Today (16/6/11) in Greece, the Prime Minister is trying to form a new government that will help the country tackle its large and growing debts. Austerity measures have been put in place by the Greek government and these cuts and subsequent job losses (unemployment now stands at 15.9%) have resulted in massive riots.
Critics of the eurozone and Greek membership are suggesting that the price Greece has to pay to remain a member might be too high. Billions of euros have already been given to the bankrupt country and yet it seems to have made little difference – more money is now needed, but Finance Ministers have so far been unable to agree on how best to finance another bailout. These concerns have adversely affected financial markets, as investors sell their shares in light of the economic concerns surrounding Greece. The trends in financial markets over recent weeks suggest a growing feeling that Greece may default on its debt.
If an agreement isn’t reached between European leaders and/or Greece doesn’t accept the terms, then it could spell even more trouble and not just for the Greek economy and the eurozone. Banks across Europe have lent money to Greece and if an agreement isn’t reached, then this will mean losses for the private sector. Whilst these losses may be manageable, further trouble may arise due to contagion. Other countries with substantial debts, including Spain, Ireland and Portugal could mean a significant increase in these potential losses.
As the crisis in Greece continues, doubts remain over whether the European leaders even know how to deal with the crisis and this creates a lack of confidence in the markets. Activities over the coming weeks will play a large part in the future of Greece’s eurozone membership, trends in financial markets and the direction of the UK economy. The following articles consider Greece’s debt crisis.
Greece debt crisis sends financial markets reeling BBC News (16/6/11)
Euro slumps vs Swissie, Greece intensifies concern Reuters (16/6/11)
EU and IMF agree Greek debt deal Financial Times, Peter Spiegel (16/6/11)
Greece crisis: Commissioners fear ‘future of Eurozone’ BBC News, Joe Lynam (15/6/11)
Stocks slump as Greece crisis turns violent Bloomberg Business Week, Pan Pylas (15/6/11)
Euro slides as Greek default fears deepen Financial Times, Peter Garnham (16/6/11)
Germany insists all of EU must pay for Greece bailout Guardian, Ian Traynor (15/6/11)
US stocks slump on US, Greek woes Associated Press (16/6/11)
More time to argue about Greece BBC News, Stephanie Flanders (16/6/11)
Greece: Eurozone ministers delay decision on vital loan BBC News (20/6/11)
Greece crisis: Revolution in the offing? BBC News, Gavin Hewitt (19/6/11)
Greece crisis: Not Europe’s Lehman (it could be worse) BBC News, Robert Peston (20/6/11)
Greek debt crisis: eurozone ministers delay decision on €12bn lifeline Guardian, Ian Traynor (20/6/11)
Eurozone must act before Greek crisis leads to global meltdown, IMF warns Guardian, Larry Elliott (20/6/11)
Greece: Private-sector voluntary aid may be impossible BBC News, Robert Peston (21/6/11)
Greece crisis and the best way to cook a lobster BBC News, Stephanie Flanders (22/6/11)
Questions
- What is meant by contagion and why is this a potential problem?
- What are the options open to European leaders to finance the bail out?
- If an agreement is not reached or Greece do no accept the terms, how might the UK economy be affected?
- What has been the impact of recent events in Greece and Europe on financial markets and currencies across the world? Explain your answer.
- Why are critics suggesting that the price of Greece remaining in the Eurozone might be too high? If Greece was not a member state what would it mean it could do differently to help it deal with its mounting debts?
The banking sector was at the heart of the credit crunch and it may also be at the heart of the recovery. Too much lending to those who could not repay has now translated into government encouragement and targets to stimulate further lending. Banks made a deal with the government (Project Merlin) to lend £76bn to small and medium sized companies (SMEs) in 2011, however, the data for the first quarter of 2011 shows that the top five UK banks lent only £16.8bn, some £2.2bn short of their quarterly target (about 12%). Despite this sum still being a significant figure, small companies have said that they are still finding it difficult to obtain credit from banks. A poll found 44% of companies that asked for a loan were turned down and many were discouraged from even applying as they had almost no chance.
Encouraging banks to lend and hence stimulating investment by businesses may prove crucial to the UK’s recovery. Vince Cable’s words with regard to lending emphasise its importance:
“We will monitor the banks’ performance extremely closely and if they fail to meet the commitments they have agreed we will examine options for further action.”
If small businesses can obtain credit, it will help them to develop and expand and this should have knock on effects on the rest of the economy. Jobs could be created, giving more people an income, which in turn should stimulate consumption, further investment and finally aggregate demand. It may not be the case that the UK’s recovery is entirely dependent on bank lending, but it could certainly play an important role, hence the government’s insistence for further lending. It may also act to create confidence in the economy. The following articles consider the bank’s role in providing credit to SMEs.
Articles
Bank lending falling short of promises by £25m a day Mail Online, Becky Barrow (24/5/11)
Cable tells banks to increase lending to small firms BBC News (23/5/11)
Bank lending targets: What the experts say Guardian, Alex Hawkes (23/5/11)
Major banks fail to meet their lending targets Independent, Sean Farrell (24/5/11)
Banks on course to miss small business lending target Guardian, Philip Inman (23/5/11)
Project Merlin needs to be less woolly and more wizard Guardian, Nils Pratley (23/5/11)
Bankers caused the crash and now they strangle recovery Guardian, Polly Toynbee (27/5/11)
Data
Trends in Lending Bank of England (see in particular, Lending to UK Businesses)
Questions
- Why have banks not met their lending targets for the first quarter of 2011?
- Why is project Merlin so potentially important to the recovery of the economy?
- Using an AD/AS diagram, illustrate the possible effects of further lending.
- Are there any possible adverse consequences of too much lending?
- Why might banks have little incentive to increase their lending to SMEs?
Just as the Bank of England has an inflation target of 2%, so does the ECB. UK inflation has been significantly above its target rate for many months and so has the eurozone’s inflation rate, which is up to 2.8% in April from its previous level of 2.7% the previous month. The increase in the general price level has been fuelled by rising costs of raw materials and high energy prices. Whilst interest rates in the UK have remained at 0.5% in a bid to stimulate economic growth, the ECB has increased interest rates by a quarter point to 1.25% and the latest inflation data may be further pressure for further rises. However, any increase in rates will put more pressure on countries such as Greece, Ireland and Portugal who are facing tough austerity measures and may put their recoveries in jeopardy.
The ECB has been optimistic about growth and it may need to be with this and possibly subsequent interest rate hikes, as they are likely to depress aggregate demand. Furthermore, European Commission’s ‘economic sentiment’ indicator has fallen to 106.2, which is the weakest since November. Eurozone unemployment remains at just under 10%, oil prices remain high and this has depressed optimism across the eurozone countries. The euro, meanwhile, continues to strengthen (up 12% against the dollar over the past year) and this has enhanced the fragile state of affairs in those countries suffering from tough austerity measures. An economist at ING has said:
“The combination of high oil prices, a strong euro, and fiscal and monetary tightening has started to dent the economic mood in the euro zone.”
Eurozone inflation rises again Telegraph, Emma Rowley (29/4/11)
Eurozone inflation rate rises to 2.8% BBC News (29/4/11)
Eurozone inflation jumps to 2.8% Financial Times, Ralph Atkins (29/4/11)
Euro zone inflation rises, points to higher ECB rates Reuters, Jan Strupczewski (29/4/11)
Eurozone inflation further above target at 2.8pct The Associated Press (29/4/11)
Questions
- What is the relationship between interest rates and inflation. Why have the ECB and the Bank of England reacted differently to rising inflation?
- Is the inflation currently being experienced in the Eurozone cost-push or demand-pull? Illustrate your answer with the help of a diagram.
- What is the relationship between interest rates and the exchange rate?
- Why is there some concern about the ‘economic sentiment’ indicator in the Eurozone?
- What is the relationship between interest rates and economic growth? Explain the process by which a change in interest rates could affect AD and then economic growth and employment.
- Why is this interest rate rise (and possible further rises) likely to hurt countries, such as Ireland and Greece more than other countries within the Eurozone?
There’s been a lot of bad news about the economy, but perhaps things are looking up. Inflation is now at 4% and the latest data suggests that unemployment has fallen, with more jobs being created in the private sector. An estimated 143,000 jobs were created, many of which were full-time and the ILO measure if unemployment is down by some 17,000. There is still some doom and gloom, as growth in annual average earnings has fallen slightly and this will undoubtedly affect retail sales. Numbers claiming JSA have also increased marginally to 1.5 million and youth unemployment has seen a small increase to 20.4%. A big area of concern is that unemployment might rise in the coming months due to the time lag. Growth in the last quarter of 2010 was negative and this could increase unemployment when the full effects are felt in the labour market later in the year. Howard Archer, the Chief Economist at HIS Global Insight had this to say about the latest data.
‘Despite the overall firmer tone of the latest labour market data, we retain the view that unemployment is headed up over the coming months. We suspect that likely below-trend growth will mean that the private sector will be unable to fully compensate for the increasing job losses in the public sector that will result from the fiscal squeeze that is now really kicking in. Indeed, we believe that private sector companies will become increasingly careful in their employment plans in the face of a struggling economy and elevated input costs.’
The wage price spiral hasn’t begun as many though, and this may encourage the Bank of England to keep interest rates down, especially as inflation has come down to 4% and concerns about growth still remain. So despite good news about unemployment overall falling, young workers, women and public sector workers have not benefited. Youth unemployment is up, more women are claiming JSA and more jobs in the public sector are expected to be cut this year. The following articles consider the implications.
UK Unemployment: What the experts say Guardian (13/4/11)
Good news on jobs BBC News blogs: Stephanomics, Stephanie Flanders (13/4/11)
Unemployment falls, but young are left on the shelf Independent, Sean O’Grady (14/4/11)
Unemployment falls but jobs market remains fragile Telegraph, Louisa Peacock (14/4/11)
UK unemployment data reveals downturn victims as jobless total drops Guardian, Heather Stewart (13/4/11)
FTSE boosted by dip in unemployment The Press Association (14/4/11)
Unemployment falls: reaction (including video) Telegraph (14/4/11)
Questions
- What is the ILO method of measuring unemployment?
- To what extent does the change in unemployment and inflation conform with the Phillips curve?
- What can explain the fall in the unemployment rate, despite the decline in the economy in the last quarter of 2010?
- Explain how the FTSE was affected by the lower unemployment rate.
- Why is unemployment expected to rise later this year?
- Why has there been a rise in the numbers claiming JSA, despite unemployment falling?
- What is meant by the wage-price spiral and why has it not occured?
In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. And there it has remained for almost 2 years and as yet, no change is in sight. In the February 2011 meeting of the Monetary Policy Committee (who are responsible for setting interest rates to keep inflation on target), the decision was to keep interest rates at 0.5% rather than raise them to tackle high and rising UK inflation. Those in favour of keeping interest rates at this record low argue that any increase could damage the UK’s ability to recover and may lead to the dreaded double-dip recession. This is of particular concern given the economy’s performance in the last quarter of 2010.
However, one group that will certainly not be happy is the savers. With instant-access savings accounts paying on average just 0.84% before tax and with inflation at 3.7%, savers aren’t just not gaining much interest, but are actually seeing the value of their money in real terms fall. Howard Archer of HIS Global Insight said:
“For now, we retain our view that the Bank of England will hold off from raising interest rates until the latter months of the year. Even if interest rates do rise in the near term, the likelihood is still that they will rise only gradually and remain very low compared to past norms.
Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2pc by the end of 2012.”
Following some speculation that the Bank of England may succumb to the pressure of inflation and hike up interest rates (markets had priced in a 20% chance of a rate rise), sterling did take a hit, but after the decision to keep rates at 0.5%, sterling recovered against the dollar. There is a belief amongst some traders that rates will rise in May, but others believe rates may remain at 0.5% until much later in 2011, as the country aims to avoid plunging back into recession. Of 49 economists that responsed to a poll by Reuters, three quarters of them said that rates would rise by the end of 2011, with median forecasts predicting a rise around November. This is certainly a space to watch, as it has implications for everyone in the UK and for many in countries around the world.
BOE leaves bank rate unchanged at 0.5% at Feb meeting Automated Trader (10/2/11)
Economists predict interest rates will rise in November Telegraph, Szu Ping Chan (11/2/11)
UK May rate hike view holds firm after BOE Reuters, Kirsten Donovan (10/2/11)
Interest rates: What the economists say Guardian (10/2/11)
Fixed rate mortgages becoming more expensive BBC News (10/2/11)
Bank rate: savers’ celebrations on hold Telegraph, Richard Evans (10/2/11)
Inflation fears turn up heat ahead of bank rate decision City AM, Julian Harris (10/2/11)
Sterling takes BOE in its stride, higher rate talk aids Reuters, Anirban Nag (10/2/11)
Bank of England holds interest rates of 0.5% Telegraph, Emma Rowley (10/2/11)
Questions
- Why are interest rates such an important tool of monetary policy? Think about which variables of aggregate demand will be affected by the Bank of England’s decision.
- What is the relationship between interest rates and inflation?
- What explanation is there for the fall in the value of sterling following speculation that interest rates may rise? Why did sterling recover after the Bank of England’s decision?
- How has the recent speculation affected fixed rate mortgages?
- What does the Telegraph article about “savers’ celebrations on hold” mean about the ‘real value’ of money and savings?
- What are (a) the arguments for keeping interest rates at 0.5% and (b) the arguments for raising interest rates? Who wins and loses in each case?
- Are there any other government policies that could be used to combat inflation, without creating the possibility of a double-dip recession? Why haven’t they been used?