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.
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13% fall in household wealth will shape any 2010 rebound
One key reason to expect a more subdued recovery from the downturn is that the household sector in the UK has suffered a huge negative wealth effect over the last couple of years. Asset values have fallen but outstanding debts have not and it is this imbalance that will shape the nature of any rebound in consumer demand for goods and services even though the cost of borrowing is at unusually low levels. The National Institute has done some research on the negative shift in personal sector wealth and it is reported in this article in the Telegraph.
Speculators and Exceptions to the Law of Demand
To what extent are speculators responsible for the increasing volatility of commodity prices? Expectations of price movements for globally traded commodities can have a huge impact on demand in the markets and the bets that speculators make on the forward prices of commodities such as oil can lead to rapid price hikes. We saw this with food and oil in 2008 - with enormous consequences for consumers and producers in developed and developing countries - and perhaps we are seeing this again as 2009 draws to a close. The world price of crude oil is already heading north again towardsa $90 a barrel.
This BBC world service audio report is a good resource on the impact of speculation and its possible links to exceptions to the law of demand where a rise in actual or expected prices can bring about an expansion of market demand.
“The International Food Policy Research Institute in Washington has studied price movements and concluded that they couldn’t all be explained by the fundamentals. And, perhaps most damning of all, a big-time speculator is now identifying speculation as one of the causes in the movement of the price of oil.”
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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A2 Macro: Domestic and External Headwinds
As part of an introduction to a deeper analysis of economic cycles one of my A2 groups considered some of the domestic and external economic headwinds that will shape the next stage of the business cycle - not least the likely pattern of any recovery in activity. The aim of the exercise was to emphasise the importance of the inter-connected nature of modern economies. And also to reinforce the idea that policy decisions taken inside the UK economy can be blown off course by external shocks.
Here are some of the ideas
Domestic influences
Consumer expectations - about future changes in taxes, unemployment, house prices, real incomes
Business expectations - the state of confidence / pessimism about sales, costs, credit availability, cash-flow and profits
Scope for further monetary policy decisions - e.g. extension of quantitative easing, edge policy rates to zero
Fiscal policy changes - need to scale back borrowing, control G, likely sharp rise in the tax burden
Access to credit and the cost of borrowing - are the banks and other lenders sufficiently recapitalised to start lending?
External influences
Shape and strength of recovery in economies of our major trading partners
Ability of the global economy to coordinate a sustained recovery
Growing pressures for protectionism / economic nationalism
Volatile exchange rates
Volatile international commodity prices
Large swings in direction of foreign direct investment / international capital flows
It is really important for A2 macroeconomists to keep abreast of the news and develop a deeper awareness of what is happening and the mutliple inter-relationships between economic, financial and political forces. Are we in a substantially brighter position than six months ago? What causes turning points in cycles? The anniversary of the collapse of Lehman Bros is an opportune moment to take stock of where we are.
Some suggestions for reading
Telegraph: Too early to celebrate the end of the recession
Guardian: Recession is officially over, according to leading thinktank
The Times: House prices rise 0.8% to fuel rebound hopes
Japanese unemployment rises to record high
Japan may have edged out of technical recession in recent weeks but deflationary pressures continue to bear down on their economy.
read more...»Causes of a double-dip recession
To drive the economy out of recession requires extra demand but where is this demand coming from? Cuts in interest rates and a big fiscal stimulus in many countries (notably China and the United States) has helped to cushion the scale of the slump but sometimes despite tentative signs of green shoots, an economy can go into the second stage of a downturn, this is known as a double-dip recession. This can happen if the initial ‘kick’ of the fiscal and monetary stimulus starts to wear off.
This Newsnight video report by Paul Mason (recently returned from a lengthy period analysing the Chinese economy) features Martin Weale, Director of the NIESR and my old tutor at Cambridge who argues that Britain will have to get used to being 3 or 4 per cent poorer and expect a deterioration in public services with government spending cuts inevitable in the coming years.
There are signs that borrowing costs are starting to rise, particularly mortgage costs and loan and overdraft charges for businesses. This may undermine confidence and engender any green shoots.
CAPEX under pressure as spare capacity grows
The recession is creating a growing amount of spare productive capacity across many different markets and industries. From container ships to hotels and from steel plants to airlines, the fall in demand has lowered capacity utilisation and put a big squeeze on profits. That pressure on profit margins comes not just from weaker revenues. Keep in mind that many businesses have a large fixed cost component such as the overhead costs of operating a network. Thus when output is contracting, the average fixed costs of production increase.
Declining demand and rising productive slack inevitably cause a fall in planned investment spending - economists term this a negative accelerator effect. BBC news reports that British Airways is cutting capital spending in response to the slump in demand and mounting losses. “The airline said it had cut spending by 20% to £580m ($952m) from £725m, and had lengthened its schedule of orders for 12 Airbus A380 aircraft.”
Further evidence for the reverse accelerator affect comes from Japan where Japanese firms cut their capital spending by a record level in the first quarter of 2009. In contrast Stagecoach is increasing investment in a fleet of greener buses.
Paul Krugman at the LSE
““The central problem of depression-prevention has been solved, for all practical purposes.” Robert Lucas, 2003
In a world of depression economics many of the standard rules of economics no longer apply. The global economy remains in the grip of a sustained downturn, the duration of which might make Japan’s “lost decade” look favourable in comparison. And macro policy-makers are grappling with an infection that has proved highly resistant to the usual doses of anti-biotic. Despite a remarkable attempt at stimulating demand – through the acceptance of large fiscal deficits and the dual attack of conventional and unconventional monetary policy – things seems to getting worse albeit more slowly.
This seemed to me to be gist of the core message from the first of the Lionel Robbins lectures delivered by the 2008 Nobel Prize Winner for Economics, Professor Paul Krugman of Princeton speaking at the LSE this evening.
Revision - Animal Spirits
Animal spirits refers to the expectations of businesses, entrepreneurs and consumers. When business confidence is high, we expect to see a rise in planned capital investment at each rate of interest. If there is a downturn in business confidence, for example during a recession, then planned investment may fall and some capital investment projects may be scrapped even when interest rates are fairly low.
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