Friday, February 26, 2010

Party Time!

Economic growth for 2009Q4 revised UP!

That's made my Friday...

UPDATE: It should be clarified, this is growth in the last three months of 2009, last year, that we're talking about.  Because it takes a long time to count up all the different parts of economic activity, and because we are all impatient, the Office for National Statistics (ONS), which counts up GDP, releases numbers in stages.

The first stage, when we thought growth was 0.1%, was based on 40% of the numbers being added up for GDP - so based on 40% of the economy.  These numbers are based on more of the economy, and naturally once one counts up more of the economy, a more accurate picture is arrived at.

The final number for GDP growth may be different still, but given most of the numbers are added up now, it seems certain that the UK did grow in 2009Q4, and grew more than it shrank in 2009Q3, which is positive news.

Of course, this doesn't necessarily change how things are happening right now, in 2010Q1.  If it gives businesses more confidence however, it may help matters.  For example, combined with the weak pound, if firms now decide economic matters are looking better, they may expand their exporting activity, thus hiring more workers, and hence helping contribute to more economic growth and lower unemployment in the current quarter.

We'll have to wait and see!

Don't buy dollars!

At least, not right now - overnight the pound dropped to its lowest level in nine months against the US dollar, as reported by the BBC.  From the article, much of what was covered in this week's lectures is referred to, notably economic factors affecting the way the UK economy is viewed by speculators.

For example, some analysts suggest that the possible revision downward of 2009Q4 economic growth from 0.1% to zero or even negative has meant that investors have decided to hold the wealth in other forms, speculating on the possibility the pound will fall if that happens.  The Office for National Statistics is due to announce today (Friday) the revisions to its earlier 0.1% figure.  That 0.1% number was found looking at only 40% of the economy, and so may not be exactly right - we'll see!

Another interesting point made in the article is that political uncertainty is affecting the pound.  As Labour closes the Tories' lead in the polls (or rather, the Tories contribute to losing their lead), the probability of a hung parliament (neither party has a majority) increases, and this is seen as a bad thing when an economy is in recession.  This is because it is harder to get new legislation passed that might help kick start the economy.

So this leaves Labour in a bit of a catch-22 situation - if it closes the gap, which is good for them, then the pound takes a hit - something which usually has negative conurtations, as people associate the strength of an economy with the strength of its currency (erroneously).  On the other hand, it should help British exporters to sell goods abroad, which can't be a bad thing...

Thursday, February 25, 2010

Speculatory Demand for Money

In Tuesday's lecture we talked about the speculatory demand for holding money - where people hold money in order to take advantage of some opportunity for earning a return (interest) on their money.

Greece is a natural target for speculation right now: People hold money looking for opportunities to profit from the country's ills. The standard target in this kind of situation is an ailing country's currency, and indeed the euro has fallen in recent weeks as Greece's problems mount. But the fall has been nothing compared to how the drachma would have fallen, had that still been Greece's currency.

An article in the New York Times discusses the role of particular types of financial assets surrounding Greece, assets called credit-default swaps. These are bits of paper bought and sold by traders in financial markets, with something of a twist - they pay out to the holder if some other company (or even country in Greece's case) suffers some kind of credit event - e.g. a default. So they are a way that concerns investors can hedge themselves against a large loss from a bankruptcy.

Of course, given these types of possible assets to invest in, traders are more likely to invest in them (swaps) than actual Greek government debt, meaning that the supply of funds in the market for Greek government debt is drying up, increasing the price in that market, making Greece's situation even worse.

But, these types of financial dealings were exactly the ones manipulated by the Greek government itself to hide the extent of its debt, and clearly these assets are helpful means of insurance for worried investors, hence some snap decision by politicians to ban them would not necessarily be productive in any way in reducing risks and losses and instabilities in financial markets.

Avoid Bad Science!

In particular, bad science by extremes of the political spectrum - those are the ones that generally tend to produce it to try and win you over to their rather untenable beliefs.

An example is given today via the above plot, produced in American by a lady called Veronique de Rugy, who is somewhat anti-government, and hence would fit in nicely with the 20 economists, and George Osborne's Tories.

The plot shows that private sector unemployment fell in the US since the stimulus package (that injection of government cash into the circular flow of income), and even public sector (government) employment fell too.

This, it is claimed, is clear evidence that the stimulus failed. Please, as a result of your university education, if you take one thing out of your degree take out the ability to analyse bad science like this!

To show properly whether or not the stimulus worked we would need to analyse a parallel version of the US (or UK) economy, in which the stimulus package was not launched. This is how in an experiment you would analyse the effects of some treatment (say a new cure for cancer): You give some subjects the treatment, and restrict the treatment from another group, the control group. Then you compare the outcomes between these two groups.

Of course, the problem is the control group for the US or UK economy, the version of it that didn't get the treatment. It doesn't exist.

So we actually have no basis on which to analyse the stimulus package, because we have no idea how many jobs would have been lost had the package not been announced and implemented. Of course that kind of caution doesn't tend to hold back economic fundamentalists like de Rugy.

It may be that the stimulus failed, it may be job losses were higher under it than they might have been without it - but the important thing is that we'll never know this. This is somewhat unsettling, but we're not 100% without hope.

Economic theory, the kind of stuff you're learning this term, allows us to start trying to analyse things like the effect of policy. Because in economic theory we build up a simplified theoretical model of the economy. We then can, in that model economy, look at what happens if we increase government spending, and what happens if we don't increase government spending. It's not perfect, since our model are simplified. But it's a much better attempt at the problem than the bad science example above from de Rugy.

More from George Osborne

We've talked this week in the lectures about the letters between the 20 economists and the 60 relating to how the government should cut the deficit and national debt.

George Osborne, in a speech at Cass Business School in London, has reiterated his intention to cut the deficit right away if in power, the case made by the economists.

If you'd like to hear more of George (I certainly don't need to hear any more of his views that I strongly disagree with, but maybe you like them), then at 12 today he talks at the Wolverhampton Wanderers' football ground in central Wolverhampton. Email if you're interested.

Wednesday, February 24, 2010

Was Mervyn King in yesterday's lecture?

Mervyn King is a powerful man: He's the governor of the Bank of England, the UK's central bank. Recall we learnt about central banks briefly this week: They oversee the financial system, even though they don't directly regulate it (the FSA does that).

Part of that program of oversight saw a lengthy period of quantitative easing, which was basically buying different types of securities (we've learnt about some of these, many of which are bits of paper saying IOU), so that more money entered the system (the amount the Bank paid for the securities). This is a simple increase in the monetary base, and the hope of course was that banks would start lending again, to get the economy going (recall, if we want export led growth, exporting firms need to be able to borrow to expand in order to export!).

That stopped recently, but yesterday Mervyn King announced it might have to begin again, because things aren't looking so rosy. Note in the article the effect of this announcement: The exchange rate fell against the dollar and euro. We talked about this yesterday. Expectations of a rising supply of money in the UK means an expectation of a falling exchange rate, and hence those people that hold money for speculatory purposes (remember the speculatory demand for money) sold pounds quickly, expecting this to happen. They may have bought them back now, and hence have more pounds because they sold, held the money speculatively, and then bought pounds back.

There's so much in the linked Guardian article related to what we've been learning this week and throughout this term, I couldn't recommended having a quick skim read any higher, and also yesterday Vince Cable, leader of the Lib Dems, criticised banks for not having begun lending to people (mainly small businesses), despite the public money they've received. This is exactly the money multiplier process in action: The Lib Dems are saying it's too small because banks are still not behaving properly, and we could do with a higher multiplier to help the economy get going.

Tuesday, February 23, 2010

One type of financial asset: A Mortgage

A common financial asset, linked in with what we're covering in lectures this week, is a mortgage. A mortgage is a loan to buy a house with, where the collateral for the loan is the actual house itself - i.e. if you fail to pay off the loan and default, the institution that gave you the loan takes possession of the house.

It's a very illiquid asset in the sense it takes a long time to mature - most mortgages are 25 years in length, hence it will be 25 years before you see that money again, if you give somebody a mortgage.

Anyhow, many fewer have been granted in January compared to December, according to the BBC. This was partly to do with all that snow hampering economic activity (not just schools closing...), but also because of tax incentives imposed by the government. In January, stamp duty was reimposed on house purchases. Stamp duty is a tax the government collects on house sales. So in December people rushed through house purchases in order to avoid paying stamp duty, which can be pretty hefty.

Is this bad news for the housing market? And moreover is it bad news for the economy? Probably not, is the suggestion in the article, at least for the former - since the drop was only related to some very temporary factors that won't persist (tax changes and weather - we hope!), hence it's likely the market will pick up again.

Is that a good thing for the economy? Given, as we found out early in term, the UK is a nation of estate agents, perhaps! But for those of us hoping one day to buy a house, slightly less encouraging if it means house prices start rising again...

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Building Societies

Yesterday I mentioned a dying breed, Building Societies. Naturally that's a slightly pessimistic take, and in fact many of the Building Societies I thought were long gone still exist, including the Leeds Building Society.

Nonetheless, Moody's, which is a credit rating agency, has raised concerns about the building society sector. Credit rating agencies make pronouncements on the credit-worthiness of various types of institutions, ranging from banks and building societies to sovereign governments. They have recently, for example, been raising big questions about Greece's credit-worthiness. These agencies give ratings to institutions, and types of assets - hence in the Sub Prime Primer the talk of triple A (AAA) rated assets.

Anyhow, Moody's has suggested that Building Societies may be unable to raise the necessary liquidity to match its obligations to customers without government help, talking of a £300bn gap.

You can now start to understand much of what is discussed in this article from yesterday's lecture: Retail banking funds are talked about, as consumers apparently have moved away from smaller building societies to the percieved safety of government-owned banks, while wholesale funds are mentioned, as banks and other intermediaries still seem reluctant to deal with each other, it seems. Recall that banks and building societies will often deal with each other, and make loans to each other, to ensure that all banks and building societies have the funds they need for day-to-day transactions.

This article seems to suggest that consolidation is around the corner: That means that mergers and take-overs are very likely. If a building society thinks it will be unable to meet its demands from customers, then the best thing will be to be taken over by a bigger bank that has the ability to meet the liquidity requirements customers make - or be bailed out/nationalised like Northern Rock.

So I imagine we should expect Santander to buy a load more building societies in the next year or two...

Unemployment: Missed that one...

Last week, I guess while I was en route back to the UK, I missed the latest unemployment numbers being released for the UK economy: Claimant count up, total unemployment slightly down.

A bit like the previous month's numbers (a fall in both), the change in the unemployment rate (which remember is a survey carried out by the International Labour Organisation, part of the UN) is miniscule - but that in itself is not a bad thing: It means unemployment is not rising!

The claimant count though has risen, but that again is not surprising: People will have ended temporary contracts after the New Year as shops return to normal activity after the Christmas period. I'm slightly concerned about the analysts that expected a fall in the claimant count - who are these people?!

Furthermore, historically unemployment lags after GDP growth in a recovery, as firms first seek to expand activity using slack with their current staff rather than taking the risk of hiring more people. We should expect unemployment falls to come later, if the recovery is prolonged.

A concern is a changing nature of the composition of unemployment noted in the article: More long-term unemployed. A lot of old industries have bitten the dust in the last year or two, such as shipbuilding in the North of England and Scotland, and car manufacturing in the West Midlands, which probably contributes to this. So altogether mixed news on unemployment...

Monday, February 22, 2010

Sunday's other news

As well as Gordon Brown being accused of being a bully (that I can well believe), yesterday the Tories announced very vague plans to allow Joe Public to buy shares in the various banks that are currently publically owned in the UK. I suspect the Tories were probably pleased that the bullying row started, as it's meant they've avoided scrutiny over their plans, which seem to be little more than populist.

The idea is that the shares the UK government currently owns (in return for the massive amounts of cash given to banks to shore up their balance sheets last year) would be given at discounted prices to young people and those on low incomes. In today's lecture we covered much of the stuff mentioned in that sentence: We discussed how banks have balance sheets with assets (claims they have on others) and liabilities (claims others have on them), and noted that in the crisis, all of a sudden bank assets (claims they had) became worthless as many people (and banks) couldn't pay what they owed and defaulted.

This of course meant banks had nothing to use for day-to-day activities as all their assets had vanished and selling them on these secondary markets would have yielded nothing. So the UK government stepped in and provided the kind of cash needed for things like meeting current account holders' demand for their money (bank liabilities), in return for bank shares.

Banks operate as intermediaries, but operate like firms, on the behalf of their shareholders - hence their purpose is to maximise shareholder return. Given the recent explosive return to profitability of the banking sector, shares ought to be very valuable in these banks, because when firms make profits they usually pay shareholders a dividend, a share of that profit.

Back to the Tory plan. It sounds like a really nice idea, but one has to ask whether anyone would really want these shares? The banks have lost much value in recent years, and who is to say that what value is left won't go again? Also, would these young people and unemployed people make good shareholders? Better analysis than this can be found from Robert Peston.

Friday, February 19, 2010

60 wise economists

I've returned to the UK to find economists are battling things out in the newspapers! Somehow BBC's international site, which I must have been getting in Japan, didn't include anything about the 20 economists in last weekend's Sunday Times. These economists said the government needs to get on with reducing the size of the deficit and hence national debt, before things get out of control.

This analysis, by very prominent economists indeed (Ken Rogoff, Tom Sargent are superstars of the economics world), counters what Rob lectured you on this week on the multiplier and accelerator. Nonetheless, their points are valid: There does need to be some plan in place to reduce the deficit so that those people lending Britian money to finance the deficit can know there is a realistic chance of getting that money back.

It shows fundamentally that economics is not a bland discipline where everybody agrees on everythin. It also shows the economy is an incredibly complex beast, which defies attempts to understand it with simple models.

However, today saw Act 2 of the debate. 60 economists have written two separate leters to the FT: See here, and here. Again we have heavyweights - Nobel prizewinner Joe Stiglitz, as well as many other likely future winners (including my old PhD supervisor, Sir David F. Hendry).

These 60 economists agree with the kind of analysis Rob gave you last week: Multipliers and accelerators are out there and matter. Cut spending now and there is a great risk of pushing the economy right back into recession. Recession means no growth, higher spending on benefits, lower tax receipts, which will only worsen the deficit.

I'm with Rob, and I'm with the 60 economists. But I do have one concession to the 20. While deficit cutting can't start now, a detailed plan for its eventual repayment should be set out now, to convince the UK's creditors that there is a credible plan and intent to repay the debt eventually.

Monday, February 15, 2010


Optional essay due Friday on WebCT. Drop box now created. Try the essay if you can, your class tutor will mark it and give some feedback.

Rob Elliot lectures this week, so carrying on tomorrow (Tuesday at 3pm in Law, 4pm in Howarth).

My office hours are cancelled today and tomorrow, and will instead take place 2-4pm Friday. Sorry for any inconvenience.

If you haven't already, subscribe to the Twitter feed (username: econ101b) for latest information on the course in terms of lectures, assignments, classes and office hours. Twitter will be the main form of communication for admin matters, this blog for extra interesting reading related to the course.

Winter Olympics

The Winter Olympics have begun in Vancouver, Canada, to much fanfare and not a little tragedy.

An interesting question is whether hosting an event such as the Olympics is beneficial for an economy. It represents a massive increase in government spending usually, and this will certainly be the case for the UK as it hosts the games in 2012. Such increases could be beneficial if they stimulate the economy - government spending is an injection.

However, this depends on the extent of the multipler of such spending - does the money spent on building stadia and other facilities go into the pockets of workers who then spend it in the supermarket, which then ends up in the pockets of supermarket workers who spend it elsewhere, and so on?

Japan has found that the multipler for fiscal projects is as little as 0.3: So 1 yen going into public works (they have an awful lot of useless empty roads here) yields only 0.3 of a yen in terms of actual increase in national output - so in fact the effect is negative. As such, the government here has now stopped all such investments and there are half built roads doing nothing now.

Many people however claim that the Olympics are bad for a nation. Taxes are higher, and potentially inflation will be too - particularly as the UK already has a very large budget deficit.

Does the prestige effect help? More tourists spending money coming to the country? It's a very big calculation, and the pessimists say it's not worth it, while the optimists say it is...

Japan is motoring along again

Japan, where I currently am for just a few more days, today released its figures for 2009Q4 GDP growth. As you can see, it takes all countries a long time to add up all the output going on in their economies - these are figures for October, November and December of last year, not the current quarter, which we're half way through.

Japan is growing again, and growing strongly. While the UK posted a rather meek 0.1% growth in 2009Q4 (that's GDP 0.1% higher in October, November and December 2009 compared to the same months in 2008), Japan has reported growth of 1.1% over the same period.

It seems like Japan is taking off again after many years of sluggish growth - the lost decades we looked briefly at in lectures. Japan is being threatened in its status as the world's second largest economy by China.

However, although total GDP in China may soon surpass Japan's, it will be a long time before GDP per capita (so the GDP per person in the economy) of China will catch up with Japan, if it even ever will...

Saturday, February 13, 2010

Loonie Left Proposal

On first reading, the suggestion by the New Economics Foundation, reported on the BBC website, sounds great - 4 day weekend, wehey!

Naturally, it'll never happen, but suppose for a moment it did. This would represent a massive shift to the left in the Aggregate Supply curve for the economy, since we could produce much less if we could only work for 21 hours each week.

Moreover, it's an entirely illogical proposal: Force people to work less - what about those people that want to work 37.5 hours a week, and don't feel like they've done enough if they haven't put a good work week in? Some people might like it, but forcing people to work less instead of the current situation where some people feel forced to work more doesn't seem like much of a difference.

Friday, February 12, 2010

Double Dip Ahead

Figures released today show that Germany didn't grow at all in the last quarter of 2009, registering a change in GDP over that period of 0%. France grew stronger than expected, but overall the Eurozone grew by just 0.1% compared to 0.4% in 2009Q3, raising fears of a double dip recession.

The article describes Germany's resurgence as being export-led - exports are an injection of money into the circular flow. However, domestic demand appears to still be weak, and it is always difficult to rely on the spending of other countries for growth in your own economy, since this is less under the potential control of domestic policymakers (via monetary or fiscal policy).

Saturday, February 6, 2010

Britain has been hit harder than you think

That's the view of Samuel Brittan: See here.

There's much good stuff to read in here, including theories on how big the output gap currently is - that's the difference between actual and potential output.

Also, he comments on why unemployment has not rised as much as people expected - the theory is that firms have hoarded labour instead of firing people (as has happened in the US). So if the recovery doesn't start soon and keep going, there may be more job losses as firms give up waiting and fire the workers they had been hoarding.

Thursday, February 4, 2010

The End of Quantitative Easing

Today the Bank of England announced it was ending its quantitative easing policy, after pumping £200bn into the UK economy. We talked about this in weeks 2 and 3, about the determination of inflation.

At a very simple level, quantitative easing (QE), pumping billions of pounds into the economy, should create inflation because there is a huge increase in the supply of money, while the demand for money remains unchanged.

However, we noted in the lectures that actually, it's the intersection of aggregate demand and aggregate supply that determines inflation. This is because while money can be created by the Bank of England, it has to actually work its way into one of the components of aggregate demand: C, I, G or NX. That's consumption, investment, government spending or net exports.

Because the QE only went to banks to shore up their balance sheets, which had been hit by many bad loans (such as exposure to US sub-prime mortgages), it hasn't actually made it into investment (via more credit being made available to firms to invest), or goverment spending or consumption. Banks have basically sat on the cash so far.

As the BBC article points out, this may cause problems in months and years to come, as the economy picks up, as this money may well be lend out then by banks, and used for Consumption or Investment, and then we may start to see inflation pressures return, and a need to drain this money out of the system again - for example by higher interest rates.

But that's a bridge to be crossed as and when the UK returns to strong economic growth...

Obama and China Spar

The US and China are again at each others' throats, at least figuratively. Yesterday President Obama declared his intent to put pressure on China to be more reasonable with its exchange rate policy. China obliged today with a suitably defiant response.

What he meant was he hoped China would loosen its strict policy on its exchange rate. China operates a fixed exchange rate with the US dollar, and where necessary intervenes to protect this rate.

It's long been argued the Chinese exchange rate is too low. China's motive to keep it low is clear: A low exchange rate means us Brits, Europeans and Americans find Chinese goods cheaper, and hence buy more of them. However, Americans have long cried foul over this - not that they can buy cheaper goods, but that the exchange rate is artificially low, meaning that American consumers prefer Chinese goods to US goods.

If the Chinese exchange rate appreciated, as the theory of the determination of a currency's value, that we went through in week 3, suggests it should (there's loads of demand for Chinese currency so we can buy their goods and the supply isn't increasing much), then Chinese goods would become more expensive, and the theory suggests, we would buy less and get more domestically produced goods.

So China's exchange rate policy makes trade deficits in the UK and US much worse, potentially costing jobs here, and hence why the US often cries foul at this market intervention that adversely affects their industries.

Of course such arguments and efforts being placed in lobbying in Washington and Beijing are efforts not being made to make US (and UK) industry more productive and hence more competitive. It's a little like the schoolkid who stops and says "that's not fair" but doesn't try and do anything about it.

Furthermore, it's likely a little short sighted. We're relying on all these cheap Chinese goods to keep our prices down here in the West. If the exchange rate changed, all the goods we import would cost a lot more, and we'd be poorer as a whole. It's somewhat optimistic to think that suddenly UK (or US) industry will suddenly step in to fill this breach.

But maybe we are happy accepting a little more inflation if it means more jobs eventually return to our shores? But will they? Won't some other country start producing at a cheaper price than we can produce? Why shouldn't we try and develop new jobs in new industries, and accept the industries of old are just that?

We have to accept the negative consequences of the world order we established: We get cheaper, vastly higher-tech goods, but we must move with the times and get on with producing the next thing the world wants, instead of subsidising or protecting the things the world doesn't want any more (at the price we can produce them at).

Wednesday, February 3, 2010

Exchange Rate Woes

The pound fell again yesterday and today after some more statistics were released, and in anticipation of the next Bank of England Monetary Policy Comittee meeting, according to Reuters.

The article discusses the factors that caused the pound to lose value: Lack of confidence in the UK economy. If investors do not believe the UK is about to pick up, there are probably better places for them to put their money - notably other industrialised nations that are growing much faster than the UK is. More growth means more opportunity to make returns on assets. We discussed a number of these factors in our lectures in week 3 on the exchange rate.

Monday, February 1, 2010

Planned Injections not Equalling Withdrawals

We've covered the circular flow of income recently in lectures, and in particular looked at government spending G (injection) and taxation T (withdrawal).

We also said that there is nothing guaranteeing that injections will equal withdrawals, although we talked about forces that will force equilibrium to be restored.

President Obama today announced a $1.56tn (yes, trillion) budget deficit plan for the US, in a very obvious example of injections massively exceeding withdrawals for the US economy.

The US government is still attempting to stimulate economic activity in the US economy by injecting money into the circular flow.

Naturally in years to come forces will move to close this deficit: Either the US economy will grow strongly (enabling spending on benefits to fall and tax revenues to increase), US inflation will rise (reducing the dollar value of the debt), or the US will default on its debt obligations - or some combination of those three...