guardian, Paul Harris (5/1/11)
Data
Federal Reserve Economic Data: FRED Federal Reserve Bank of St. Louis (US macroeconomic datasets)
United States GDP Growth Rate Trading Economics
US unemployment statistics Bureau of Labor Statistics
Questions
- Why might nominal wages be sticky downwards in specific jobs in specific companies?
- Why might nominal average wages in the economy not be sticky downwards?
- Why is unemployment rising in the USA?
- Why might there be a problem of hysteresis in the USA that provides an explanation of the reluctance of unemployment to fall?
- Why might a fall in wages end up being contractionary?
- What lessons can be learned from the Great Depression about cures for unemployment?
- How might unemployment be brought down in the USA?
- Why may making wages somewhat more flexible, as opposed to perfectly flexible, not be a good thing?
One of the interesting things about the recent recession was the dilemma that it posed for governments. As aggregate demand fell, unemployment rose, incomes fell, which reduced demand further and so national output began to decline. Obviously there were many other factors contributing to this decline, in particular the housing market, but the long and the short of it is, aggregate demand was falling. With the AD curve shifting inwards, we would expect the average price level to fall at the same time: i.e. inflation doesn’t tend to be much of a problem during a recession. It is this fact that posed something of a dilemma. In the recession, not only was aggregate demand low, but inflation was rising. The explanation for this: in large part due to rising commodity prices – a supply-side shock. Governments had to deal with low national output and inflation: this combination made policy changes much more complex.
While prices for many goods and commodities did fall significantly after their peak in 2008, there has been a gradual rise again and there seems to be no end in sight. Headline food prices, in particular, have increased almost to their 2008 levels, although in real terms prices are still lower. Onions in India; cabbage, pork and mackerel in South Korea; chillies in Indonesia – the list goes on. The rapidly rising prices of these basic foodstuffs has, in many cases, led to emergency government intervention. However, there are fewer concerns this time round, as many hope that the causes of these higher prices are not just the increases in demand but crucially temporary supply shocks. Bloomberg’s Businessweek Assistant Managing Editor, Sheelah Kolhatkar, said:
There are a lot of reasons [for rising prices]. Weather is cited as a big one. There’s been sort of freak weather in different parts of the world. Russia experienced a drought. There are floods in Australia. There’s been sort of freezing weather in Florida. Our own Midwest experienced flooding earlier this year. And because the market for a lot of these food commodities is global, when something strange happens somewhere, that can affect a crop.
On the other hand, there are growing concerns at the timing of this inflation: the developed world has barely escaped from recession. How is it that inflation can already be a problem? Furthermore, with loose monetary policy in many countries, rising food and commodity prices could continue for some time.
An interesting question to consider is which countries will be affected the most? In Britain, like other developed countries, food consumption accounts for between 15 and 20 per cent of a household budget. However, in developing countries, food can take up between 50 and 75 per cent of a houshold budget, so any rise in food prices is disastrous.
What does it mean for the recovery? Well, if food (a necessity) is increasing in price, households have little choice but to pay the higher prices. This means they have less disposable income for other goods, hence aggregate demand may be adversely affected. The following articles will hopefully give you some ‘food for thought’!
Articles
Soaring food prices cast shadow over trading Financial Times, Dave Shellock (14/1/11)
Next shock will be high food prices Sydney Morning Herald (17/1/11)
Commodities can still shock BBC News blogs, Stephanomics, Stephanie Flanders (13/1/11)
Many countries face catastrophe as inflation creeps up the food chain Independent, Hamish McRae (16/1/11)
Soaring demand soaks food oil reserves Sydney Morning Herald, Luzi Ann Javier (17/1/11)
Government to subsidise essential food items Sunday Observer, Gammi Warushamana (16/1/11)
Brace for higher food prices Jamaica Observer, Julia Richardson (16/1/11)
Jordanians protest against soaring food prices Guardian, Johnny McDevitt (15/1/11)
Inflation, the old enemy, is back. But this is no time to be frightened Guardian, Larry Elliott (16/1/11)
Global effort to calm food prices Washington Post, Steve Mufson (15/1/11)
The link between commodity prices and Monetary Policy Seeking Alpha (14/1/11)
Australian floods bost commodity prices, shares and funds Telegraph, Ian Cowie (13/1/11)
Soaring cost of oil and food will result in turmoil Belfast Telegraph Hamish McRae (18/1/11)
Q&A: Why food prices and fuel costs are going up BBC News (14/1/11)
Data
Commodity Prices Index Mundi
Questions
- What is the difference between headline food prices and real prices?
- What are the demand-side factors causing food prices to increase?
- What factors have affected the supply-side of the food market? Use a diagram to illustrate both the demand and supply-side factors.
- Can you identify some of the key differences between the causes of the rising food prices in 2008 and the rising food prices we’re seeing at the moment?
- Who are the winners and losers of rising food prices?
- What methods of government intervention are available to stabilise prices? Are they likely to be efficient and equitable?
- How is the exchange rate affecting food prices?
- Why could a loose monetary policy make food price inflation even worse?
- What are the main consequences of rising food and commodity prices? Think about the impact on different groups within society.
For most people, buying a new car is a luxury and in times of hardship it is a luxury that many cannot afford. Sales of new cars did grow during 2010 by 1.8% compared to the previous year, although the end of the car scrappage scheme in March 2010 did see a fall in sales. Sales went from being 19.9 per cent up on 2009 in the first half of the year, to being 13.8 per cent down for the remainder of 2010. On top of this, they are predicted to fall by some 5% over the coming 12 months.
Part of the explanation of this trend is the VAT rise. While an extra 2.5% is hardly noticeable on many every day items (as we saw when VAT was reduced to 15%), it will have a much larger effect on more expensive items, such as cars.
It was expected that people thinking of buying a new car would try to beat the VAT rise and so car firms hoped for a surge in sales during December. However, this did not occur and with VAT at 20% during 2011, car prices will rise: a £15,000 car will cost an extra £320. Another contributing factor to the lower than expected sales in December was the snow. Retail sales in December collapsed by 37.5%, where as fleet sales, which are less likely to be affected by the adverse weather rose by 5.1%. Similar patterns were seen in Spain, Italy and France, but in Germany sales were up by 7% on the year from December 2009.
The good news for the UK car industry is that the second half of 2011 is expected to see growth, so there may be some recovery. Furthermore, UK-built cars have seen a rise in sales – up by 17%. Finally, as petrol prices continue to rise, it is hoped that this might encourage people to trade in their less efficient old cars for more fuel-efficient new cars. This will certainly be an industry to watch over the next few months.
Snow hits new car sales Telegraph, Graham Ruddick (8/1/11)
UK new car sales to fall in 2011, says industry BBC News (7/1/11)
Mixed end to the year for European car sales Independent (7/1/11)
Car sales set to stall? Daily Mirror, Clinton Manning (8/1/11)
UK new car sales rose 1.8pc in 2010 despite end of scrappage scheme Telegraph, Amy Wilson (7/1/11)
New car sales increased in 2010 Telegraph, Chris Knapman (7/1/11)
Car registrations fall 18% from year ago Financial Times, Norma Cohen (7/1/11)
Questions
- What type of tax is VAT? Illustrate the effect of such a tax on a diagram and explain why the higher the price of the good, the bigger the impact of the VAT rise. How might this impact inflation?
- Why are car sales expected to fall in the UK over the coming year? Given this expected trend, what might we expect to see in terms of car prices?
- What impact might rising petrol prices have on new car purchases? What figure would you expect to see for cross elasticity of demand?
- How might the expected decline in car sales affect the UK economy over the next 12 months?
- What type of market structure is the car industry? (Think about the characteristics of monopolistic competition and oligopoly.)
- How did the car scrappage scheme help car sales?
- What might explain the different trend seen in the German car industry?
Just how large is the UK’s Gross Domestic Product and how quickly is it growing? Well, the latest Quarterly National Accounts from the Office for National Statistics show that the value of our economy’s output in Q3 2010 was £365.9 million. When measured across the latest four quarters, i.e. from the start of Q4 2009 to the end of Q3 2010, the total value of our economy’s output was £1.440 trillion. Across calendar year 2009 the UK’s GDP is estimated to have been £1.394 trillion.
When analysed in terms of the expenditure on the goods and services produced in the latest four quarters, household final consumption contributed £910.4 billion towards Gross Domestic Product. In other words, household expenditure over these four quarters was equivalent to 63% of GDP, exactly in line with its average since 1948. This only serves to demonstrate just how important the spending by households is for our short-term economic prospects.
Another important expenditure-component of GDP is gross capital formation. This is capital expenditure by the private and public sector and is estimated to have been £202.9 billion over the latest four quarters, equivalent to 14% of GDP. This is an important component because as well as affecting current levels of GDP, it also affects our economy’s potential output. This points to changes in capital expenditure having both a demand-side and a supply-side impact. Interestingly, the long-term average share for gross capital formation in GDP is around 18% and so about 4 percentage points higher than is currently the case.
So we now have a number which reflects the size of our economy: a little over £1.4 trillion. But, what about the rate at which the economy is growing? This time we have to be a little careful as to which GDP numbers we are using. The numbers we have so far considered have been measured at current prices and so at prevailing prices. When analysing the rate of economic growth, rather than analyse GDP at current prices, economists look at GDP at constant prices. By doing this we can immediately see whether the volume of output has increased. This is important because in the presence of price rises, an increase in the value of output could occur even if the volume of output remained unchanged or actually fell. For instance, in 1974 the volume of output or real GDP fell by 1.3%, but because the average price of our domestic output (known as the GDP deflator) rose by 14.8%, GDP measured at current prices rose by nearly 13½%.
The latest ONS figures show that real GDP grew by 0.7% in the third quarter 2010. For the record, GDP at current prices (nominal GDP) grew by 0.9%. The 0.7% increase in GDP in volume terms is down on the 1.1% figure for Q2. While this appears to constitute a reasonable rate of economic growth we can see from the articles below the concern amongst commentators that this third estimate of growth for Q3 had seen a downward revision from the previous estimates of 0.8%. Nonetheless, when compared with Q3 2009, the output of the UK economy in Q3 2010 is estimated to have grown by 2.7%. This is the strongest annual rate of economic growth since the third quarter of 2007.
Despite its relatively low historic share of GDP, gross capital formation was the most rapidly growing expenditure component in Q3, increasing by 5.2% over the quarter and by 16.6% over the latest four quarters. Household spending grew by 0.3% over the quarter and by 2% over the latest four quarters. Meanwhile, government final consumption, i.e. those government purchases not classified as capital expenditures, fell by 0.4% over the quarter and by 1.3% over the latest four quarters. Finally, the volume of exports rose by 1.5% over the quarter and by 7.5% over the latest four quarters, but the volume of imports increased more rapidly rising by 1.7% over the quarter and by 10.3% over the latest four quarters. This has contributed to a UK trade deficit from the start of Q4 2009 to the end of Q3 2010 of a little over £40.5 billion.
Articles
UK recovery weaker than first thought, official data shows Telegraph, Emma Rowley and Philip Aldrick (23/12/10)
Service sector output dips Financial Times, Chris Giles (23/12/10)
UK’s official economic growth estimates revised down Guardian, Graeme Wearden (22/12/10)
UK economic growth revised down BBC News (22/12/10)
Economic growth weaker than thought Press Association (22/12/10)
UK economic growth in 3rd quarter revised downward Bloomberg, Robert Barr (22/10/12)
Economic growth ‘is lower than we thought’ admits ONS Scotsman, Natalie Thomas (23/12/10)
UK GDP growth: analysts view of the revised data Telegraph (22/12/10)
Data
Latest on GDP growth Office for National Statistics (22/12/10)
Quarterly National Accounts, 3rd Quarter 2010 Office for National Statistics (22/12/10)
UK Economic Accounts, Time Series Data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission
Questions
- What do you understand by the terms nominal GDP and real GDP?
- Can you think of any other contexts in which we might wish to distinguish between nominal and real changes?
- The following are the estimates of GDP at constant 2006 prices:
Q3 2009= £322.655bn, Q2 2010= £328.881bn, Q3 2010= £331.222bn Show how you would calculate both the quarterly rate of change and the annual rate of change for Q3 2010.
- What would happen to our estimates of the level of constant–price GDP in (3) if the base year for prices was 1986 rather than 2006? What would happen to the quarterly and annual growth rates you calculated? Explain your answer.
- Explain how gross capital formation could have both demand-side and supply-side effects on the economy? How significant do you think such supply-side effects can be?
- How important for short-term economic growth do you think household spending is? What factors do you think will be important in affecting household spending in the months ahead?
It is the Bank of England’s responsibility to ensure that inflation remains on target. They use interest rates and the money supply to keep inflation within a 1% band of the inflation target set by the government = 2%. However, for the past 12 months, we have had an inflation rate above the 3% maximum and this looks set to continue. Official figures show that the CPI inflation rate has risen to 3.3% in November, up from 3.2% in October 2010 – above the inflation target. There was also movement on the RPI from 4.5% to 4.7% during the same months. The ONS suggests that this increase is largely down to record increases in food, clothing and furniture prices: not the best news as Christmas approaches. It is not just consumers that are facing rising prices, as factories are also experiencing increasing costs of production, especially with the rising cost of crude oil (see A crude story). Interest rates have not changed, as policymakers believe prices will be ‘reined in’ before too long.
However, the government expects inflation to remain above target over the next year, especially with the approaching increase in VAT from 17.5% to 20%. As this tax is increased, retail prices will also rise and hence inflation is likely to remain high. There is also concern that retailers will use the increase in VAT to push through further price rises. A report by KPMG suggests that 60% of retailers intend not only to increase prices to cover the rise in VAT, but to increase prices over and above the VAT rise.
Despite the planned VAT rise spelling bad news for inflation, it could be the spending cuts that offset this. As next year brings a year of austerity through a decrease in public spending, this could deflate the economy and hence bring inflation back within target. However, there are suggestions that more quantitative easing may be on the cards in order to stimulate growth, if it appears to be slowing next year. The Bank of England’s Deputy Governor, Charles Bean said:
“It is certainly possible that we may well want to undertake a second round of quantitative easing if there is a clear sign that UK output growth and with it inflation prospects are slowing,” Bean told a business audience in London.”
The following articles consider the rising costs experienced by firms, the factors behind the inflation and some of the likely effects we may see over the coming months.
Articles
UK inflation rises to a surprise six-month high The Telegraph, Emma Rowley (14/12/10)
UK inflation rate rises to 3.3% in November BBC News (14/12/10)
Inflation unexpectedly hits 6-month high in November Reuters, David Milliken and Christina Fincher (14/12/10)
Food and clothing push up inflation Associated Press (14/12/10)
Retailers ‘to increase prices by more than VAT rise’ BBC News (14/12/10)
VAT increase ‘will hide price rises’ Guardian, Phillip Inman (14/12/10)
Slower growth may warrant more QE Reuters, Peter Griffiths and David Milliken (13/12/10)
Factories feel squeeze of inflation The Telegraph, Emma Rowley (13/12/10)
Figures show rise in input prices The Press Association (13/12/10)
November producer input prices up more than expected Reuters (13/12/10)
Data
Inflation ONS
Inflation Report Bank of England
Questions
- What is the difference between the RPI and CPI? How are each calculated?
- Why are interest rates the main tool for keeping inflation on target at 2%? How do they work?
- Is the inflation we are experiencing due to demand-pull or cost-push factors? Illustrate this on diagram. How are expectations relevant here?
- Explain why the rise in VAT next year may make inflation worse – use a diagram to help your explanation.
- Explain the process by which rising prices of crude oil affect manufacturers, retailers and hence the retail prices we see in shops.
- How are the inflation rate, the interest rate and the exchange rate linked? What could explain the pound jumping by ‘as much as 0.2pc against the dollar after the report’ was released?
- Explain why the public spending cuts next year may reduce inflation. Why might more quantitative easing be needed and how could this affect inflation in the coming months?