Tag: money supply

The term hyperinflation is almost an understatement when it comes to describing the level of inflation in Zimbabwe. In July 2008, inflation was estimated to be 231 million per cent. In January 2009, two estimates were made: one of 5 sextillion per cent (5 and 21 zeros); the other of 6.5 quindecillion novemdecillion per cent (65 and 107 zeros). These figures are simply mind-boggling for most people living in low-inflation economies.

Commentators say that prices can double in a single day and this can render banknotes useless very quickly. In fact, local banknotes are scarcely used as people turn to overseas currencies that offer more stability. Recognising this, in late January 2009 the government officially allowed foreign currencies to be used in Zimbabwe as well as the Zimbabwe dollar.

In an attempt to stabilise the currency the Zimbabwean central bank on more than one occasion has tried dropping several zeros from the currency. But this has had little effect and in January 2009 a new series of banknotes was issued, including a Z$100 trillion note. This is unlikely to be the last issue though, but what comes after a trillion?

Zimbabwe rolls out Z$100tr note BBC News Online (16/1/09)
ZIMBABWE: Inflation at 6.5 quindecillion novemdecillion percent IRIN News (United Nations) (21/1/09)

Questions

  1. Define the term hyperinflation.
  2. Analyse the main causes of hyperinflation.
  3. Discuss policies that the Zimbabwean government could adopt to try to reduce the level of inflation in the economy.
  4. Assess the impact of hyperinflation on the other major macro-economic targets.
  5. Research another instance of hyperinflation and write a brief summary of the cause(s) and the solution(s). You may find the Wikipedia entry on hyperinflation a good starting point.

While deflation was quite common right up to World War II, it has not been seen in the UK since 1947. The podcast considers whether it might return and looks at the impact of deflation on economic activity. There is a short case study on the deflationary years suffered by Japan between 1997 and 2006 and a consideration of policies that might be appropriate to overcome defaltionary pressures.

Economists never like to use simple words when there are more complex ones available! So, the new term for printing money is ‘quantitative easing’. This refers to deliberate increases in the money supply aimed at preventing deflation. The real concern is whether quantitative easing will stoke up inflationary pressures for the future – the balance between inflation and deflation is a fine line to tread. Quantitative easing becomes necessary when there is danger of deflation and interest rates have already been cut as far as is possible.

Another problem, in the short term, is that an increase in the monetary base may have little effect on broader money (M4 in the UK) if people do not want to borrow and thus credit creation is limited.

The articles below all look at various different aspects of quantitative easing.

Europeans Disagree Drastically On Fed Rate Cut Deutsche Welle (17/12/08)
Financial crisis: Free money coming your way! Telegraph (17/12/08)
Wondering what on earth Nils was on about? He’s written this for you BBC News Online (PM programme) (18/12/08)
Japan forecasts no growth in 2009 BBC News Online (19/12/08)
New economic policy: If you haven’t got enough of this stuff, just print some more Scotsman (18/12/08)
Ground Zero The Economist (18/12/08)
Fed throws out the rulebook Times Online (18/12/08)
Quantitative easing: the modern way to print money or a therapy of last resort? Telegraph (8/1/09)
Forget hard choices. We need pampering Times Online (18/12/08)
Jeremy Warner: Darling wants say on ‘quantitative easing’ Independent (8/1/09)

Questions

  1. Define the term ‘quantitative easing’.
  2. Explain the mechanism by which the monetary authorities can implement a policy of quantitative easing.
  3. Discuss the relative effectiveness of cuts in interest rates and quantitative easing to boost aggregate demand in a recession.
  4. Analyse the impact on an economy of a prolonged period of deflation.

Sir Alan Walters, one of Mrs Thatcher’s key economic advisers, has died at the age of 82. Though he always tried to shun media attention, Sir Alan attracted a considerable amount of it when he clashed publicly with the then Chancellor, Nigel Lawson, over the Exchange Rate Mechanism (ERM). When faced with the choice from Nigel Lawson that either Alan Walters went or he did, Mrs Thatcher famously chose her adviser over her Chancellor. This lent Sir Alan a degree of infamy in economic circles and he is perhaps known best as one of the most influential monetarists of the period. Sir Alan was an early advocate of money supply targeting and always argued that the money supply should not be manipulated for political reasons. His advice was also key in the budget of 1981 which raised taxes in the middle of a recession, something that in this current recession would appear to be unthinkable.

Thatcher’s economic guru dies Independent (6/1/09)
Nigel Lawson and Thatcher’s guru in a political bloodbath Telegraph (5/1/09)
Mrs Thatcher always agreed with Alan Times Online (5/1/09)
Thatcher pays tribute to Walters BBC News Online (5/1/09)
Thatcher economic adviser Walters dies The Herald (6/1/09)
Sir Alan Walters, Thatcher’s economic guru, dies aged 82 Times Online (5/1/09)
Sir Alan Walters Telegraph (6/1/09)
Mrs Thatcher’s monetarist guru The Economist (6/1/09)

Questions

  1. Write a short paragraph setting out the key influences of Sir Alan Walters on economic policy in the 1980s and 1990s.
  2. Explain what is meant by money supply targeting.
  3. Discuss the effectiveness of money supply targeting in combatting inflation in the 1980s.
  4. Examine whether money supply targeting might once again be an effective tool in the monetary policy ‘armoury’.

A key determinant of the credit crunch was a shortage of liquidity and a breakdown of the interbank lending market. In an attempt to ease the credit situation and restart the interbank lending market, the Bank of England auctioned over £40bn of credit at the end of September. The aim of this was to boost the liquidity position of the banks.

Central banks pump billions into system Guardian (27/9/08)
Bank of England pumps £55bn into credit markets Times Online (26/9/08)
Where has all the money gone? BBC Magazine (15/10/08)

Questions

1. Explain why the Bank of England needed to boost liquidity in the money markets.
2. Using diagrams as appropriate, show the impact of this increase in credit on the money markets. What constraints does the Bank of England face in ensuring that it achieves the desired outcome?
3. Discuss whether the approach of raising liquidity is likely to be more or less effective than a change in the regulatory framework.