It’s not just the roads in the UK that were frozen, as the Bank of England unsurprisingly decided to keep interest rates frozen at 0.5%. Furthermore, many economists do not expect to see interest rates increase for some time. Roger Bootle has predicted that rates could stay low for up to 5 years and this will contribute to a continuing weak pound and spell further trouble for importers and their customers.
The Bank of England also left its money-creation programme of ‘quantitative easing’ unchanged, but next month it will have to decide whether to extend quantitative easing beyond the limits of £200 billion that it set back in November.
Whilst we are supposedly beginning our economic recovery – with 2009 quarter 4 figures showing the first rise in output since the first quarter of 2008 – its strength remains questionable. Indeed, the rise in output in the last three months of 2009 was a mere 0.1%. So how important are interest rates in helping to sustain the recovery? Can they really pull us out of the recession by remaining at just 0.5%? Read the articles below which look at freezing interest rates and quantitative easing.
FTSE unaffected by interest rate decision In the News (7/1/10)
Freeze on UK interest rates BBC News (7/1/10)
Bank of England may raise interest rates as soon as March, leading economist predicts Telegraph (7/1/10)
Interest rates and quantitative easing on hold Guardian, Larry Elliott (7/1/10)
Bank of England extends quantitative easing by £25bn – but is it enough? Guardian, Larry Elliott (5/11/10)
Questions for QE BBC News blogs, Stephanomics, Stephanie Flanders (7/1/10)
Interest rates could stay low for 5 years, says Bootle BBC News (7/1/10)
Questions
- How do low interest rates contribute to a weak pound? How does this affect exporters and importers?
- What is quantitative easing? Should the QE programme be extended? What are the arguments for and against this in terms of economic recovery and public debt?
- How much of an impact do you think the recession will have on government policy over the next few months?
- Explain the transmission mechanisms by which changes in interest rates affect the goods market.
- If the Bank of England were not independent, what do you think would be happening to interest rates?
Most businesses have suffered over the past year or so. Profits and sales have fallen, as the UK (and global) economy suffered from a recession that’s seen UK interest rates at 0.5%, unemployment rising and public debt at unprecedented levels. Christmas trading always sees a boost in sales and that’s just what’s happened for many businesses. Shoppers have responded to the doom and gloom of the past year by spending and making up for a hard year. Phrases such as “I decided to treat myself” became common on the news as reporters travelled to shopping centres across the UK. However, shops such as M&S and Next have warned that attempts by the government to reduce the public deficit could derail the consumer recovery.
These positive stories, whilst true, are a useful tool to help boost consumer confidence and keep expectations positive for the coming months. However, there are warnings that these figures shouldn’t be taken out of context. The economy is still in trouble and public debt has reached almost 60% of GDP. With cuts in government spending and rises in taxation expected, how much confidence should be taken from these positive signs in the retail sector? Only time will tell.
Online powers Shop Direct sales Financial Times, Esther Bintliff (6/1/10)
Poundland, House of Fraser and Co-op see sales rise BBC News (11/1/10)
Links of London see buoyant festive sales Telegraph, James Hall (5/1/10)
John Lewis reports bumper Christmas trading Retail Week, Jennifer Creevy (5/1/10)
New Look expects to build on strong Christmas London Evening Standard (7/1/10)
Christmas trade booming in City Star News Group, Alex de Vos (7/1/10)
Record trading for Cash Generator Manchester Evening News (7/1/10)
Sainsbury’s hails ‘strong’ Christmas trading BBC News (7/1/10)
Cautious M&S reports strong Christmas trade Times Online, Marcus Leroux and Robert Lindsay (6/1/10)
Asda reports ‘solid’ Christmas trading Guardian (6/1/10)
Questions
- Why are expectations important for the future of the British economy? Are the expectations rational or adaptive or a combination of the two?
- Are high Christmas sales really a sign that the economy is recovering? Discuss both sides of the argument. Will high sales now have an adverse effect on future trade in the UK?
- How will expected cuts in government spending affect sales in the retail sector?
- Tax rises are a possibility. How will this affect consumers and sales in the coming year? Think about the circular flow of income.
- If interest rates are increased in the coming months, trace through the likely effects in the goods market.
No, I’m not talking about the UK suffering from snow and becoming a land of ice! Towards the end of 2008, Icelandic banks hit the headlines and for all the wrong reasons. Icelandic banks were key lenders to some of the key businesses and entrepreneurs in the UK and an online bank held the accounts of over 150,000 Brits. The Icelandic government tried to rescue their banking sector, but with little success and we saw it collapse, sending shockwaves through UK banks. The UK economy lost millions and this contributed to the worsening financial system within our shores.
Iceland’s President has been under serious pressure, from the UK and Dutch governments on one side and from the Icelandic people on the other. A quarter of voters in Iceland have signed a petition against plans to repay money lost by foreigners when an Icelandic online bank collapsed. When the Icesave scheme collapsed in 2008, British and Dutch savers lost approximately £3.4bn (€3.8bn). Although they were compensated by the British and Dutch governments, this still meant that the taxpayers in these countries were owed the money by Iceland.
Iceland’s Parliament approved the plans to reimburse the money, but the people are encouraging their President to veto the bill. They argue that repaying this money will cost the Icelandic taxpayers: the compensation is some 12,000 euros for each of Iceland’s residents. Campaigners say that the Icelandic people are being forced to pay for the mistakes of the banks. Whilst UK taxpayers lost out, the Icelandic people’s arguments have something of a déjà-vu about them: after all it wasn’t long ago that the UK people were asking why we should have to suffer from higher taxes and future cuts in government spending to bail out the banks, when it wasn’t our fault that they collapsed in the first place. The following articles consider this issue.
Icelandic bank with British savers’ money enters crisis talks Telegraph, Rowena Mason (4/10/08)
Town Hall’s £830m Iceland shortfall This is Money, Daniel Martin (6/1/10)
Iceland leader vetoes bank repayments bill BBC News (5/1/10)
iIceland blocks repayment of £2.3bn to Britain Times Online, Robert Lindsay (5/1/10)
Iceland petition against pay-out over Icesave collapse BBC News (2/1/10)
Iceland’s President under pressure over Icesave Telegraph, Angela Monaghan (3/1/10)
Peston’s Picks: We’re all Icelanders now BBC News (7/1/10)
Iceland President says country will pay UK government BBC News (7/1/10)
Questions
- For the Icelandic people, what are the arguments (a) for and (b) against repaying money owed to the UK and the Netherlands?
- For the British and Dutch people, what are the arguments (a) for and (b) against repayment?
- How will this repayment (or lack thereof) affect the recovery of the British economy?
- Will the repayment of this money adversely affect the Icelandic economy? Explain your answer. Think about tax cuts and the effect on consumer incomes.
- Why is this a key example of international policy interdependence?
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
- What is likely to happen to the major economies of the world in 2010?
- How much reliance should be placed on macroeconomic forecasts for the medium term (1 or 2 years)?
- For what reasons might the UK economy fare (a) better or (b) worse than forecast?
- 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?
- Why may the world face a ‘long hard slog’ in recovering from recession?
- Why is the world in 2010 ‘balanced precariously’ and why are there huge uncertainties? (See Robert Peston’s blog.)
- Why are China and India likely to see much faster rates of economic growth than the USA, the EU and Japan?
- 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?
- 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
- Explain what the three fan charts, Charts 1, 2 and 3 on pages 6, 7 and 8 of the Inflation Report, show.
- Why is the Bank of England more optimistic than in its previous report (August 2009)?
- Why did the sterling exchange rate fall on the publication of the report?
- Has the policy of expansionary monetary policy proved to be beneficial and should the Bank of England continue to pursue an expansionary monetary policy?
- What determines the balance of effects of an expansionary monetary policy on (a) asset prices; (b) real output; and (c) inflation?
- How have relatively flexible labour markets affected the impact of recession on (a) wage rates; (b) unemployment?