Tag: forecasting

On February 14, the Sunday Times published a letter by 20 eminent economists calling on the next government to cut the public-sector deficit more rapidly than that planned in last December’s pre-Budget report.

In order to minimise this risk and support a sustainable recovery, the next government should set out a detailed plan to reduce the structural budget deficit more quickly than set out in the 2009 pre-Budget report.

The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.

Then on 18 February the Financial Times published two letters, between them from more than 60 economists, backing Alistair Darling’s policy of delaying cuts until the recovery is firmly established. They openly disagreed with the 20 economists who wrote to the Sunday Times.

… while unemployment is still high, it would be dangerous to reduce the government’s contribution to aggregate demand beyond the cuts already planned for 2010-11 (which amount to 1 per cent of gross domestic product). Further immediate cuts – even supposing they are practicable – would not produce an offsetting increase in private sector aggregate demand, and could easily reduce it. History is littered with examples of premature withdrawal of the government stimulus, from the US in 1937 to Japan in 1997. With people’s livelihoods at stake, a responsible government should avoid reckless actions.

… A sharp shock now would not remove the need for a sustained medium-term programme of deficit reduction. But it would be positively dangerous. If next year the government spent less and saved more than it currently plans, this would not “make a sustainable recovery more likely”. The weight of evidence points in the opposite direction.

So why do such eminent economists have apparently such divergent views on tackling the public-sector deficit? Is there any common ground between them? What does the disagreement imply about the state of macroeconomics? Read the letters and articles and then try answering the questions.

Tories right on cuts, say economists Sunday Times, David Smith (14/2/10)
Letter: UK economy cries out for credible rescue plan Sunday Times, 20 economists (14/2/10)
Economists reject calls for budget cuts Financial Times, Jean Eaglesham and Daniel Pimlott (18/2/10)
Letter: First priority must be to restore robust growth Financial Times, Lord Skidelsky and others (18/2/10)
Letter: Sharp shock now would be dangerous Financial Times, Lord Layard and others (18/2/10)
Economists urge swift action to reduce budget deficit BBC News (14/2/10)
Economists back delay on government spending cuts BBC News (19/2/10)
Economists back delay on government spending cuts BBC News (19/2/10)
Men of letters III BBC News blogs: Stephanomics, Stephanie Flanders (19/2/10)
Daily View: When to cut spending? (including podcast) BBC News blogs, Clare Spencer (19/2/10)
Cautious economists and cutters battle it out in print Guardian (20/2/10)
The great economics rift reopens Guardian, Gavyn Davies (19/2/10)
Focus on growth. Don’t argue about cuts Times Online, Eamonn Butler (20/2/10)
Recession’s ruins hide plenty of spare capacity Sunday Times, David Smith (14/2/10)

Questions

  1. To what extent is the disagreement between the two sets of economists largely one of the timing of the cuts?
  2. Is the disagreement the result of (a) different analysis, (b) different objectives or (c) different interpretation of forecasts of the robustness of the recovery and how markets are likely to respond to alternative policies? Or is it a combination of two of them or all three? Explain your answer.
  3. How would new classical economists respond to the Keynesian argument that it is necessary to focus on aggregate demand if the economy is to experience a sustained recovery?
  4. How would Keynesian economists respond to the argument that rapid cuts will reassure markets and allow private-sector recovery to more than compensate for reduced public-sector activity?
  5. Why is the effect of the recession on the supply-side of the economy crucial in determining the sustainability of a demand-led recovery?
  6. Distinguish between the cyclical and structural deficits. How would the policies advocated by the two groups of economists impact on the structural deficit?

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

    1. For what reasons might inflation be expected to fall back to 2% later in the year?
    2. 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.
    3. 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?
    4. 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.
    5. What is meant by ‘core inflation’? Why did this rise to 2.8% in December 2009?
    6. What is the role of expectations in determining (a) inflation and (b) real GDP in 24 months’ time?
    7. Why, according to David Blanchflower, is the MPC not ‘fit for purpose’?

    At the start of the new decade, many commentators are getting out their crystal balls to take a look into the future. Below you will find a selection of their predictions, including six extracts from The Economist’s ‘The World in 2010’.

    In 2009, the world economy shrank for the first time since 1945. Will it now bounce back, or will global recovery be slow, or will there be a ‘double-dip recession’ with output falling once more before sustained recovery eventally sets in? And what about particular economies? How will the UK fare compared with other countries? How will the USA and the eurozone perform? Will China and India be the powerhouses of global recovery?

    Then there is the whole question of the financial sector. Is it now fixed? Will businesses and consumers have sufficient access to credit – is the credit crunch over? Has toxic debt been expunged from the banking system? Do banks now have sufficient capital?

    And what about debt? Even though private-sector debt is falling in many countries as households and businesses scale back borrowing and as banks have imposed tighter lending criteria, public-sector debt is soaring around the world. Will financial markets continue to support these growing levels of sovereign debt? Will central banks have to continue with quantitative easing in order to support these levels of debt and to keep interest rates down?

    Economic Outlook: 2010 may narrow gap Financial Times, Chris Flood (27/12/09)
    CIPD Annual Barometer Forecast: UK economy to shed a further 250,000 jobs before unemployment peaks at 2.8 million in 2010 Chartered Institute of Personnel and Development (CIPD) (21/12/09)
    Unemployment ‘set to peak in 2010’ Guardian (29/12/09)
    Unemployment ‘will peak at 2.8m’ in 2010 BBC News (29/12/09)
    What employment prospects lie ahead in 2010? BBC News, Shanaz Musafer (3/1/10)
    Money printing scheme is working, Bank of England says Times Online, Gráinne Gilmore and Francesca Steele (1/1/10)
    Bank optimism rises as credit to business eases Guardian, Ashley Seager (31/12/09)
    The world in 2010: China continues its unstoppable economic charge Independent, Alistair Dawber (2/1/10)
    The US slowly emerges from the gloom of 2009 Independent, Alistair Dawber (2/1/10)
    Year dominated by weak dollar Financial Times, Anjli Raval (2/1/10)
    A year when tipsters took a tumble Times Online, David Wighton (1/1/10)
    PMEAC pegs growth at 8% in ’10-11 Times of India (2/1/10)
    China and the other Brics will rebuild a new world economic order The Observer, Ashley Seager (3/1/10)
    Five countries that crashed and burned in the credit crunch face a hard road to recovery The Observer, Heather Stewart, Ashley Seager, David Teather, Richard Wachman and Zoe Wood (3/1/10)
    HSBC goes out on a limb and predicts growth beyond dreams of Chancellor Times Online, Gráinne Gilmore (2/1/10)
    Uncertainty dogs sterling Financial Times, Peter Garnham (2/1/10)
    A tough year to forecast as recovery hangs in the balance Scotsman, George Kerevan (30/12/09)
    Unstable equilibrium in 2010 BBC News blogs, Peston’s Picks (30/12/09)
    Intriguing economic questions for 2010 BBC News blogs, Stephanomics (23/12/09)
    The hard slog ahead The Economist (13/11/09)
    In the wake of a crisis The Economist (13/11/09)
    Now for the long term The Economist, Matthew Bishop (13/11/09)
    Recessionomics The Economist, Anatole Kaletsky (13/11/09)
    The World in 2010: From the editor The Economist, Michael Pilkington (13/11/09)
    The hard slog ahead The Economist (13/11/09)

    For forecasts of various economies and regions see
    World Economic Outlook (OECD)
    European Economic Forecast – autumn 2009 (European Commission)
    Tables set A and Tables set B from World Economic Outlook (IMF)

    Questions

    1. What is likely to happen to the major economies of the world in 2010?
    2. How much reliance should be placed on macroeconomic forecasts for the medium term (1 or 2 years)?
    3. For what reasons might the UK economy fare (a) better or (b) worse than forecast?
    4. Why has unemployment risen less in the UK, and many other countries too, during the current recession compared to previous recessions? Does the flexibility of labour markets affect the amount that unemployment rises during a period of declining aggregate demand?
    5. Why may the world face a ‘long hard slog’ in recovering from recession?
    6. Why is the world in 2010 ‘balanced precariously’ and why are there huge uncertainties? (See Robert Peston’s blog.)
    7. Why are China and India likely to see much faster rates of economic growth than the USA, the EU and Japan?
    8. What is likely to happen to stock markets over the coming 12 months? What will be the main factors influencing the demand for and supply of shares?
    9. What fiscal and monetary policies are most appropriate during the coming 12 months?

    The Bank of England’s latest quarterly Inflation Report was published on November 11. With all the gloomy news over the past few months the report is pleasantly up-beat – certainly for the longer term. As Mervyn King, Governor of the Bank of England, states in his opening remarks to the publication of the report, “The considerable stimulus from the past easing of monetary and fiscal policy and the depreciation of sterling should lead to a recovery in economic activity.”

    Nevertheless, recovery will be slow, especially at first. This means that it will be some time before output returns to pre-recession levels. “Despite a recovery in economic growth, output is unlikely, at least for a considerable period, to return to a level consistent with a continuation of its pre-crisis trend. That is in large part because the impact of the downturn on the supply capacity of the economy is expected to persist. But it is also because there is likely to be sustained weakness of demand relative to that capacity.”

    There is surprisingly good news too on employment and unemployment. Although unemployment has risen sharply in recent months, the rate of increase is slowing and “There was a small increase of 6000 in the number of people in employment to 28.93 million, the first quarterly increase since May–July 2008 (see Labour market statistics, November 2009).

    So should we be putting out the flags? Can the Bank of England ease off on quantitative easing (see Easing up on quantitative easing)? Or does it still need to keep on increasing money supply, especially as fiscal policy will have to get a lot tighter? The following articles consider the issues.

    Mervyn King: economy remains ‘uncertain’ (video) Channel 4 News, Faisal Islam (11/11/09)
    Bank of England governor dampens hopes of swift UK recovery Guardian, Graeme Wearden (11/11/09)
    Recovery has only just started, warns sombre King Guardian, Heather Stewart (11/11/09)
    Cautious good cheer BBC News, Stephanomics (11/11/09)
    Bank of England’s Mervyn King says UK only just started on recovery road Telegraph (11/11/09)
    The Bank of England’s Inflation Report is useless. Here’s why. Telegraph, Edmund Conway (11/11/09)
    Bank of England raises growth and inflation forecasts: economists react (includes video) Telegraph (11/11/09)
    Bank of England talks up hopes of strong recovery Times Online, Robert Lindsay (11/11/09)
    Bank of England cautions on economic recovery BusinessWeek, Jane Wardell(11/11/09)
    Just who benefits from quantitative easing? WalesOnline (11/11/09)
    Inflation Report: Forget the fan charts, what we need is a clear economic policy Telegraph, Jeremy Warner (11/11/09)
    We’ve no choice but to keep inflating Independent, Hamish McRae (11/11/09)
    Is there a break in the economic gloom? (video) BBC Newsnight, Paul Mason (12/11/09)

    The Bank of England Inflation Report can be found at the following site, which contains links to the full report, the Governor’s opening remarks, charts, a podcast and a webcast:
    Inflation Report November 2009 Bank of England

    Questions

    1. Explain what the three fan charts, Charts 1, 2 and 3 on pages 6, 7 and 8 of the Inflation Report, show.
    2. Why is the Bank of England more optimistic than in its previous report (August 2009)?
    3. Why did the sterling exchange rate fall on the publication of the report?
    4. Has the policy of expansionary monetary policy proved to be beneficial and should the Bank of England continue to pursue an expansionary monetary policy?
    5. What determines the balance of effects of an expansionary monetary policy on (a) asset prices; (b) real output; and (c) inflation?
    6. How have relatively flexible labour markets affected the impact of recession on (a) wage rates; (b) unemployment?

    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

    1. 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.
    2. How is the price of gold related to the strength of the US dollar?
    3. Explain whether gold is a commodity or a currency (or both).
    4. 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.