Monday, November 22, 2010

Ireland's Bail Out and the Euro

Don't just be aware of politicians and their inability to grasp the simple economics you'll be learning this year and throughout your degree, be aware also of journalists who peddle bad economics and bad science in the pursuit of convincing you of their prior prejudice.

Today, Ireland will be bailed out by a number of international institutions: The Eurozone, the EU and the IMF. It's the upshot of Ireland's banks taking on a vast amount of liabilities, way in excess of the entire GDP of Ireland. In other words, it's the upshot of hugely bad decisions on the part of bankers in Ireland.

Of course, this is grotesque for so many Irish people, who have had to endure massive austerity measures as a result of these terrible decisions. However, if you read the Telegraph, the Daily Mail and the Sun today about the situation, you'll probably come away believing the Euro is the sole reason for all of Ireland's problems.

You may even hear Tory politicians like Douglas Carswell who may try to tell you that Ireland's difficulties are entirely Euro based and that in fact we're not bailing out Ireland today, but the Eurozone.

Let's stand back for a moment. A single currency between Ireland and most of its major trading partners has existed now for 10 years, against the pleasure of people like Douglas Carswell and the right-wing, Europhobic media. So you have to take things with a pinch of salt. You have to ask things like, as an economist: What is an Optimal Currency Area? Is it the Eurozone? Is it bigger? Is it smaller? The North East of the UK often struggles with being in the same Poundzone as the South East - although of course Carswell and co don't call for the break-up of the Poundzone which bears all the characteristics of the Eurozone.

The answer, of course, is that there are some benefits to a common currency. It's nice to not have to change currency, to be subject to the whims of the foreign exchange markets. But as economic experience and theory has shown over the years, this is only true to the extent that changes in the level of competitiveness (reflected in productivity) can be recognised within this arrangement: Either by the moving of prices or exchange rates to ensure the Law of One Price, or PPP, roughly holds.

More on all of this next term. In the meantime - look beyond what journalists and politicians write and ask why they write it in the first place...

Friday, November 19, 2010

What is a Central Bank and Why Do We Have One?

It's become very fashionable in the US (I guess it's always been fashionable in reality but it seems to have been amplified since 2007) to criticise the Fed - that's the US central bank system.

There's been a recent discussion between Tyler Cowen and Alex Tabarrok, with a bit extra from Brian Caplan, about this.

Tabarrok, along with some of the research he cites, goes a little further than perhaps many of us in the UK might even begin to think: He talks about what would have happened had the Fed never existed. In 1903 the Federal Reserve system was established, whereas the Bank of England has been existence much longer (although not necessarily in its current form).

This is a much stronger position than just assessing the performance of an institution, but it does beg the question: What would happen instead? What exactly does a central bank do? Reportedly the Fed was given the mandate to stabilise the economy and hence conduct monetary policy.

So the research Tabarrok considers looks at pre- and post-Fed and looks at how the economy fared. It finds that post-Fed, things went a bit messy: Great Depression and all that.

But the big problem here is: Can we really rewind the clock and carry out this comparison? We don't know what the US, post-1913, would have looked like without the Fed in place so the comparison is a little false. We can try and control for all of the other factors which might explain economic outcomes, but this is an imperfect science.

So we're basically left with economic theory; what does economic theory tell us about the functions of a central bank? Come back next term for lectures, and we'll find out!

Monday, November 15, 2010


The QE2, you may believe, is a cruise liner, but you'd be wrong. It's what hip and happening economists are calling the second bout of Quantitative Easing by central banks around the world. Well, by the US Central Bank, the Federal Reserve, at any rate. Relatively strong UK economic growth last quarter meant the Bank of England decided against QE2 at its last MPC meeting.

Quantitative easing is, in very simple and not overly accurate terms, the printing of money by central banks. Its official name in the US is the "large-scale asset purchase plan": It is the central bank buying huge amounts of financial assets (bonds and bills) on financial markets, the result being that they push money into the economy (since they have to use money to buy these assets).

The hopeful idea is that this enables the economy to grow because there is more money going around for people to use; one of the common themes of commentators on the state of the global economy has been that no money is available for investing as banks repair their balance sheets.

One way which we'll learn about next term that Central Banks influence economic activity is through interest rates. Lower interest rates make current use of money cheaper (credit is cheaper, less opportunity cost related to saving) and hence this is a common policy used for helping economies escape recessions. However, once interest rates reach zero then Central Banks cannot reduce them any lower to stimulate economic activity, and hence why some central banks have resorted to QE: It is an alternative way to make more money available more cheaply.

As may not be totally unsurprising given the current political climate in America, opinions are strongly divided about QE2. Some argue it's essential to stimulate economic growth in the circumstances, but others are worried about it, not least Sarah Palin.

Wednesday, November 10, 2010

Gold is very valuable and immensely powerful

More on gold. And inflation. This article by David Leonhardt ridicules the media and others who continually talk about new record high prices in commodities such as oil or gold: They aren't adjusting for inflation! Inflation means that it costs more pounds or dollars to get the same thing at a later point in time, as you probably are well aware of. So that means that prices generally rise, and hence new record highs can be quite common.

It's a nice little explanation of this. The article then talks about the wider agenda of people touting the price of gold and is quite complicated. The first bit about adjusting for inflation though is somewhat amusing...

Good as Gold?

You'll learn next term about the history of monetary arrangements that the industrialised world has dabbled with over the years.

Most tend to be abandoned in perceived failure - funnily enough usually around the time of some recession or time of economic difficulty.

The current time of economic difficulty is no different, and people are once again making suggestions that perhaps the current monetary arrangement, inflation targetting, has run its course.

The argument is: Inflation targetting was all well and good; it gave us low and stable inflation and a long period of growth - but it also gave us asset price bubbles (share prices, house prices, commodity prices), most of which have at different points led to small recessions, and arguably to the huge recession we just suffered.

So, instead, some people have suggested a return to something called the Gold Standard. The World Bank's chief Robert Zoellick made the suggestion in the FT last week.

A gold standard is where the value of the currency is backed (at least partially) in gold, some recognisable tangible object. This is in contrast to the current system where currency is backed only in our faith that it is worth what it is worth.

If you're interested in reading more about this suggestion, and how it has been greeted, then there's a New York Times discussion on it here, with contributions from various top economists from the US.