An accommodatory policy is best described as a neutral macroeconomic policy stance in the face of an economic shock.read more...»
Sean O’Grady writes here about the decision by the Reserve Bank of India to raise interest rates once more to combat retail price inflation that hovers just below the ten per cent mark. A volcanic hat tip to John Richards from Tonbridge for spotting this one.
John points out that the article covers some really interesting macroeconomic aspects: namely the use of policy interest rates to control a booming economy, changes in reserve asset ratios (remember them?) as a tool of monetary control (limiting new bank lending), And also the high importance of food in the inflation basket for Indian consumers and the uneven impact of growth on the poorest parts of Indian society.
“The World Bank has said that faster economic growth has seen rising disparities between urban and rural areas in India, prosperous and lagging states, and skilled and low-skilled workers. India’s richest states have incomes that are five times higher than those of the poorest states – a gap that is higher than in most other democratic countries, and may damage social cohesion.”
The latest Bank of England survey on financial and credit conditions finds that smaller businesses are finding it tough to get the credit they need to finance an upturn in sales and production. Interest rate spreads on new loans are rising and it is larger firms that seem to be benefitting from lower borrowing costs. A Times article explains that “larger groups are enjoying a reduction in the cost of borrowing and improved access to credit as banks favour lower-risk custom.” - the main commercial banks continue to adopt a risk averse approach to new lending and this may hamper prospects of recovery.
Unsecured loans for consumers have also become harder to get and more expensive despite the ultra-low interest rate policy of the Bank of England. In 2006, the top 10 average rate for a £3,000 personal loan was 6.49%, but today it is 14.92%, analysis by price comparison website moneysupermarket.com has shown.
Many thanks to Geoff for producing this superb 51-slide analysis and evaluation of the prospects for the UK Economy in 2010. Updated to 25 March 2010 with the latest available data.read more...»
Interesting speech given last week to Cambridge Alumni by Charles Bean (Deputy Governor at the MPC): ‘The UK Economy after the Crisis: Monetary policy when it is not so NICE’. The graphs that it refers to can be found here.
Paul Krugman expands on the nature of the liquidity trap and why more of the world economy might be in this situation than is commonly supposed. His opening paragraph raises an interesting question for A2 economists - does a liquidity trap encourage protectionist policies and heighten the risks of a period of prolonged de-globalisation?
“Being in a liquidity trap reverses many of the usual rules of economic policy. Virtue becomes vice: attempts to save more actually make us poorer, in both the short and the long run. Prudence becomes folly: a stern determination to balance budgets and avoid any risk of inflation is the road to disaster. Mercantilism works: countries that subsidize exports and restrict imports actually do gain at their trading partners’ expense.”
Here is an interesting approach to interest-rate setting by the US Central Bank - the Federal Reserve. The Fed has pledged to maintain ultra-low interest rates for the time being in a bid to support and sustain a recovery in domestic demand and output and reduce the risk of a double-dip recession later on this year.read more...»
An excellent Channel 4 Dispatches documentary last night on Cameron’s government. Lots of good stuff here for both Politics and Economics students, for example discussing the proposed “Office for Budget Responsibility” to introduce more independence into Treasury forecasts. There’s been lots of talk about fiscal tightening in recent months, but this program asks where exactly do the Tories want to start fiscal tightening - and the non-committal answers will have you laughing/crying*, with no Shadow Minister agreeing to a cut in their department; and the Conservative party not wanting to admit to future tax rises just before the election. It also discusses the issue of the Conservatives and their stance on Europe.
*delete as appropriate.
An excellent article in last week’s Economist magazine, which focuses on the difficult task of weaning the world economy off its fiscal and monetary stimulus. In recent years, Interest rates have plummeted, and budget deficits soared; whilst quantitative easing has come out the woodwork; but last week’s announcement that the Fed raised the discount rate in its first step of contractionary policy in quite some time as well as our own general election around the corner, where fiscal prudence is high on the agenda and it seems that the beginning of the next phase in economic policy has begun.read more...»
This is a good example for AS students which illustrates how a change in interest rates can affect the exchange rate. Late on Thursday the US Federal Reserve raised their discount rate - the price at which banks borrow emergency money from the Fed - from 0.5% to 0.75%.
The move was unexpected, and has given rise to plenty of speculation that they will follow this with a rise in their federal funds rate - the benchmark rate at which banks lend to each other and is used to set rates on mortgages and car loans.
That means that currency speculators have bought the dollar heavily, betting on further rate rises and pushing the exchange value of the dollar up to a nine-month high against a basket of other currencies.
The swift response in exchange markets shows exactly how freely floating exchange rates can be directly affected by a change in interest rates. As BBC News and the Telegraph report, central bankers are deeply concerned that such speculation could slow growth in output just as recovery is beginning, and officials from the Fed have been active in offering reassurance that the promise to keep rates low for an extended period remains in place. “The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy,” the Fed said.
In spite of that, the massive foreign exchange market is still looking for a chance to make a profit by buying the dollar now.
This BBC news video provides an interesting window on the pressures for wages to rise in the booming city of Shanghai. The impressive rebound in Chinese economic growth is driven by the strength of the underlying growth forces in the economy together with the impact of the huge fiscal stimulus. But for many young professionals growth is causing the cost of living to surge - food and property prices are the main concerns. Inflation is a genuine risk for the Chinese economy - what might the Chinese authorities do about this?read more...»
Mervyn King delivers the latest Inflation Report from the Bank of England and focuses on the strength of two forces:
1/ The tailwind of the policy stimulus from monetary and fiscal policy
2/ The headwind of the continued deleveraging in the financial system
It is a good analogy to use and one that students should be able to latch onto as they grapple with their macroeconomics.
This BBC news video provides a good overview of the Bank’s current thinking. In it the Governor explains why the Bank will - for the third time - expects to write to the Chancellor to explain an inflation overshoot. And he comes out with a good quote “Monetary policy can do little to affect short-term changes in inflation” ....... instead it has more leverage on the growth of total spending in the economy which (relative to the supply-side capacity of the economy) affects demand-pull inflationary pressures during the economic cycle.
David Blanchflower argues in this interview on the Radio 4 Today programme that the Bank of England acted too late during the financial crisis and may be on the threshold of making similar errors in setting policy rates in 2010. he suggests that the MPC is not fit for purpose and that a change in target is called for. But he doesn’t explain clearly what should take its place. So students will get something from this piece but are left unfulfilled. John Humphries should have pressed Blanchflower further.
Statistics about the speed of China’s development never cease to be amazing, no matter how many times you read them. Here is another one; in the dark days of 2009 the Chinese economy grew by yet another 8.7% (10.7% in the final quarter of the year) so that it is now set to overtake Japan, which probably shrank by 6% over the same period, to be the world’s second largest economy. And yet, according to Ma Jiantang, head of the National Bureau of Statistics, there are still 150 million people in China living on $1 a day and so poor according to the UN’s standard rating. This gives a remarkable contrast as the world’s second or third largest economy is also a developing nation with enormous conflicts and trade-offs in macroeconomic policy to resolve. Mr Ma also referred to the concerns about inflation in China - he said price rises were “mild and under control”, but over recent days the government has tried to limit the amount of loans made by the country’s banks in order to avoid a ‘domestic bubble’ of growth. This is the focus of the Times’ report, which highlights expectations that there may be a rise in interest rates in China in the next two months.read more...»
1/ BBC news video - UK interest rates could stay low for five years - One of the UK’s best known economists, Roger Bootle, predicts that interest rates will stay below 1% for the next five years
2/ Telegraph - Economists question success of Bank of England’s £200bn money-printing plan - Economists have cast doubt on whether the Bank of England’s £200bn quantitative easing (QE) programme is working
3/ Telegraph - Why the Bank of England will raise interest rates as deflationary threat melts away - despite massive amounts of Quantitative Easing (QE) in both the US and UK. It is surely only a matter of time before short-term rates follow suit. Or so you would assume
4/ Guardian - Too dangerous to raise interest rates yet - Setting interest rates is a dangerous game - and one that could choke off recovery
5/ The Times - Profile of Willem Buiter - Maverick laughs all the way to the bank - More booms and busts lie in wait, economist Willem Buiter predicts.
This revised and extended revision presentation on monetary policy is designed for AS students
This hints that the transmission mechanism of monetary policy might have broken down. When ultra-low interest rates appear to be ineffective in restoring confidence and spending, this is known as the liquidity trap. For the exam you need to explain how a reduction in policy interest rates can stimulate household and business sector demand and also (through the exchange rate) providing a stimulus to export s. But we do not live in normal times! There are grounds for thinking that – in the short term at least – the impact of monetary policy may have been reduced. Here are some reasons:read more...»
Many thanks to Geoff for updating his popular revision presentation for AS students on Aggregate Demand
Week in Westminster today featured a fascinating discussion about the impact of a hung parliament - the outcome of an indecisive election which results in no clear majority for any party. There is a view that this may be the outcome of the General Election which is due by June next year, and asking around my A2 students, is something which they see as a real possibility, as they struggle to evaluate the policies of the three main parties. It is well worth listening to and analysing with students who are in the midst of examining the macroeconomic indicators and fiscal policy, and perhaps asking them to suggest what they would do, if elected as Chancellor early next summer, in order to deal with the aftermath of the enormous fiscal stimulus injected to the economy over the last year and the probable fragile recovery from the UK’s longest recession. The link to the BBC i-player is here - listen to Lord David Steel and Roy Hattersley discussing how best to deal with the lack of a majority, then move forward to 15 minutes into the programme to hear the statements of each of the party leaders on fiscal stimulus, deficit and economic policy followed by analysis from columnists Larry Elliott of The Guardian and Liam Halligan of The Sunday Telegraph.
This new revision presentation examines the causes and effects of deflation and the possible economic policy responses.
Launch interactive presentation on deflation
Some say that “words have meaning and names have power”. Well when Mervyn King speaks, markets listen. And sell the pound too.read more...»
This revision presentation examines recent data on the extent of saving in the UK economy.
The BBC carries this interesting video discussion with De Anne Julius about the impact of the Bank’s Quantitative Easing programme designed to support demand and lending in the UK economy. She emphasises the importance of gradually withdrawing the QE programme and she argues that the main effect of QE so far has been to hold down the interest rate on government debt (gilts) but that there is little evidence so far that QE has enabled a rise in lending to consumers and small businesses. The Indy’s Big Question looks at QE in their edition today.read more...»
Here is a summary of four reports posted on the Business and Economics sections of the BBC News website over the last few days. Be warned - none of them are particularly hopeful, the green shoots of summer giving way to autumn mists.
I do recommend this 4-minute interview to help explore the reasons for the weakness of sterling and whether it is helping the UK economy. Mark Thompson , a dealer at Moneycorp, was interviewed on Radio 5’s ‘Breakfast’ programme, and explained the shocks to the economy caused by the use of Quantitative Easing and the negative bank deposit rate (which means that if banks choose to hold money on deposit with the Bank of England it actually costs them money, rather than gaining them a return as interest). He sees these as strong statements that had been deliberately used to depress the value of the pound on the currency markets, thus encouraging exports and raising the price of imports, so that there is a substitution effect towards home-produced goods, which we can see is reducing the negative trade balance and so helping to raise the level of AD.
The link here will take you to the Friday 25th September episode of the programme, and should remain live until the end of this week; I think that after that it will be unavailable. Once you have opened the i-player page, use the scroll bar below the ‘control panel’ to move forward through the programme to 1 hour 48 minutes, which is the start of the interview.
This useful article from the BBC looks at debt, repayments and savings for individuals in the UK. In July UK households actually paid back more debt than they took out for the first time since the Bank of England started recording this data 16 years ago in 1993. At the end of that month total household savings amounted to £1.1 trillion, and total outstanding lending to individuals stood at £1.46 trillion (which is almost a trillion more than in 1993). Of this, £1.23 trillion was mortgage debt and £231m was other forms of consumer credit. Households are now starting to get the message about repaying that debt, with the average individual paying back £10 more than they borrowed in July – but the average personal debt standing at £24,000 is going to take an awful long time to pay back at £10 a month.read more...»
CPI inflation has fallen to 1.6%, and RPI inflation started to recover to -1.3%, in the measure of the annual rate to August. Is this good news?
For CPI, it means that the rate is moving further away from the target of 2%, which would be a concern if it was to continue on that trend, but the RPI measure indicates a slightly lower level of deflation, which should be a welcome sign. However, in both cases, it depends upon the reason as well as the expectation of what happens next. In a speech to the Treasury Select Committee, Mervyn King suggested that inflation is likely to be volatile over the next year, and focusing on GDP, he said that there were signs of a recovery to positive growth in the third quarter of the year.
But he remains very cautious; although the European Commission forecast the UK to grow 0.2% between July and September, this is less than in France or Germany, and Mervyn King suggested three factors, or headwinds, against which UK growth would have to struggle in order to become positive.read more...»
As the US effectively prints more money, Chinese officials are expressing concern over the impact that this will have on their economyread more...»
I am cross-posting Jon’s excellent blog on Keynes and the multiplier over at his excellent IB Blog that flags up some handy recent articles on this important macro policy concept:
In its simplest form Keynesianism argues that governments should be proactive during economic downturns rather than relying upon the power of the markets and interest rate cuts. Proactive in the sense that the government should borrow money and start spending. The doctrine lost favour in the 1970s as monetarist theory gained popularity. As you will be well aware Keynes has returned in earnest over the past 18 months as governments across the globe have pumped billions into the spluttering economies in the hope of restarting them. Although early days there are tentative signs that Keynes may have be right once again.
Key to his argument of the effectiveness of pumping money into an economy is that of the multpier. Conway provides an excellent overview of the multiplier in his piece today:
Say the US government orders a $10bn (£6bn) aircraft carrier. You might assume the effect of this would be merely to pump $10bn into the US economy. Under the multiplier argument, the actual effect would be bigger. The shipbuilder takes on more employees and generates more profits; its workers spend more on consumer goods. Depending on the average consumer’s “propensity to consume”, this could raise total economic output by far more than the amount of public money actually injected.
If the $10bn increase caused total United States economic output to rise by $5bn, the multiplier would be 0.5; if it rose by $15bn, the multiplier would be 1.5.
The article also provides some good points that students could use when being critical of fiscal policy (these were particuarly prevalent when monetarists were arguing against Keynesianism in the 1970s):
One of their main arguments was that governments cannot “fine-tune” an economy by regularly adjusting fiscal and monetary policy to keep employment high. There is simply too long a time lag between recognising the need for such a policy (tax cuts, say) and the policy taking effect. Even if policy-makers speedily identify the problem, it takes time for laws to be drafted and passed, and more time still for the tax cuts actually to drip through the wider economy.
There are a couple of recently published books on Keynes that you may want to get your teeth into:
Keynes: Return of the Master by R Skidelsky
This week the UK Treasury will release details of the embryonic macro-prudential policy - a policy designed to prevent the asset price bubbles that have plagued the UK at regular intervals over the years. Robert Peston has a blog on this here and portrays it as a victory for the Bank of England. We will learn more in the coming days and weeks of the technical detail behind macro-prudential policy.
I was reminded reading Robert’s blog of the policy prescription put forward by John Calverley in his most recent book “When Bubbles Burst” - will the Macro Prudential Policy Committee operate in a similar vein to an Asset Valuation Committee?
“John Calverley floats the idea of an independent Asset Valuation Committee whose job would be to improve the flow of financial information available to stock market and property investors, alerting us to when asset prices were either dangerously over-valued or under-priced in the market and perhaps giving people a stronger base on which to reallocate their portfolios and achieve better long term returns. An Asset Valuation Committee might act as a set of Wise Elders to the herd many of whom have spent much of the last two decades stampeding from one asset class to another – from internet shares to buy-to-let property – without stopping to calculate in the cold light of day the risks of the decisions they have taken.”
The Bank of England has released its latest health check on the stability (or otherwise) of the UK financial system.
Without a recovery in financial sector balance sheets and a return of an appetite to lend and unfreeze the supply of credit, any recovery will be delayed and weak.
Banks continue to de-leverage aggressively and I have met several owners of profitable and well managed smaller businesses in recent weeks who have complained that their banks are getting in touch directly to change the conditions of their credit facilities. In some cases the banks are adding 1 or 2 per cent to the rates charged for overdrafts and loans - which themselves are already a high multiple of the policy interest rate. It is the banking equivalent of the rip-off extra charges for people flying with the lower-cost airlines.read more...»
Both the Chancellor of the Exchequer and the Governor of the Bank of England gave their Mansion House speeches to the City yesterday, and both addressed the issue of regulation of the banking system. But while the Chancellor emphasised that he had no plans to fundamentally change the regulation system, the Governor called for more powers for the Bank to intervene and prevent excessive risk taking. This is at odds with the approach outlined by Alastair Darling, who referred instead to encouraging a change of management culture in the banks which would encourage bankers to manage themselves more effectively, being “rewarded for long-term success, not for failure”. He seems to suggest that the solution lies more in ensuring that banks are led by Boards of Directors with “the right people of the right skills and the right experience …. and they need to be equipped to ask the right questions.” He also called for an end to short-termism: “Their focus must be on long-term wealth creation and not short-term profits.”read more...»
Revision notes on aspects of the EU single currency - is the UK economy better off outside of the Euro?read more...»
Professor David (Danny) Blanchflower predicts an age of austerity for the UK in this Radio 4 interview (1st June) as he reflects on a three year stint as a member of the Monetary Policy Committee.read more...»
One of the paradoxes of this recession is that savers - who by and large have been as far removed from causing the crisis as it is possible to be - have seen rates of return on individual accounts collapse.
With policy interest rates dropping close to the floor and likely to stay below 1% for possibly a year or more, the rate of return on liquid savings accounts is desperately poor. Indeed the real interest rate is negative. Bank of England figures show that the average interest rate on instant access accounts - including current accounts - was 0.15% at the end of April. Hence the need for savers to think long term about their savings options and search for better long term accounts offering a better fixed rate of interest.
It involves sacificing liquidity for a higher rate of return. In this sense, nothing has changed because there has always been an inverse relationship between liquidity and interest rates - but the problem facing millions of savers, many of whom risk falling into relative poverty because of the collapse in income from interest-bearing accounts is highlighted in this BBC article.
Most of us at some time in our lives need to borrow money to finance spending. From taking out a mortgage to making frequent use of bank credit cards, borrowing is a normal feature of life and not necessarily something to be worries about. What matter is whether building up debt is sustainable – in other words, can those who rely on debt pay it back? Credit means being able to buy now and pay later. The credit market for individuals is complex at the best of times and there is plenty of scope for individuals to end up in trouble if they borrow irresponsibly or are subject to mis-selling of loan products from the financial services industry.read more...»
The optimist - the new member of the MPC Professor David Miles who spoke at our economics society recently and is decidedly bullish in this article in the Western Daily Mail about the impact of the huge macro policy stimulus.
“Economic history teaches us that a combination of tax cuts, running large fiscal deficits, substantial cuts in interests rates and more quantitative easing is likely, with a certain time lag, to have a substantial impact on demand in the economy and it may well be that the worst of the recession may well be behind us.”
On the other hand, the IMF - “The current recession is likely to be unusually long and severe and the recovery sluggish,” the IMF said in releasing two chapters from its twice-yearly World Economic Outlook (WEO). Have a read here
This summer you can expect many column inches devoted to searching for green shoots of economic recovery. There must come a time when the unprecedented policy stimulus applied to the UK economy will start to bear fruit and evidence emerges of a turning point in the business cycle.read more...»
A quick heads up on a brief profile of David Miles in The Times this morning
This brief “Industry Speak Explainer” from the Guardian provides a vsimple explanation of how the government borrows money by selling gilts. It explains how the Bank of England’s policy of quantitative easing, which involves buying up to £75bn of gilts in an attempt to drive up their price and push down the yield, is an attempt to avoid crowding out by persuading investors to sell gilts back to the Bank and spend the cash on other assets instead, helping to drive up their prices, reduce the cost of borrowing, and stoke new demand across the economy.read more...»
Sailing very close to what is allowed under the terms of Bank of England independence, the Governor of the Bank Mervyn King has made a dramatic statement about how much scope the government has to launch a fresh fiscal stimulus when the delayed Budget is announced on the 22nd of April.read more...»
Some good news today ... David Miles, one of the City’s finest economists and a real expert on housing finance and the broader workings of the economy, has been appointed onto the Monetary Policy Committee. He starts his tenure in June.read more...»
The Financial Times reports today that the Swiss Central Bank has started to intervene in the currency markets to lower the value of the Swiss Franc because they fear that a rapidly appreciating currency will worsen their economic slowdown.read more...»
I have attached some notes from an excellent seminar given last night by Stephen King, Chief Global Economist of HSBC to a large group of keen AS and A2 economists. The Egerton Room at Eton College was pretty packed to hear Mr King give a really clear overview of the risks facing the world economy. There are so many moving parts at the moment that no one country can fix the problems - this demands a coordinated response. And there is a real sense that macro-economic policy has lost control. With it the risk of a descent into economic nationalism and a reversal of globalisation can become acute.
Q&A: Why when base rates change does it cause other interest rates to also change?
The concise answer is that the Bank of England acts as the nation’s central bank and it can use its daily operations in the money markets to nudge other interest rates higher or lower.read more...»
There is much in the press this morning about the fact that the Bank of England has asked Alistair Darling if it can begin the process of ‘quantitative easing’ (many refer to it as ‘printing money’). What does this actually mean though? There is an excellent graphic in today’s Times that makes it all a little clearer.
There was also a good blog from the BBC’s Economics editor Stephanie Flanders yesterday on quantitative easing.
Heather Stewart is also on good form this morning with a good Q & A piece in today’s Guardian.
The conditions under which investor flight might happen for the UK is something we have discussed in our recent A2 lessons on exchange rates and macroeconomic policy and it forms the basis for a short article in the Financial Times today…read more...»
The Bank of England’s Monetary Policy Committee (MPC) has lowered the Bank Rate by 50bps to 1.00%.read more...»
I am discussing the macroeconomic effects of exchange rate movements with my AS students this week.
The suddeness and severity of the recent depreciation of sterling, both against the US dollar and the Euro as well as on a trade weighted basis provides plenty of ammunition for a good lesson which seeks to develop their understanding of the transmission mechanism of exchange rate fluctuations together with a chance to develop their evaluation skills. I have made the AS macro student handout available for download below - it contains up to date charts on sterling together with a short exercise for students on how different stakeholders might be impacted by a sterling depreciation.
Roger Bootle’s quarterly Deloitte Economic Review rarely disappoints and the new edition which is available here provides a timely and crystal-clear explanation of the demand and supply-side factors that might bring about price deflation in the UK economy during 2009 and into 2010.
Seven forces are raised as contributing to downward pressure on the general price level
1. The sharp fall in global food and energy prices
2. Intense competition amongst retailers such as deep-discounting to maintain cash flow and market share
3. The impact of the temporary cut in VAT from 17.5% to 15%
4. Falling housing costs including lower mortgage interest repayments (which affects RPI inflation)
5. The lagged effects of a large margin of spare capacity in the economy due to the negative output gap
6. Downward pressure on basic pay settlements and average earnings - how many people will take pay cuts this year?
7. The sustained and persistent decline in asset prices with consequences for consumer confidence and aggregate demand
For AS students - consider how these forces might be explained and illustrated using AD and SRAS analysis.
The risks of price deflation are not insignificant, indeed as Bootle points out, price deflation might have been rare during the latter part of the twentieth century but we have had plenty of instances of it in the UK in earlier ages.
What of the likely consequences of a bout of price deflation?
Some of the forces mentioned above are indeed likely to be temporary (the VAT cut is reversed in 2010) and some will have favourable effects on real income and spending power. But the consensus seems to be that deflation can have a pervasive and damaging effect on the real economy:
1. A rise in the real value of debts - personal, corporate and state
2. A change in the psychology and expectations of businesses and consumers
3. Second round effects including pressure for wages to fall and output to be cut back further
4. The possibility that the usual instruments of monetary policy become ineffective
5. Consequences for welfare benefits - will the government cut unemployment and state pensions in a world of deflation?
6. The damaging effects on the corporate sector of falling prices and profit margins
Sterling’s continued depreciation perhaps holds out the best hope of avoiding deflation this year as does a partial rebound in the price of oil and gas and other inputs. Bootle predicts that - having cut policy interest rates to the bare bones of 1.5% - the Government and Bank of England are likely to resort to further emergency measures to prevent a Japanese-style deflationary spiral.