What's Happening in the Eurozone?!

This blog is currently in something of limbo land; it's my hope that via whatever RSS feed or other means you have (bookmarks) once you started reading this blog associated with taking econ101b in Birmingham that you keep reading it; the aim is to keep pointing out relevant real world events. Of course though, the current term in Birmingham is econ101a, and hence I'm yet to lecture econ101b for the current year.

Nonetheless, the world doesn't stop between March of one year and January of the next, and one vast, gaping example is the eurozone crisis.

What, exactly, is going on here? One thing that is hugely true is that anything surrounding Europe in any form attracts huge amounts of emotive and vitriolic argument, and not a little bit of deception too by those able to keep their emotions hidden. Europe may divide the Tory party, but it also divides most British folk too.

So we must try to abstract from this. What is currently happening is a number of countries within (and without - e.g. Iceland) the eurozone is that they are struggling to borrow to cover their spending plans. In all cases, governments have particular spending plans they would like to enact, and in order to fulfil them they are currently borrowing because tax receipts do not cover their desired expenditures. The problem is that such borrowing requires paying interest to the willing lender, and currently a lot of lenders appear to be less willing to lend to these countries.

In some cases, this has got to the stage where a default (the country effectively goes bankrupt, telling those that lent to it that they won't be repaid ever) seems inevitable. Naturally, the problem here then is for those creditors who lose a source of income, and also for the governments that default since it will lead to dramatically higher interest rates in the future to borrow (would you lend to someone who just told people they couldn't repay?).

There then appears to be a problem because some of these countries that may default are within the eurozone. Were these countries like the UK and outside the UK, then a default may be less likely because they could simply print more money to pay off debts and inflate away the debt in time, but of course this recourse isn't available to eurozone countries since they do not have the power to print their own currency. Also, outside the eurozone they could default, making them more competitive as a nation hence hopefully able to start exporting more and importing less which would help the process of escaping from debt. However, if their debt was denominated in a foreign country (e.g. US dollar or euro), then this devaluation would only make the situation worse, as their debts would increase.

It will probably be fairly obvious, but a large number of people are suggesting that the euro is entirely to blame for the problems countries like Spain, Italy, Ireland and Greece are suffering, because they can't devalue. But it's a little more complicated than that, since as said that assumes their debts are in their own currency. Many countries borrow from abroad, and were Greece outside the eurozone, it's not obvious they wouldn't still have borrowed from eurozone banks. When debt is denominated in foreign currencies, then if an economy runs into trouble as Greece has, and its currency depreciates as would be expected, then its debt increase because they are foreign currency debts.

Generally, those blaming the euro for all the troubles were predisposed against the euro, because as you are likely learning, things are never quite as simple as that in economics, and often a bit of economic theory spoils a good rant.

Now, what are the consequences of a eurozone country defaulting? Does it need to leave the eurozone as a result? It doesn't appear obvious that they do - although again, those that don't like the euro appear dead set on presenting this as the only outcome. Given the trans-national nature of the monetary system they are engaged in, Greece defaulting is little different to any economic entity (e.g. a firm, a person) going bankrupt within a country. They will suffer the consequences as they rebuild afterwards, and perhaps some functions of government activity in Greece will be disrupted for a while around the default. But they will recover.

Why, then, are eurozone countries (and the IMF and the EU) ploughing millions and billions and trillions into Greece? Probably the best explanation (that doesn't recourse to euroscepticism) is, like the bail out of the banks in 2008, governments see this as the course of action that minimises disruption. A full scale default by Greece would create some problems for banks that are exposed to Greek debt, which would then translate into the domestic activity of these banks, already criticised for their lack of domestic lending in many countries. The consequence would be, of course, more depressed economic activity.

However, it seems the result of such actions of ploughing in the trillions is only to prolong the agony as opposed to actually providing Greece with any lasting solution. Some kind of adjustment (it is an economy that doesn't produce productively enough, effectively) is required in Greece but the problem is that in the course of that adjustment things will only get worse - budget deficits worse, economic growth worse, etc. The bottom line though appears to be that the necessary adjustments don't appear to be being made because they are not being forced to be made because of all the talk of European bail outs, repeated ones, that just prolong the market uncertainty.

Greece simply defaulting of its own right, starting from scratch again, is likely the best solution. It won't be pretty, but most likely a lot prettier than the current situation of bail out after bail out being announced, none of which are ever sufficient to stem market uncertainty (nor should they be since Greece as an entity does not appear to have changed). The Greece starting from scratch could decide from the outset what its desired level of public spending and government intervention is, and could decide this based on what it can borrow and at what rates (potentially not even borrowing at all). Currently its previous obligations tie it (and the rest of Europe) up in knots; at least if it defaulted and started again, that uncertainty would be over.

Keynes, Economics and Econometrics

Perhaps one of the biggest names in economics is Keynes; even those who have no knowledge of economics have heard of this chap Keynes. His work appears to float in and out of flavour, with a resurgence in 2008, but a fall back in 2009 on as we've headed towards the economics of austerity. Much is said and mis-said about Keynes, and one thing often presented is that he was anti-econometrics. There's a really good blog written by some econometrics lecturers in Canada which has a post on Keynes and his contributions to econometrics - it's well worth a read if you're interested in how the disciplines of economics and econometrics have developed.

BAE Systems and Welcome!

Welcome to Birmingham! Term has just started in earnest, and if you've just arrived to start your first year here, a particular welcome! Come second term, after Christmas, you'll have me lecturing you on macroeconomics for econ101b, while currently you have Martin Jensen for econ101a, Principles of Microeconomics.

Both terms we'll be teaching the basics of economics and attempting to apply them to events happening in the world around us. One such event that is happening today is that BAE Systems is announcing the shedding of a large number of jobs. This is being billed as very bad news for the economy, and undoubtedly it is not great news since it is people losing jobs, losing incomes, at a not particularly bright time economically.

However, such a superficial analysis is bad, and has potentially troubling implications. The analysis is very short term in nature, and implies that perhaps governments should be doing more about things like this. It's short term because BAE is acting now to keep itself in good business shape moving towards the future - it will be more profitable as a result, and will exist longer into the future, providing jobs throughout the UK for longer.

It's also a partial analysis in that it considers just one firm in just one industry - and also makes the suggestion that we should be protecting this particular industry since it is a UK based exporter. But should we? You will learn (or be reminded) about perfect competition this term, notably the idea that in an ideal situation, firms will expand until all profit opportunities are exhausted, and also will exit markets for which profit opportunities have turned into loss-making enterprises. Clearly, in its current shape, BAE is not profitable, and if it is to be supported in that shape, it will become bloated and uncompetitive on a global stage - exactly what we apparently most want in the UK economy.

Instead, these skilled workers should be allowed to move to other companies or industries, allowing them to grow where there are profitable opportunities - and such growing industries will almost certainly export, and even if not, they will be producing what people want (since they are profitable).

There is no reason for government to get in the way of this and thankfully the signs are good. By not getting in the way will the government achieve this aim of "rebalancing" the economy - they will allow, if red tape is cut, businesses to grow in areas where there is demand, as opposed to offering tax breaks to any particular industry - such favourable treatment for any industry will only result in more of the same.

So: I hope you're looking forward to studying here at Birmingham and challenging your perceptions about real world events using the tools of economists. See you next term!

John Redwood and His Blue Tinted Glasses

A little too often I end up reading (and often) linking up to stuff written by US economists about the US economy. It often has a lot of relevance for the UK economy. I do now read a few UK economics blogs, and highly recommend some of them.

Towards the left of centre, and inherently sensible, is Duncan's Economics Blog. You may want to rule out the blog's writer, Duncan Weldon, because he was involved with advising the previous Labour government. I'd urge you to get past that, and remember that more often than not, politicians ignore the best advice of economists. Duncan is highly knowledgeable, and engages with those on both sides of the debates that rage within the discipline of economics. I'd recommend this perhaps most highly of the UK economics blogs I read - the only downside is that he doesn't post quite as frequently as some.

Another blog in the left-of-centre realm is Stumbling and Mumbling; while this guy (Chris Dillow) claims not to be an economist, he is very familiar with a lot of economics, and hence his blog is hugely interesting. In general its microeconomic, but it does step out into the macroeconomic, and this recent post on the 50p tax rate is, as usual, excellent. Of course, it should be pointed out, Dillow is a self-proclaimed Marxist.

Then, of course, there is the other side of the spectrum. There's David Smith's Economics Blog, written by a Sunday Times economics correspondent. Even if you are more persuaded by those who lean left, I'd strongly encourage you to be reading what those you disagree with say, and respond to it. That's one of the reasons I read these blogs. Smith is scathing at times about the previous government and the current opposition (I think unreasonably so), but is constructive in what he suggests, and his recent post on the possibility of future Quantitative Easing and other monetary measures is worth reading.

If you want to read someone that right wingers champion as a great economist, but who is actually a politician and hence anything he writes should be taken with a large pinch of salt, try out John Redwood (if you can get past that picture at the top!). Redwood is apparently a trained economist, yet he is clearly a politician first, economist second, if his recent post on immigration is anything to go by. You can try very hard, but you'll be hard pressed to find an economist who believes blocking immigration (particularly at some arbitrarily set cap) is a good thing, yet Redwood's constituents want this, and hence so does he, and he makes all sorts of contortions to justify why he opposes immigration. He is also unashamedly partisan, as this post about the banks shows. He can't resist a pop at the last government in his closing paragraph - choosing to ignore all the financial big bang legislation of the Conservatives in the 1980s and 1990s, instead trying in true politician style to lay all the blame for the size of the financial sector at Labour's door.

It's nonetheless good to read the blogs of people like Redwood, and if you're more of a right-wing disposition, Weldon and Dillow. You'll disagree with them undoubtedly, but it will help you greatly as you develop at university as an economist to think about why you disagree, and why you think they are wrong; are your arguments really up to scratch?

Keynes, Hayek and Economics

The new academic year is about to start, and hence you may be about to make the journey to Birmingham to begin your undergraduate degree in economics, and may have somehow stumbled across this blog - if so, welcome! If not, welcome still. The point of this blog is to help those studying econ101ab at Birmingham to see that what they are studying is important and topical, and can help you think more clearly about all the major topics on any given day....

You'll hopefully learn, if you haven't already, about something called Keynesian economics, named after John Maynard Keynes, a British economist who wrote most famously between the two World Wars. His ideas were controversial as they went again the grain of classical economic thinking, the thinking most prevalent at the time; that of balanced budgets, and allowing the forces of the market to do their work, waiting for the long run to see that all was well.

Keynes made a fairly simple point, notably that there may just be situations where the economy doesn't just pick up. Recall, he wrote his most famous contribution, his General Theory, during the Great Depression when the economy failed to pick up and things didn't seem at any point soon to be getting better. Classical economists would say that in the long run, the depressed demand in many markets would lead to the necessary re-adjustments (falling real wages) such that eventually, things would pick up again - in the long run. Keynes's retort, famously, was that "in the long run we're all dead".

Keynesian thought led to demand management, where governments use fiscal and monetary policy to engineer stability: To remedy the downturns and temper the boom times. It hasn't always been the flavour of the month however, and the strong monetarist counter-revolution of the late 1960s and 1970s appeared to have destroyed Keynesianism. However, a certain group of economists, of the Austrian variety aligning themselves behind Friedrich von Hayek have persistently argued against Keynes and Keynesianism. Hayek's main thesis was that man isn't capable on his own of understanding the market, nor is any government, and hence should refrain from attempting to set up mechanisms in the face of the market; such attempts are doomed to fail.

Such Austrian economists are prolific bloggers, and hence you can read their thoughts at Cafe Hayek and EconLog perhaps most vociferously. Today in the US (and Canada) it's Labour Day, and hence it was predictable that at these blogs, something would be posted in the ilk of responding to Keynesian economics, which is percieved by Austrians to have been particularly sympathetic to workers.

Hence, Don Boudreaux, who has a habit of posting the letters he's written to just about everyone who happened to utter anything he disagreed with, writes and posts on Cafe Hayek, his letter regarding what good Keynes apparently brough humanity. It's an interesting read, and I would encourage you to read the blogs of Austrians because they will challenge you to substantiate the things you believe and are taught in what is a Keynes dominated profession, much to the dislike of Austrians.

What you will find as you study economics is that views you previously held that were away from the centre ground, so to speak, will be challenged, and I doubt you'll be able to keep to them. For example, strong views regarding minimum wages I doubt you'll keep once you're done your degree. Equally, if you enter with strong right-wing views which may border on the Austrian, I think you'll also be challenged away from them.

The fundamental assertion of Austrians is that the market knows best, the market does best. You'll learn about the Fundamental Theorems of Welfare Economics, and hence you will learn that the market is an effective tool for communicating the most information to the most people - provided a set of assumptions hold.

Now, the last bit is important, because it's something that the writers at EconLog and Cafe Hayek choose to ignore because it doesn't suit their prior dispositions regarding the economy. Boudreaux has at times compared the healthcare and education markets to the market for buying pet food, for example. However, as you will learn if you study Contemporary Issues in the UK Economy in your second year, and also via microeconomics, the market is only effective if the price mechanism works. It breaks down when information is imperfect.

The important thing though again that you will learn when studying economics is that the knee-jerk reaction towards governments running everything where the market fails is another mistake to make - it's one made by thost on the left usually. It may well be the case that a failure in the market due to imperfect information of some sort or another cannot be remedied by government, and the government will only make the situation worse. The market for rail travel may be an example; all the assumptions of perfectly functioning markets are not upheld, but it doesn't mean that the government will run the railways better than the private sector.

However, health is dramatically different to pet food. Buying the wrong pet food may lead to an unhappy dog for a day or so; the mistake is easily rectified. Buying the wrong healthcare treatment from the wrong healthcare provider may well not be so easy to rectify. Information is not so readily available to all market participants, and hence you see that working from principles of information we can conclude that healthcare is not likely a market best left to market forces - regardless of your prior prejudices in this area. Now, the solution will not necessarily be a full blown NHS, but it also won't be a fully free market.

The bottom line to this post is this: Boudreaux, the writer of the blog post linked up earlier, takes a position on the fringes of the economics profession, and in order to do that, he has to ignore much evidence contrary to what he originally believes. He has to ignore all the above regarding information in health markets and other such markets. But on the other hand, he's just as wrong as the person who believes only the government should be running most (if not all) things - both must ignore basic economic theory to justify their position. Hopefully by the end of your three years, you'll take neither position, and you'll be able to reason and justify all the things you believe about the economy, hence when you read people like Boudreaux, you can understand why he's wrong.

Oxford Economics Dictionary Online

As I mentioned in the revision lecture on Tuesday, getting yourself an economics dictionary will be really useful for you in getting short and sharp definitions for the concepts you're talking about in any essay question.  I just noticed that you can find the Oxford Economics Dictionary online at http://www.enotes.com/econ-encyclopedia/.

Start Your Own Blog!

Why not start your own blog? This may seem like an odd and daunting idea, or it may really attract your attention. Why would you want to start your own blog? One really great thing is that it really helps you to learn about things and make sense of them in your head - if you're going to write about them, and have people read what you write, then you need to have things clear!

Blogs are free to start - Blogger, what I use for this blog, is free and provided by Google, hence if you have a Google Account, it's straightforward to set up a blog. Another alternative is Wordpress, which again is free. You simply sign up, give your blog a name and you're ready to go.

If you do so, or if you already have a blog and you're a keen reader of this blog (and/or currently on econ101ab), let me know - I'd be delighted to follow your blogs...