US rate rise causes hot flows of money
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.
Inflationary pressures in China
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 on Tailwinds and Headwinds
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.
Call to scrap the MPC
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.
Chinese growth in words and pictures
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...»Assorted Links (18 Jan 2010) - Focus on Interest Rates
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.
Revision Presentation - Monetary Policy for AS Economics
This revised and extended revision presentation on monetary policy is designed for AS students
Launch interactive version of presentation
Download pdf of slide handouts
Is monetary policy becoming less effective?
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...»Aggregate Demand - Teacher Revision Presentation
Many thanks to Geoff for updating his popular revision presentation for AS students on Aggregate Demand
Launch interactive version
Download slides handout
The Economics of a Hung Parliament
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.
Deflation - Teacher Presentation
This new revision presentation examines the causes and effects of deflation and the possible economic policy responses.
Launch interactive presentation on deflation
Download pdf handout of presentation slides
The power of words…
Some say that “words have meaning and names have power”. Well when Mervyn King speaks, markets listen. And sell the pound too.
read more...»Economics of Saving - Teacher Presentation
This revision presentation examines recent data on the extent of saving in the UK economy.
Launch interactive presentation on the Economics of Saving
Download printable pdf of slides
Judging the impact of QE
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...»Gloomy summary
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.
Cause and effect of the weakness of sterling
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.
Debt repayment - a virtue or a curse?
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...»King confirms green shoots
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...»China’s concern over US monetary expansion
As the US effectively prints more money, Chinese officials are expressing concern over the impact that this will have on their economy
read more...»Keynes and the Multiplier Effect
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:
The Telegraph continues with it series of extracts from Edmund Conway’s new book and today it focuses on the twentieth centuries greatest economist John Maynard Keynes.
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
Keynes: The Twenthieth Century Most Influential Economist by P Clarke
The Birth of Macro_Prudential Policy
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.”
BoE Health Check on the UK Economy
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...»King and Chancellor at odds over intervention
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...»Europe Revision: The Euro
Revision notes on aspects of the EU single currency - is the UK economy better off outside of the Euro?
read more...»Blanchflower reflects on his time on the MPC
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...»Savers must sacrifice liquidity for a return
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.
Revision: Consumer Borrowing
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...»Optimism and Pessimism
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
(Very) Tentative Green Shoots
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...»David Miles - Brief Profile
A quick heads up on a brief profile of David Miles in The Times this morning
