After the November 2009 meeting of the Monetary Policy Committee, the Bank of England announced that it would keep Bank Rate on hold at 0.5%, at which rate it has been since March. It also said that it would spend a further £25 billion over the next three months on asset purchases, primarily government bonds, thereby pumping additional money into the economy: the process known as “quantitative easing“. This would bring total asset purchases under the scheme to £200bn.
But although this represents a further increase in money supply, the rate of increase is slowing down. In the previous three months, £50 billion of assets had been purchased. So does this imply that the Bank of England sees a recovery around the corner? Will money supply have been expanded enough to finance the desired increase in spending – on both consumption and investment?
A problem so far is that most of the extra money has not been spent on goods and services. Banks have been building up their reserves, with much of the money simply being re-deposited in the Bank of England as reserve balances (see Table A1.1.1 in “Bankstats). At the same time, households have been taking on very little extra debt – indeed, In July, total household debt actually fell (see “Payback time) and consumer debt (i.e. excluding mortgages) has continued to fall. If quantitative easing is to work, the money must be spent!
But with the monetary base having expanded so much, is there a danger that, once the recovery gathers pace, spending growth will return with a vengeance? Will inflation rapidly become a problem again with an overheating economy? The following articles examine the issues.
Interest rates held at 0.5 per cent (includes video) Channel 4 News (5/11/09)
Bank of England extends quantitative easing to £200bn Guardian, Larry Elliott (5/11/09)
What the economists say: Quantitative easing £25bn boost Guardian (5/11/09)
Bank of England faced with its biggest split on policy in a decade Independent, Sean O’Grady (4/11/09)
Bank of England expands money-printing programme to £200bn to fight downturn (includes video) Telegraph (5/11/09)
The one thing worse than quantitative easing would be no QE at all Telegraph, Edmund Conway (5/11/09)
BoE: It ain’t over till it’s over Telegraph, Edmund Conway blog (5/11/09)
Bank raises stimulus to £200bn to end recession Times Online, Grainne Gilmore (5/11/09)
Bank of England to inject another £25bn of stimulus money Management Today (5/11/09)
Extra £25bn to stimulate economy BBC News (5/11/09)
Quantitative easing ‘not working’ (video of DeAnne Julius: former MPC member) BBC News (5/11/09)
Boxed in BBC Stephanomics (5/11/09)
The BoE’s £25bn gambit Financial Times, Chris Giles blog (5/11/09)
US to reduce Quantitative Easing as rates kept low Telegraph, James Quinn (4/11/09)
Quantitative easing ‘unpleasant’ BBC Today Programme, Stephen Bell and Wilem Buiter (7/11/09)
Experts debate whether quantitative easing is working (video) BBC Newsnight (6/11/09)
Questions
- What has been happening to the velocity of circulation of (narrow) money in the past few months? Explain the significance of this.
- What is likely to happen to the velocity of circulation in the coming months if (a) the economy recovers quite strongly; (b) recovery is modest?
- What is the relationship between quantitative easing and the growth in broad money (i.e. M4 in the UK)? How will banks’ desire to build up their reserves affect this relationship?
- Is the UK economy in a liquidity trap? Explain.
- Why is it likely that the Bank of England may well engage in more quantitative easing next March and beyond? How is the fiscal situation likely to affect Bank of England decisions?
- Examine the argument for the Bank of England buying more private-sector debt (virtually all of the asset purchases have been of public-sector debt)?
A key determinant of the length of any phase of the business cycle is consumer confidence. If people have gloomy expectations and confidence of a recovery is low, then a recession that should have lasted 6 months ends up lasting for years. Companies don’t see an end to the recession and keep holding off on investment plans and the public don’t want to go out and start spending, because there’s no guarantee that the economy is on its way back up. The more you worry about your finances, the less likely you are to go out and start spending, even though that could be the stimulus that a shrinking economy needs.
According to the British Retail Consortium, consumer confidence in the UK is on its way back up and currently stands at an 18-month high – which doesn’t actually say much given the past 18-months!! Despite this, job worries still remain and this has been highlighted significantly in the past week, when Britain’s youngest person ever was made redundant: a 13-year old paper boy. Whilst consumer confidence is argued to be returning to the UK, consumer confidence has been going in the opposite direction in the USA, with further fears of job losses. US confidence had been improving but unexpectedly fell in October. Is that what the UK has to look forward to?
So, why is consumer confidence so important? How does it affect the length of recovery and what is expected to happen over the next few months? Read the articles below to find out more.
US consumer confidence takes hit BBC News (27/10/09)
Consumer confidence hits 18-month high The Independent, David Prosser (1/11/09)
Consumer confidence on the rise BBC News (2/11/09)
Confidence boost hints that worst of recession now over The Scotsman, Peter Ranscombe (2/11/09)
US Michigan Sentiment fell to 70.6 this month Bloomberg, Courtney Schlisserman (30/10/09)
Euro-zone Consumer confidence improves The Wall Street Journal, Ilona Billington and Roman Kessler (30/10/09)
Retailers set for a merry Christmas DIYWeek (2/11/09)
Job fears still remain despite biggest increase in consumer confidence in 18 months, says British Retail Consortium Liverpool Echo, Neil Hodgson (2/11/09)
Business and consumer surveys in each of the EU countries and in the EU as a whole can be found at:
Business and Consumer Surveys European Commission
Questions
- In what ways does consumer confidence affect economic growth?
- Are there likely to be any adverse consequences of consumer confidence returning to the market?
- What are some of the reasons for the unexpected fall in consumer confidence in the USA? Do you think a similar thing is likely to happen in the UK?
- Expectations are crucial in economics. What is the difference between adaptive and rational expectations? How do they affect adjustment to the short- and long-run equilibrium?
- Can anything be done to improve confidence or is it simply a case of leaving things as they are … and waiting?
Gold prices have been soaring in recent months. In fact, such is the demand for the precious metal that Harrods has just started selling gold bars. “The Knightsbridge department store yesterday began selling bars of pure Swiss gold bullion as part of a range that is being displayed in a miniature vault on the lower ground floor” (see eighth link below).
In November 2008, gold was trading at around $750 per ounce; by October 2009, the price had reached $1080 per ounce. Why has this happened? Will the trend continue? What does it signify about the world economy – both its current and likely future state? The following articles look at the causes and effects of this new ‘golden age’.
Gold prices continue to hit new highs Guardian (7/10/09)
Gold price hits fresh high Guardian (14/10/09)
Gold’s bull run set to roar ahead This is Money (17/10/09)
Why the price of gold is rising BBC News (13/10/09)
Gold price ‘set to double in four years’ (includes video) Telegraph (10/10/09)
Gold at $1,500? Don’t hold your breath Telegraph (10/10/09)
Bullion bulls The Economist (8/10/09)
Harrods put Swiss gold bars up for sale in a miniature vault Times Online (16/10/09)
Gold Eases from New High as “Less Bad” Data Drives Up Equities, Oil & Wall Street Bonuses BullionVault (14/10/09)
Gold Just Broke Its Neck, Targets $5,250? The market Oracle (14/10/09)
Questions
- Use a demand and supply diagram to illustrate the change in the price of gold between November 2008 and October 2009. Does the explanation lie largely of the demand or the supply side? Use the concepts of price elasticity of demand and supply to explain the size of the price change for any given shift in demand or supply.
- How is the price of gold related to the strength of the US dollar?
- Explain whether gold is a commodity or a currency (or both).
- What is meant by the ‘head and shoulders pattern’ in the price of gold? Is the use of ‘patterns’ a good way of predicting future prices? Give reasons why it may or may not be.
CPI inflation in the 12 months to September 2009 fell to 1.1% (from 1.6% in the 12 months to August). RPI inflation for the same period was -1.3%. In other words, retail prices actually fell by 1.3% in the 12 months to September. According to the ONS, “By far the largest downward pressure affecting the change in the CPI annual rate came from housing and household services. This was principally due to average gas and electricity bills, which were unchanged between August and September this year but rose a year ago when some of the major suppliers increased their tariffs.” (See below for link.)
If the CPI inflation rate falls below 1% (or rises above 3%), the Governor of the Bank of England is required to write a letter to the Chancellor of the Exchequer explaining why and also what the Bank of England intends to do about this. The Bank of England targets the forecast CPI inflation 24 months’ hence and attempts to achieve a rate of 2%. Normally, if the forecast rate is below 2%, the Monetary Policy Committee will decide to cut the rate of interest. The last Bank of England Inflation Report (August 2009) forecast CPI inflation of around 1.5% in 24 months’ time. If the November Inflation Report forecasts a similar figure, or even below, what can be done? Bank Rate is already at a historic low of just 0.5% and a further cut is unlikely to have much effect. Should the Bank of England, then, engage in another dose of quantitative easing? Perhaps the letter, if it has soon to be written, will make it clear.
UK consumer price inflation at 5-year low BusinessWeek (13/10/09)
Recession helps push inflation to five-year low Independent (14/10/09)
Inflation falls to lowest in five years Guardian (13/10/09)
Inflation dip likely to be short-lived Guardian (13/10/09)
Deflation, not inflation would be the bigger threat if the Conservatives do what they say Jeremy Warner blog, Telegraph (13/10/09)
Pound hit by falling UK inflation BBC News (13/10/09)
Pound hit by falling UK inflation (video) BBC News (13/10/09)
Pound pays price as inflation slides to five-year low Times Online (14/10/09)
Investors weigh risks of inflation and deflation Financial Times (12/10/09)
Wage ‘catch up’ for public sector BBC Today Programme (14/10/09)
Current data on UK Inflation (National Statistics)
Time series data (annual, quarterly and monthly) on UK prices and inflation Economic and labour Market Review (National Statistics)
Questions
- Why did the annual rate of CPI inflation fall so much in September 2009?
- Is the Bank of England Governor likely to have to write a letter (or letters) to the Chancellor in the coming months? Explain why or why not. What is likely to be the role of expectations in determining whether a letter has to be written?
- Why did the sterling exchange rate fall on the announcement of the inflation figure? What are likely to be the effects of this? What will determine the size of these effects?
- Why may additional amounts of quantitative easing be necessary in the coming months? How would a contractionary fiscal policy affect the desirability of additional quantitative easing?
In an attempt to stave off recession, countries around the world have made extensive used of fiscal stimuli. Combinations of tax cuts and increases in government expenditure have been used to boost aggregate demand and thereby to halt falling national income. “The G20 group of economies … have introduced stimulus packages worth an average of 2% of GDP this year and 1.6% of GDP in 2010.”
But how much will national income respond to a particular fiscal stimulus? It depends on the size of the fiscal multiplier for each type of government expenditure increase or tax cut. The bigger the multiplier for each expansionary measure, the more will national income rise. Clearly, to estimate the effects of their fiscal measures, governments would very much like to know the size of these multipliers. But that’s not so easy, as the following article from The Economist explains.
Much ado about multipliers The Economist (24/9/09)
Questions
- What are the formulae for (a) the government expenditure multiplier; (b) the tax multiplier?
- Why is the value of the multiplier likely to vary with the type of government expenditure increase or tax cut that is used? Which types of government expenditure increases and tax cuts are likely to have (a) the largest effects; (b) the fastest acting effects?
- Why is the size of any particular fiscal multiplier difficult to predict? How do expectations impact on the size of the multiplier?
- Under what circumstances are fiscal measures likely to be ‘crowded out’? How can monetary policy be used to prevent, or at least minimise, crowding out?