Recent data on the US economy suggest that it may be heading back towards recession. Confidence is waning as growth slows. US GDP growth figures for the second quarter of 2010 have just been revised downwards: from 2.4% to 1.6%. And although growth is still quite strongly positive, unemployment is not coming down.
Most economists still think that the US economy will avoid a double dip, but many think that it is nevertheless a distinct possibility. For example, economists at Goldman Sachs put the likelihood of a double-dip recession at 25% to 30%, which although less than 50% is still a substantial risk.
Ben Bernanke, Chairman of the Federal Reserve, told a gathering of bankers and economists in Wyoming on August 27 that the Fed “will do all that it can” to avoid a double dip. According to Bernanke:
In many countries, including the United States and most other advanced industrial nations, growth during the past year has been too slow and joblessness remains too high… Central bankers alone cannot solve the world’s economic problems. That said, monetary policy continues to play a prominent role in promoting the economic recovery and will be the focus of my remarks today.
Bernanke outlined four monetary policy options that could be pursued, the first three of which were real possibilities for the Fed if economic growth did stall.
• The first would be to sell long-term government securities on the open market – a form of open-market operation. This quantitative easing would expand the money supply and should push long-term interest rates down (short-term interest rates are already virtually zero).
• The second would be to reduce interest rates paid to banks on reserves held in the Fed. These are currently around 0.25% and hence the scope for reductions here are very limited
• The third would be to promise to keep short-term interest rates low for a longer period than markets currently expect, thereby assuring markets that borrowing would remain cheap for some considerable time.
• The fourth option, and one not currently contemplated by the Fed, would be to raise the inflation rate target above its current level of 1.5% to 2%.
The first of the following two podcasts, which includes an interview with US Managing Editor of the Financial Times, Gillian Tett, looks at what the Fed might do. Is the solution to expand aggregate demand through monetary policy or are the problems more structural in nature? The other podcasts and the articles look at Bernanke’s proposals and their scope for avoiding a double dip.
Podcasts
‘No magic wand’ for US economy BBC Today Programme, Mark Mardell and Gillian Tett (27/8/10)
Fed Offers Higher Ground In Economic Mudslide NPR, Scott Horsley (28/8/10)
Roubini Interview Excerpt Bloomberg, Nouriel Roubini (27/8/10)
Articles
Bernanke Says Fed Will Do `All It Can’ to Ensure U.S. Recovery Bloomberg, Craig Torres and Scott Lanman (27/8/10)
What ammunition does the Fed have left? Reuters (27/8/10)
Fed is prepared to keep U.S. out of recession, Bernanke vows Los Angeles Times, Jim Puzzanghera (28/8/10)
Bernanke soothes rattled markets Telegraph (28/8/10)
Ben Bernanke promises to step in as US economy veers back towards recession Guardian, Katie Allen (27/8/10)
Shoot out at Jackson Hole – the world’s central bankers take aim at deflation Independent, Sean O’Grady (27/8/10)
Treasury Two-Year Yields Increase Most Since April After Bernanke Speech Bloomberg, Cordell Eddings (28/8/10)
Bernanke speech shows effort to find Fed consensus One News Now, Jeannine Aversa (28/8/10)
Analysis: The uncomfortable mathematics of monetary policy Reuters, Pedro Nicolaci da Costa (28/8/10)
Ben Bernanke calls for help to revive the stuttering US economy Guardian, Richard Adams (28/8/10)
Fed stands by to boost US growth Financial Times, Robin Harding, Michael Mackenzie and Alan Rappeport (27/8/10)
Bernanke outlines options for Fed Financial Times, Robin Harding (27/8/10)
Speech
The Economic Outlook and Monetary Policy Ben Bernanke (27/8/10)
Data
US Bond Rates Yahoo Finance
US interest rates Federal Reserve Statistical Release
Questions
- Why is growth in the US economy slowing?
- Why has the recovery from recession in the USA so far not resulted in a reduction in unemployment?
- What structural problems are there in the US economy?
- What further scope is there for monetary policy in stimulating the US economy?
- What are the arguments for the Fed introducing a new programme of quantitative easing?
- How important are expectations in determining whether the US recovery will be maintained or whether there will be a double-dip recession?
- What impact did Bernanke’s speech have on bond markets and why?
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?