Thursday, May 27, 2010

More on the Cuts

The internet is a rich source of blogs written by economists when they should probably be doing some work.

I'm keen on blogs by intelligent economists that argue against the current general public's sympathy for the need for efficiency savings, massive deficit reduction and a reduction in the size of the state on the grounds that the Tories made the arguments. So I enjoyed this morning reading a blog called Stumbling and Mumbling.

From three days ago, a post on Nick Clegg's abandonment of his previous position in favour of the Tory line, and his clear confusion on the subject. It does seem a shame that Clegg can't just say: Yep, we had to give in on this one in the interests of the coalition holding together, but instead has to put on this really rather sad show that he really now thinks this is necessary. As the blog post makes clear, his position is pretty weak at best.

From two days ago, a comment on the actual cuts, making use of some of the microeconomics learnt in econ101a as well as thinking about the macro scale of things learnt in econ101b.

How exactly is the big boss (Osborne) going to know where the inefficiencies are? It's in the interests of those that profit from the inefficiencies to hide them in any large institution (and the public sector at millions of workers is pretty huge!). As a result, Osborne couldn't really identify many efficiency savings and so has just done what was long expected, and cut anyway.

Wednesday, May 26, 2010

The OECD on the UK via the WSJ

The OECD publishes fairly frequent forecasts on the state of the global economy, and its constituent parts - so recently it has revised its opinion on the UK: See here.

It thinks UK interest rates should rise to about 3.5% by the end of 2011 to cope with rising inflationary pressures likely to come about due to a recovering economy and a lot of money moving around (after Quantitative Easing). 3.5% seems high, but then this is 18 months down the line, and a lot of water could pass under the bridge between now and then...

The Cuts!

So the Tories (helped by the Lib Dems) got into power in the end, and late last week were able to announce the first installment in their cuts, £6.25bn announced by George Osborne last week. As noted in the Times article flagged up in the last post on GDP growth, this fiscal tightening is likely to act as a "brake on growth".

That comes from the simple analysis from the circular flow of income and the multiplier effect. From there, government spending (G) was an injection of funds into the circular flow, and taxation (T) a withdrawal. If G rises, the money then goes round the cycle a few times, with withdrawals along the way. So if £6.25bn was injected into the economy, the overall effect would be greater than £6.25bn.

How much greater? This depends on how much is withdrawn each time, and of course everybody is different. But let's look into some rough and ready figures. The top band of income tax is currently 40%, but of course we're taxed in many ways less directly. So lets say half our income goes in taxes. Then there's savings. The data suggest that essentially we don't bother saving much these days - although that's changing at the moment with all the talk of austerity. So lets say we save 10% of our income. Then we import a lot too, so lets say perhaps we import goods amounting to about 20% of our income. That leaves just 20% of that £6.25bn still in the cycle next time round.

The overall multiplier then will be 1/0.8=1.25 and hence £6.25bn becomes only £7.8bn. So assuming the same works in reverse, then perhaps George's cuts won't be too bad.

But, of course, what if we don't import as much as 20%? What if we save a bit less? Say we save just 2% of our income, and import 10%, then the marginal propensity to withdraw (what we divided by a moment ago for the multipler) becomes 1/(1-0.5-0.02-0.1)=1/0.38 and £6.25bn becomes £16.4bn.

How much is the economy currently growing by? GDP in 2010Q1 was £360bn up from £349bn in 2009Q1 (see So that appears to be a jump of just £11bn between 2009Q1 and 2010Q1.

We shall have to wait and see what the effect of Osborne's cuts are. At least one commentator acknowledges the effect of the multipler (see this FT article), but doesn't think it'll be big enough to tip us back into recession. It'll be interesting though (and painful for many I imagine).

Growth Revised Up

In the last week, the Office for National Statistics (ONS) has announced that GDP growth for 2010Q1 has been revised up from 0.2% to 0.3%. May not sound like a big deal but when GDP is in the order of billions, 0.3% of a billion is a substantial number.

What are these updates? Are they the outcomes of different measures of GDP? The answer is no: They are simply the ONS getting closer to the right number.

There's great clamour in our 24-hour news, instant gratification culture to get our hands on the numbers as soon as possible, and the ONS responds to that by announcing GDP as early as possible after the quarter has ended (at the end of March in this case). That comes (I think!) 40 days after the end of the quarter, and the first revision 60 days.

The initial number comes after only a supposedly representative portion of the economy has been added up, and of course over time more of the economy's (recorded) activity is added up. For 2009Q4, the first announcement was 0.2% growth, the first revision up to 0.3%, the last revision to 0.4%. Perhaps the first segment the ONS counts isn't so representative after all.

It should also be noted that it's a quarterly figure, not an annual one. The growth is based on the same quarterly figure for the previous year however (to avoid the fact that production post-Christmas for example will always fall).

Friday, May 21, 2010

MPC Member Talks About UK Inflation

Reported in the Wall Street Journal, Adam Posen talks about the UK's current situation.

Inflation in the UK is rising while it's falling elsewhere, and we're above target yet the Bank of England isn't about to start raising interest rates.

Yet inflation expectations are a big thing: Will people infer from the Bank's lack of action that in reality inflation won't be low any more? Apparently not, Posen says. He says that from surveys and yields on particular length financial assets (ones that you could put your money into if you were concerned about inflation eroding the value of your money), expectations are still "anchored".

But why is inflation rising in the UK and not elsewhere? It's keeping the MPC up at night. We covered in our lectures cost-push and demand-pull inflation. In the last 2 years the pound has lost 25% of its value against our trading partners. That could well explain why inflation is up: Cost-push inflation, as the cost of inputs rises because we import many of our inputs.

Maybe a student of econ101b should write to Adam and help him get some sleep tonight...

Tuesday, May 18, 2010

Inflation is high

Today it's been announced that inflation has hit 3.7%, way above the Bank of England's 2% +/- 1% target. Hence the governor of the Bank of England, Mervyn King, has had to send another letter to the Chancellor. Of course, for better or worse (I'd argue the latter), the Chancellor is now George Osborne, as a coalition government formed last week between the Tories and the Lib Dems: We are living in a ConDemNation - best pun I've come across yet.

King has many valid points about inflation and why it's high - the weak exchange rate, which if you recall, makes imports more expensive. And we Brits tend to consume many imports (not least fuel). But also, this time last year VAT was at 15%, and now it's back up to 17.5%, distorting the figures.

Interestingly enough, King expects inflation in 2011 to be below target, so to fall from its current level. This is despite the record government deficit (remember how the PSNCR feeds into the money supply and hence likely feeds into inflation), and also a likely further hike in VAT to about 20%.

Exam is Over. What now?

You've done the econ101ab exam, and hopefully it wasn't too painful (despite the chaos in both rooms where the exam took place - sorry about that). In time you'll get your results.

In the meantime, I'll carry on making econ101b-related posts on here. My apologies for the long break in postings - I got somewhat carried away in Facebook debates about the economy pre-election.

Thursday, May 6, 2010

Election Day!

I guess Monday's looming exam weighs more heavily on your minds, but if you want a light hearted distraction related to the course, the Guardian is reporting that 18 of the last 20 UK elections have been correctly predicted by the US stock market, the Dow Jones.

Recall that stock markets reflect confidence in the economy, and hence can often be seen as a barometer of economic sentiment. Left-wing parties have often been seen as bad for the economy and hence the stock market may fall on expectation of a left-wing party gaining power.

So this Guardian reporter suggests that the US stock market predicts a hung parliament, but the FTSE predicts a Tory majority. We'll have to see. I could wax lyrical on what the FTSE movements mean, but I won't.

I'll vote Labour later on today, and hope for the sake of the economy that the Tories don't get that majority...