Until the credit crunch and crash of 2008/9, there appeared to be a degree of consensus amongst economists about how economies worked. Agents were generally assumed to be rational and markets generally worked to balance demand and supply at both a micro and a macro level. Although economies were subject to fluctuations associated with the business cycle, these had become relatively mild given the role of central banks in targeting inflation and the general belief that we had seen the end of boom and bust.
True, markets were not perfect. There were problems of monopoly power and externalities. Also information was not perfect. But asymmetries of information were generally felt to be relatively unimportant in the information age with easy access to market data through the internet.
Then it all went wrong. With the exception of a few economists, people were caught unawares by the credit crunch. There was too little understanding of the complexities of securitisation and the leveraged risk in these pyramids of debt built on small foundations. And there was too little regard paid to the potentially destructive power of speculation and herd behaviour.
So how should economists model what has been happening over the past three years? Do we simply need to go back to Keynesian economics, which emphasised the importance of aggregate demand and the ability of economies to settle at a high unemployment equilibrium? Can the persistence of high unemployment in the USA and elsewhere be put down to a lack of demand or is the explanation to be found in hysteresis: the persistence of a problem after the initial cause has disappeared? Can failures of markets be incorporated into standard microeconomics?
Or do we need a new paradigm: one that emphasises the behaviour of economic agents and examines how people act when there are information asymmetries? These are the questions that are examined in the podcast below. It is an interview with Nobel Prize winning economist, Joseph Stiglitz.
Podcast
Joseph Stiglitz: ‘Building blocks’ of a new economics BBC Today Programme (25/8/10)
Articles
Needed: a new economic paradigm Financial Times, Joseph Stiglitz (19/8/10)
Obama should get rid of Geithner, Summers Market Watch, Wall Street Journal, Darrell Delamaide (25/8/10)
This rebel’s heresy is not so earth-shaking Fund Strategy, Daniel Ben-Ami (23/8/10)
Questions
- What are Stiglitz’s criticisms of the economics profession in recent years?
- What, according to Stiglitz, should be the features of a new economic paradigm?
- Is such a paradigm new?
- Provide a critique of Stiglitz’s analysis.
- What do you understand by ‘behavioural economics’? Would a greater understanding of human behaviour by economists have helped avert the credit crunch and subsequent recession?
One of the key issues tackled during Labour’s term was poverty. In 1997, the UK had one of the worst child poverty rates in Europe (20% of the population) and so Labour made a concerted effort to move more people out of poverty than ever before. Low income was defined as income below 60 per cent of median income. As Chapter 1 from the first “Data and reports” link below states:
Over the period 1994/95 to 2008/09, the percentage of the population below 60 per cent and 70 per cent thresholds of contemporary median income showed slight falls on both Before Housing Costs and After Housing Costs bases. …The proportion and number of the population below low-income thresholds … fell substantially over the same period – with proportions falling by around one half.
Over the period 1994/95 to 2008/09, there was a marked fall in the proportion of children below low income thresholds held constant in real terms. 2008/09 has shown a fall compared to 2007/08.
Despite these improvements, there is a high concentration of people just above the 60% of median income level. And, although poverty rates have fallen since 1997, income inequality remains stubbornly high, with a post-tax-and-benefit Gini co-efficient hovering around 0.38 since 1992, compared with around 0.30 in the late 1970s/early 1980s.
As recession set in, there were concerns about the effect it would have on poverty figures. However, according to the Department for Work and Pensions (DWP), throughout 2008 and 2009 both children and pensioners saw their position improve, as hundreds of thousands were lifted out of poverty. According to the DWP’s annual Households Below Average Income report, mean take-home incomes grew for the seventh consecutive year – by 1% in 2008/9.
Whilst the most vulnerable seem to have survived the first test, the next will come with the substantial budget cuts the UK will see, as the government attempts to reduce the budget deficit. Poverty campaigners have warned that attempts to reduce the deficit must not be detrimental to poverty figures, by taking benefits away from those who need them. As Michelle Mitchell, the charity director at Age UK said: “Clearly there are huge challenges ahead for the new government, but now is the time to renew the fight against pensioner poverty and commit to eradicating it once and for all.”
Articles
Campaigners warn Coalition not to jeopardise falling poverty rates Guardian, Katie Allen (20/5/10)
Child poverty ‘historically high’ The Press Association (20/5/10)
Labour kept poverty in check, says IFS Financial Times, Nicholas Timmins (22/5/10)
Child poverty in Scotland increases by 10,000 in year Scotsman, Gareth Rose (21/5/10)
What the poverty figures show Guardian (20/5/10)
The untold story of poverty in working households Guardian, Peter Kenway (21/5/10)
UK pledges to reduce poverty Financial Times, Daniel Pimlott (21/5/10)
Don’t scrap child benefits, charities warn Guardian (20/5/10)
Data and reports
Households Below Average Income (HBAI) 1994/95-2008/09 Department for Work and Pensions (19/5/10)
Households Below Average Income (pdf file) National Statistics, First Release (20/5/10)
Effects of taxes and benefits on household income Office for National Statistics (see also, especially Tables 26 and 27)
Poverty and inequality in the UK: 2010 Institute for Fiscal Studies
A range of poverty data The Poverty Site
Previous blog
See also The poverty of poverty reduction policies
Questions
- What are the main causes of a) poverty and b) inequality?
- What is the difference between poverty and inequality? Can you think of any policies that might improve one of these objectives, but worsen the other?
- Explain how and why the recessions of the early 1980s, the early 1990s and between 2008 and 2009 could have led to poverty being reduced.
- The Financial Times article talks about different levels of poverty across the country. What can explain these regional disparities?
- The Coalition government has pledged to lift the income tax threshold to £10,000. What effect could this have on unemployment and poverty? How might this effect the poverty trap?
- The Guardian article ‘What the poverty figures show’ says that high levels of child poverty will cost the country at least £25bn a year. Why is this?
With the Conservatives and Liberal Democrats now in power in the UK and with the Labour Party, having lost the election, being now in the midst of a leadership campaign, politicians from across the political spectrum are balming Gordon Brown for the ‘mess the country’s in’. The UK has a record budget deficit and debt, and is just emerging from a deep recession, when only a few years ago, Gordon Brown was claiming the end of boom and bust. But is the condition of the UK economy Mr Brown’s fault? Would it have been any better if others had been in charge, or if there had been even greater independence for the Bank of England of if there had been an Office of Budget Responsibility (see)?
The following podcast by Martin Wolf, chief economics commentator of the Financial Times, considers this question. He argues that:
Everybody would like to blame Gordon Brown for the financial crisis. But he was only acting in line with the national consensus on economic policy.
The economic legacy of Mr Brown FT podcasts, Martin Wolf (13/5/10)
The economic legacy of Mr Brown Financial Times, Martin Wolf (13/5/10)
Questions
- Explain what is meant by ‘the great moderation’.
- Should regulation of the banks be handed back to the Bank of England?
- Why may controlling inflation not necessarily result in stable economic growth? Is this a case of Goodhart’s Law?
- Why was the UK economy especially fragile during the banking crisis and its aftermath?
- What, according to Martin Wolf, was Mr Brown’s biggest mistake?
- Could a mistake be now being made by following the conventional wisdom that cutting the deficit is the solution to achieving sustained recovery?
Public finances aren’t in a great state – that’s no secret. However, what is remaining a secret is exactly how and when the main political parties intend to reduce the budget deficit. The UK’s credit-rating is under pressure and with the election approaching, we can expect government finances to come under increasing scrutiny. Whichever party forms the government will face the unenviable task of having to pull Britain out of a recession, while trying to reduce: 1) a forecast budget deficit for 2009/10 of £167 billion (about 13% of GDP), 2) a government debt of 68.6% of GDP, with 3) £73.8 billion alone going on interest payments and 4) a trade deficit of £8 billion. Who would be a politician?!
Phoney deficit wars BBC News, Stephanomics (26/3/10)
Questions
- What is the structural deficit?
- A fall in government spending may improve public finances, but why may it adversely affect the UK’s recovery?
- Outline the main proposals by the Labour, Conservative and Liberal Democrat Parties to tackle public finances. Are any of their proposals viable?
- Why is the UK’s credit-rating under pressure? If the UK is down-graded, what could this mean?
Is there finally cause to celebrate? Government borrowing is lower than expected. Initially, public sector net borrowing for 2009-2010 was forecast in the Pre-budget Report to be £178bn, but official public figures have reduced this to £170 bn. The fall in government revenues has not been as big as predicted and as a result, borrowing this year is likely to be between £5bn and £10bn less than expected. But, let’s not crack open the champagne quite yet, as February’s figures for public sector net borrowing are still about 41% higher in 2010 than in the same month last year.
Whilst the UK is predicted to under-shoot its public-sector net cash requirement made in the Pre-Budget Report for 2009-2010, government borrowing remains at a record high and the level of the deficit is still a worrying 12% of GDP. It is, therefore, hardly surprising that the European Commission wants the UK to bring its deficit down faster than the current government plans – and the Commission is not alone. There is considerable debate at the moment between those who want the government to bring the deficit down quicker to appease the market and those who want the government to start taking strong measures only when the recovery is well established. Their fear, very much in the Keynesian school, is that cutting too soon, by reducing aggregate demand, would push the economy back into recession.
If government spending is to be restrained, can we rely on export-lead growth? The fall in the value of our currency over the past two years should have meant a boost for exports. With a weaker pound, export growth was expected to be strong and allow us to export our way out of recession. See the news blog Expecting too much from exports. However, with figures in January 2010 showing the biggest trade deficit since August 2008 (£3.8bn) and with the volume of exports down by 8%, this may not be the case. Whilst the credit rating of the UK remains at AAA, experts say that the government should be aiming to reduce the deficit more quickly in order to retain this rating. So, although there is some good news (government borrowing will only be £170bn!) and exports are likely to increase as the global economy recovers from recession, significant problems in the UK economy still remain.
Articles
Row over leaked EU deficit report AFP news (17/3/10)
Government borrowing less than forecast BBC News (18/3/10)
Borrowing update cheers Treasury Financial Times, Chris Giles (19/3/10)
UK trade deficit widens to biggest in 17 months BBC News, Stephanie Flanders (9/3/10)
Government borrowing: what the economists say Guardian (18/3/10)
Darling to use higher revenues to cut debt Financial Times, Chris Giles and Jean Eaglesham (19/3/10)
Data
Public sector finances. February 2010 Office for National Statistics
Questions
- Why have government revenues been falling?
- What is the difference between the public-sector net cash requirement and public-sector debt?
- Why is a weak pound good for exports?
- As the global economy recovers, UK exports should begin to rise. Illustrate this idea with a circular flow of income diagram for the UK and the rest of the world.
- What are the arguments (a) for and (b) against reducing the government deficit now?
- Should the Treasury be celebrating these latest figures, or is the UK economy still in a bad way?