Explaining the Paradox of Thrift
Dugie Young looks at the paradox of thrift and its relevance to today’s financial and economic crisis.
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Pain in Spain - on the brink of depression
In our introductory AS macroeconomics we have discussed the differences between a cyclical recession and a depression. Much depends on the scale of the contraction in real national output from peak to trough of the cycle. This article from the Telegraph looks at a dire outlook for the Spanish economy which - not long ago - was one of the fastest growing countries in the European Union with a rising relative per capita income.
Quoting a report from Madrid research group RR de Acuña & Asociados, the peak to trough loss of GDP is likely to be more than 11%. “The group said Spain’s unemployment will peak at around 25pc, comparable to the worst chapter of the Great Depression......The construction sector will shrink from 18pc of GDP at the peak of the boom to around 5pc, making it unlikely that there will be any significant recovery before 2012. Even then growth will be “slow, weak, and fragile”.
A huge rise in the Spanish government’s budget deficit has left them little wriggle room for a fresh fiscal stimulus.
Spain and Ireland are frequently quoted as two EU countries whose property bubbles have been well and truly smashed with huge macroeconomic consequences. The slump in property represents a very large internal demand-side shock for a country heavily dependent on construction and also tourism for value-added measures of GDP.
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
New Deal Videos
Fasttrack History has a number of video clips covering US New Deal construction projects in the late 1930s - public information films that students will readily recognise as deeply embedded with propoganda but offering vivid video examples of the ‘shovel-ready’ jobs that remains engrained in our minds when we think of the New Deal programme. Relevant today?
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Q&A: What is the difference between a depression and a recession?
This is a good question and you wont be surprised to hear that economists have different views on the distinction between the two! My answer is that the difference is a matter of degree both about the duration of an economic downturn and also the severity.
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Economic darkness in the land of the rising sun
The scales of the fall in Japanese GDP in the 4th quarter of 2008 - a staggering 3.3% in just three months - suggests that Japan is on the verge of an extremely damaging collapse in output and jobs. Shoichi Nakagawa might have been driven to drink by the release of the figures (bizarrely timed for early on a Sunday morning) and his unsteady performance has cost him his job! Jon blogged about the Japanese recession a few days ago and to support that blog I have put together a chartroom presentation on Japan to give a flavour of the problems facing the economy.
Defining our Times
For example, the National Bureau of Economic Research in America defines it as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales”. On this basis the US economy has been in recession since the end of 2007.
While for the economist Christopher Dow, recession worthy of the name was one featuring a “clear absolute fall in GDP between one calendar year and the next”, usually but not always followed by a second fall.
David Smith goes on to examine difference interpretations of what constitutes a ‘depression’ and how we will know whether we are in one or not, drawing some comparisons with recessions and depressions from the past – which might make useful reading for those students starting to think about their entry for the RES Young Economist of the Year competition.
Charts used in this blog
US_Charts_0209.ppt
Worst case scenario for the UK
Paul Mason, Newnight’s Economics correspondent is on fine form at the moment with a cluster of really good pieces for Newsnight. Here are two recent pieces available from the BBC web site.
In ‘worst case scenario’ Paul Mason looks at some of the systemic risks facing the UK http://news.bbc.co.uk/1/hi/programmes/newsnight/7851138.stm
and in this piece he considers the rising tide of protectionist sentiment - are we now moving into an age of de-globalisation?
For a more optimistic view here is another piece from Paul Mason on the best case scenario for the UK
Bail-out Bitter
“A bitter ale for bitter times” is the marketing slogan coined by the Howe Sound Brewery in British Colombia which has just launched a new ale in honour (?) of the global financial crisis and the budgetary problems of the Canadian government. They are backing this up by offering Blue Plate depression meals in their pubs priced at affordable levels.
This is just one of the clever ways in which businesses can capture the mood of the times and generate some extra sales through a healthy dose of black humour. Restaurants are offering “credit munch” discounts and one of my students told me this week that millions of us have downloaded tracks which are specifically related to money. Favorites include the classic ABBA track “Money, Money, Money”, and Pink Floyds “Money”. These songs have seen a 28% increase in downloads from the iTunes website.
Has anyone come across other innovative “recession marketing”? If so please add your contribution!
The Fed Reaches the Floor
Ground Zero for US Interest Rates
The official judges on whether the United States is or is not in a downturn (the NBER) are now saying that the USA entered a technical recession at the end of last year. It takes some time for the statistics to provide concrete proof of this – a nation’s GDP data is always three to six months behind the times.
What is clear is that the world’s biggest economy is in serious trouble as the financial crisis spreads to Main Street and millions of jobs are at serious risk. To state that that millions of jobs might go is not an under-statement. Half a million jobs were lost in November alone.
Yesterday the United States Federal Reserve pulled on the monetary policy interest rate lever one last time. It announced a reduction in the federal funds rate to a new level of ‘between zero and 0.25 per cent’ – which means in practice that the interest rate at which the Federal Reserve is prepared to lend to other financial institutions is now at the floor.
Managing confidence and demand
The main aim of lowering interest rates is simple – to drive down the cost of borrowing for consumers and businesses in an attempt to stimulate confidence and demand in the domestic economy thereby helping to stabilise output and jobs during what promises to be a deep and painful recession.
Some students wonder why – if official interest rates are zero – why it is that loans, overdrafts, credit card rates and numerous other interest costs for borrowed money remain positive – often way above the so-called ‘policy rate’.
The main answer is that most loans – be it for a mortgage or an investment project for a company – are for much longer periods of time than the overnight lending or surplus funds between the banks within the inter-bank market.
So a property-buyer or business looking for loan finance will pay a rate of interest equal to the ‘risk free’ interest on government securities (bonds) of similar duration plus a risk premium that the lender requires as an insurance against the loan going bad. In short - the greater the risk of a borrower defaulting on their loan, the higher is the rate of interest charged.
The credit crunch has made lenders more cautious about lending – risk premium spreads have risen in most financial markets. As a result, deep cuts in policy interest rates by most of the world’s central banks have done little to reduce the real cost of credit for personal and business customers. This is one reason why monetary policy can become ineffective as a tool for managing aggregate demand.
Let us head back to the decision of the Federal Reserve to cut official interest rates to zero. Does this mean that there is nowhere else for monetary policy to go to prevent a deflationary depression?
Turning on the taps
Not quite, some of you may have read about the possibility of the US Central Bank taking some highly unusual steps which boils down to effectively printing money to stimulate liquidity in the financial system. This is known as quantitative easing and the easiest way of describing it is to say that the central bank would buy directly different types of existing debt – say long term government bonds or the dodgy debt of the failed mortgage giants Freddie Mac and Fanny Mae – and print money to pay for their purchases. This injection of money into the economic system would boost the money supply and keep interest rates low.
The Federal Reserve could – in principle – buy any outstanding assets held by the private sector of the economy – and print money to pay for them. They could guarantee to buy up fresh government debt issued by the government – for example extra government borrowing to fund President-elect Obama’s fiscal policy recovery programme.
Added to this, Ben Bernanke at the Fed could announce that the central bank expects to keep short term interest rates at super-low levels for the foreseeable future – a strategy designed to embed into people’s minds that the nominal cost of borrowed money ought to remain minimal. One of the problems of the liquidity trap is that – when interest rates are driven to zero – our expectations are that the next move will be upwards and that this could happen swiftly. The Fed needs to avoid this expectation.
Martin Wolf discusses many of these issues in his excellent piece in the Financial Times – available here. He flags up one idea – that the central bank could simply send everyone a cheque with some money to spend – perhaps using some time limited coupons?
So in the weeks and months ahead, keep a look out for some of the key decisions of the US Federal Reserve. As students you are living through an amazing moment in nearly a hundred years of economic history.
And what will the Bank of England do in response to events both here in the UK and also overseas? Is it prepared to go the distance and reduce the BoE policy rate to zero? We will find out in early January or February.
Here are three follow up articles on the latest cut in US interest rates:
BBC news: US rates slashed to nearly zero
Guardian (Chris Payne): The Fed has waved a white flag
Independent: US slashes interest rates to new zero-0.25% range
Telegraph: UK needs negative interest rates, L&G warns
The Times (Gerard Baker): Fed throws out the rulebook
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