Wednesday, January 26, 2011

Monetary and Fiscal Policy

Later in term we cover these two things in detail - for now we just hint at them, and having looked at inflation in yesterday's lecture while thinking also about unemployment and yesterday's surprising GDP growth figures announced by the ONS, last night Mervyn King (Governer of Bank of England) made a speech in Newcastle about the UK economy.

In it he mentioned the problems he faces as the head of the Bank of England, which is in control of fighting inflation: He expects inflation to rise to 5% in 2011, yet the Bank's target is 2% (plus or minus 1% so a range of 1-3%). Yet GDP growth was negative in 2010Q4, and is not expected to perk up any time soon.

The problem is that high inflation would usually be met by the Bank of England with higher interest rates, yet growth is weak: And higher interest rates would hurt growth (we'll study the interest rate transmission channel from interest rates to economic activity later in term).

The fundamental problem is that of the two basic types of inflation covered yesterday, demand-pull and cost-push, the UK is suffering cost-push at the moment: The weak exchange rate imports inflation, and commodity prices are high at the moment - both factors that makes inputs more expensive.

However, as also mentioned, inflation can come simply from expectations becoming reality. If people start expecting higher inflation then they will attempt to build that into their wage settlements, particularly if and when the economy begins to recover. Then with more money in the economy, this will likely translate into higher actual inflation. So the current cost-push inflation may turn into demand-pull inflation, and this is what the Bank of England is seeking to avoid.

It seeks to avoid it precisely with speeches like this, attempting to show us that it knows what it is talking about when it comes to the economy...

Tuesday, January 25, 2011

GDP Falls!

Those of you keen eagles will have noticed that GDP figures for 2010Q4 were announced today by the ONS, and the figures contained quite a shock: GDP fell in the last quarter of 2010.

After three quarters of positive growth, analysts had expected a small positive number for GDP growth, but numbers plummeted. There have been many concerns since the Coalition implemented its austerity package that it might plunge the UK into a double dip, and hence those worriers appear to be feeling vindicated in voicing their concerns.

However, there are good arguments for why we might have seen such a contraction: We had lousy weather for most of December! Certainly George Osborne has leapt on this explanation to maintain that austerity remains the right path to take. Construction fell particularly strongly in the period, down 3.3%, supporting this view. It's a rather British response to blame the weather, isn't it?!

Yet December was just one month out of three in the quarter. What happened in the other two months? Growth clearly couldn't have been particularly strong in that period.

Do these figures mean we're definitely heading for a double dip? Of course not. The numbers will still be revised (this is the first estimate based on just a third of the available data), although it is unlikely they will be revised up substantially enough that growth would become positive. And it's just one quarter - the working definition for a recession is two quarters of negative growth.

But it ought to be a concern. We learnt last week about the role government spending plays in aggregate demand (how much we all demand of goods in the economy), and as such it ought not to be surprising that as the government reduces G significantly, aggregate demand falls and growth slows. The government is hoping for a strong longer-term impact rather than any short-term impetus with its austerity - it argues private sector behaviour has long been crowded out by high government spending. Later in term we'll assess in more detail crowding out and we'll be better placed to give an assessment of the likely success of the Coalition's economic strategy.

Thursday, January 20, 2011

Jobless Growth?

This term you'll learn about the national economy, and then we'll extend ourselves into what economists call the open economy: Considering the national economy in the global context.

We won't be able to go too much into Globalisation, but by implication you'll learn about the economic arguments for Globalisation - along with potentially some arguments against it. It will come too late to be covered in a tutorial unfortunately so later in term I'll provide some discussion questions for you to ponder anyhow.

Nancy Folbre is an economist at the University of Massachusetts, and she has written an article in the New York Times about jobless recoveries and jobless growth.

A jobless recovery is what it says on the tin: An economic recovery (GDP is growing again), but without unemployment falling, or even employment rising. Workers in jobs are becoming more productive, it would seem, instead of more hiring taking place.

The explanation given is Globalisation. The usual dirty word. Apparently this has affected the economic incentives US companies face, meaning that while still being patriotic American companies, they are now forced to locate abroad to produce cheaper to sell the goods back to Americans. Hence the jobs producing the goods go abroad. We get cheaper prices, but not the jobs.

Of course, this very simplistic view is just that, and it ignores most if not all economic theory. It is a protectionist view. We can't really compete with these productive workers elsewhere, and moreover we don't really want to - so we erect barriers and protect ourselves - tariffs, subsidies, etc. But then we end up producing what China could produce cheaper, instead of innovating and creating better jobs producing new and better things that people want to buy (entrepreneurship), and allowing China to produce the things they have a comparative advantage in producing.

Essentially this is populist stuff: Appeal to what people want to hear now, regardless of where it will leave us in the future (substandard goods, mediocre workers molly-coddled by the government, higher prices). The truth is painful: Other countries are able to compete and produce some things America currently produces much more cheaply. It's a hassle to keep on changing and be subject to the pressures of competition. But it's healthy too, since it keeps us on the ball, producing only things that people actually want.

If you are someone prone to economic nationalism like this, it is worth asking the question: What is the difference between thinking about production here vs China, and production in the south of England vs Northern Ireland? Should we stop trading with folk in other parts of the UK? What about other parts of our city? It would be perverse. As Don Boudreaux writes:

This note is inspired by DG Lesvic’s objection to Art Carden’s use of the reductio ad absurdum – an objection that, I confess, I do not share.

Reductios work so well when arguing against proponents of economic nationalism (that is, “protectionists”) because, economically and morally speaking, there is absolutely no difference between Suzy trading with Joe her next-door neighbor and Suzy trading with Jose in Mexico, Josef in Austria, or Javu in China. None.

So when any protectionist argues, based on reason X, for restrictions on trade drawn along national political borders, it’s always enlightening to apply the same argument X to trade restrictions drawn more locally – even as locally as the individual.

Fritz Machlup said in class at NYU back in 1981 that arguments for protectionism, when followed through to their logical conclusion, always ‘prove’ that a person’s right hand should not trade with that person’s left hand.

Tuesday, January 18, 2011

Inflation Higher

The Office for National Statistics releases data on inflation month by month. We talked a little about inflation yesterday, and will go into much greater detail next week: Inflation is the change in the price level. That's a wonderfully vague definition which you'll have to improve on a little for assignments and the final exam. What price level? Whose price level?

The ONS calculates a number of price indices: Numbers that reflect the level of prices for a collection (or bundle or basket) of goods. Inflation then, according to one of these indices, is the change, year-on-year. So the number announced today was the increase in prices in December 2010 relative to December 2009. We compare year-on-year to account for seasonal patterns that might distort our understanding of what's going on in the economy. Whichever way you look at it, inflation is high.

The Bank of England is set a target of 2% for inflation, yet it was nearly 4%. This creates problems for the Bank of England because inflation is relatively high, yet GDP growth is still fairly embryonic after the recession. Any attempt to curtail inflation by the Bank of England will put downward pressure on economic growth, and hence would not be helpful.

Yet the longer inflation remains higher than target, and particularly with the VAT rise that we've just had at the start of 2011, the more it starts to get built into new wage settlements by workers. If workers are paid more, this will likely lead to higher inflation since consumers have more money to spend while supply levels haven't adjusted.

More next week...

Inflation Higher

The Office for National Statistics releases data on inflation month by month. We talked a little about inflation yesterday, and will go into much greater detail next week: Inflation is the change in the price level. That's a wonderfully vague definition which you'll have to improve on a little for assignments and the final exam. What price level? Whose price level?

The ONS calculates a number of price indices: Numbers that reflect the level of prices for a collection (or bundle or basket) of goods. Inflation then, according to one of these indices, is the change, year-on-year. So the number announced today was the increase in prices in December 2010 relative to December 2009. We compare year-on-year to account for seasonal patterns that might distort our understanding of what's going on in the economy. Whichever way you look at it, inflation is high.

The Bank of England is set a target of 2% for inflation, yet it was nearly 4%. This creates problems for the Bank of England because inflation is relatively high, yet GDP growth is still fairly embryonic after the recession. Any attempt to curtail inflation by the Bank of England will put downward pressure on economic growth, and hence would not be helpful.

Yet the longer inflation remains higher than target, and particularly with the VAT rise that we've just had at the start of 2011, the more it starts to get built into new wage settlements by workers. If workers are paid more, this will likely lead to higher inflation since consumers have more money to spend while supply levels haven't adjusted.

More next week...

Minimum Pricing on Alcohol

This is a story bound to go down badly amongst the student community: The government proposes minimum pricing for alcohol.

You will have learnt about market equilibrium in econ101a and hence about the impact of minimum prices or minimum wages (and maximum variants too) - they distort the market away from equilibrium reducing consumer and producer surpluses and creating a deadweight loss. Economically there isn't really an argument for them - when considering partial analysis such as this (i.e. analysing one market - that for alcolhol - in isolation).

Perhaps that's why the experts that have advised the government on this are not economists. Economists particularly of a more libertarian perspective would argue that such actions impinge on the liberty of people - why does the government know best what I should do in my drinking habits?

Economic arguments could be advanced though. It's important to try as best as possible to consider a general equilibrium analysis. The argument would be that alcohol is not necessarily a "good" in all situations - it can be what we described in the lecture yesterday as a "regrettable", or a "bad", when it leads to social unrest. Clearly alcohol-related violence and health issues will lead to additional costs for the taxpayer via policing and the NHS.

So provided you like a taxpayer-funded nationalised health service, it adds an extra dimension to such issues...

Monday, January 17, 2011

The Item Club and Interest Rates

As I mentioned in the lecture this morning, the Item Club of Ernst and Young provide an alternative take on the economy from the Monetary Policy Committee of the Bank of England (the committee that decides what interest rates should be - this is monetary policy, which we will consider later in term).

As described by the BBC, the Item Club thinks interest rates should remain at 0.5%, where they currently are. Monetary policy is one of the tools a government has through which to manipulate economic activity; the other main tool is fiscal policy: Government spending and taxation.

Given that the Coalition government is planning to cut government spending and has already begun raising taxes via the VAT rise, economists describe fiscal policy as tight. This means that, as we will note this term in lectures, fiscal policy will restrain economic activity by contributing to a decrease in aggregate demand.

Given this, the Item Club argue that monetary policy cannot similarly be tight. A tight monetary policy would be a policy stance aimed at achieving a fall in aggregate demand. If both policies were tight, then the decrease in aggregate demand would be even stronger resulting in much slower economic growth, and potentially another recession.

Hence the Item Club rightly, in my opinion, argues that monetary policy must remain loose, and hence interest rates should remain low.

However, inflation is above the target the Bank of England is set, and hence this is why some have argued that interest rates should rise. When we get to monetary policy later in term we will get to discuss what impact interest rates have, and hence what the role of monetary policy is.

Tuesday, January 4, 2011

Macroeconomics Time

A Happy New Year to all the readers of the econ101ab blog! The New Year signifies a new term, the second term in the academic year and this heralds econ101b, the Macroeconomics part of the course.

We're going to investigate a number of aspects of the macroeconomy during the coming term. The main text is Sloman, but one thing that it will be good for you to grasp is that macroeconomics is a very difficult beast to tame, and that any teacher of it will likely give a somewhat slanted (biased) view on the macroeconomy (some would even say it doesn't really exist).

So again I'll encourage you as part of your econ101b experience, and degree experience more generally, to be reading widely, and thinking through what you read, challenging what you believe and justifying it. If nothing else, it'll give you points to score when chatting with your mates...