To measure policy-related economic uncertainty, the Economic Policy Uncertainty construct an index from three types of underlying components.
1. The first component is an index of search results from 10 large newspapers. The newspapers included in our index are USA Today, the Miami Herald, the Chicago Tribune, the Washington Post, the Los Angeles Times, the Boston Globe, the San Francisco Chronicle, the Dallas Morning News, the New York Times, and the Wall Street Journal. From these papers, they construct a normalized index of the volume of news articles discussing economic policy uncertainty.
2. The second component of our index draws on reports by the Congressional Budget Office (CBO) that compile lists of temporary federal tax code provisions. They create annual dollar-weighted numbers of tax code provisions scheduled to expire over the next 10 years, giving a measure of the level of uncertainty regarding the path that the federal tax code will take in the future.
3. The third component of our policy-related uncertainty index draws on the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters. Here, they utilize the dispersion between individual forecasters’ predictions about future levels of the Consumer Price Index, Federal Expenditures, and State and Local Expenditures to construct indices of uncertainty about policy-related macroeconomic variables.
They find that current levels of economic policy uncertainty are at extremely elevated levels compared to recent history. Since 2008, economic policy uncertainty has averaged about twice the level of the previous 23 years. See animation from The Economist below.
America’s debt row makes economic policy more uncertain than amid actual war.
A hat tip to colleague David Parr for this great graphic. It shows which administrations have been America’s biggest borrowers from 1940-2012. What is interesting to note is the level of borrowing during recessions – grey columns. During the 1970′s there was very little borrowing as the policy of the day was to reduce the inflationary pressure and cut the money supply. Compare that with 2002 onwards and you will see an increase in debt to get out of the recessionary periods. Click the link below to go to the enlarged image.
The Lorenz curve is a useful tool used by those interested in statistics and economics to give a picture of distribution. Its plots the % of household income on the vertical scale against the % of households on the horizontal. An example is shown right.
The Gini Coefficient is derived from the same information used to create a Lorenz Curve. The co-efficient indicates the gap between two percentages: the percentage of population, and the percentage of income received by each percentage of the population. In order to calculate this you divide the area between the Lorenz Curve and the 45° line by the total area below the 45° line eg.
Area between the Lorenz Curve and the 45° line / Total area below the 45° line
The resulting number ranges between:
0 = perfect equality where say, 1% of the population = 1% of income, and
1 = maximum inequality where all the income of the economy is acquired by a single recipient.
* The straight line (45° line) shows absolute equality of income. That is, 10% of the households earn 10% of income, 50% of households earn 50% of income.
* The Lorenz Curve itself shows actual distribution of income. The further the Lorenz Curve is away from the 45° line, the more unequal is the distribution of income.
* Lorenz Curves are typically drawn from gross income. Once disposable income is taken into account, the Lorenz Curve will most likely move inwards. This is because, as we shall see, the net effect of taxes and other distributional measures of government is to bring everyone’s disposable incomes closer together.
* Those countries where the wealth is in the hands of a few, such as oil sheikdoms, will have Lorenz Curves extremely bowed.
Lorenz curves may also be drawn to show the extent of inequality in the distribution of wealth. Such curves are likely to be even further away from the line of complete equality than are those of the distribution of income. This is because most people have some disposable income while not everyone has assets.
Tools of Redistribution
If we are concerned with how well-off people are and how much inequality there is, looking only at individual or household disposable income is not enough. It is not simply a matter of how much cash income the government leaves us with. The use of taxes and transfers may be the main way of directly redistributing income, but this is not the only way by which government can influence well-being. A combination of approaches can better tackle the problem. In general we may consider that government influences the extent of inequality by:
• The way in which it raises taxes to pay for public goods that everyone has such as defence and parks. The tax system may be designed to take more from the higher income groups, while everyone gets similar benefits from the public goods.
• Giving transfers, such as family support and the sickness benefit, to those whose income is very low or who cannot earn.
• Providing collective goods mainly to the lower income groups.
• Providing targeted subsidies or subsidies received only by those with low incomes&emdash; e.g., housing loans and education grants.
• Providing general subsidies on basic goods such as bread, milk, GP services and electricity. These used to be far more important than they are today. Subsidies have the problem that they encourage waste.
• Ensuring that all employers pay a fair wage under minimum pay, equal pay and pay equity legislation.
• Ensuring that everyone has equality of opportunity. Those who wish to proceed to tertiary education, for example, should be given the opportunity.
• Encouraging training and acquisition of skills by all school leavers.
Currently at UNITEC doing a 3 day AS revision course. Used this graphic to explain indirect taxes. An indirect tax will have the following effects on the market:
• The supply curve shifts vertically upwards(effectively a shift to the left) by the amount of the tax(gf) per unit. The price increases but not by the full amount of the tax. This is because of the slopes of the demand and supply curves.
• The consumer surplus is reduced from acp to agb. The portion gbhp of the old consumer surplus is transferred to government in the form of tax.
• The producer surplus is reduced from pce to fde. The portion phdf of the old producer surplus is transferred to the government in the form of tax.
• The market is no longer able to reach equilibrium, and there is a loss of allocative efficiency resulting in the deadweight lost shown by the area bcd. This represents a loss of both consumer surplus bhc and the producer surplus hcd that is removed from the market. The deadweight loss also represents a loss of welfare to an individual or group where that loss is not offset by a welfare gain to some other individual or group.
Franz Nauschnigg wrote a piece in Project Syndicate about an emerging imbalance in the goods and services deficits that Portugal, Italy, Ireland, Greece and Spain (PIIGS) have with China. Up to 2004 the biggest deficits of the PIIGS economies was with the rest of the eurozone. But in subsequent years the figures were the following:
From the figures you can see that over the last 4 years the deficit with China has remained significant while it has narrowed with the eurozone especially with Germany. There are two reasons for this:
1. The euro has appreciated against the renminbi.
2000 – € = ¥7.4
2007 – € = ¥10.4
With this appreciation the eurozone countries exports became less competitive. The early 2000’s saw a lot of investment into the PIIGS economies which increased inflation and prices.
2. With the southern economies dependent on textiles, footwear etc the stronger euro made Chinese imports a lot cheaper than the domestic alternative. The IMF acknowldeged the fact that Chinese exports were responsible for the deficits in the PIIGS but Northern Europe wasn’t as badly affected as their export focus is more machine based which China is not able to compete with.
With monetary and fiscal expansion becoming ineffective external adjustments under three conditons might be the answer:
1. Stronger external demand
2. A less onerous financing environment
3. A weaker euro
Much of the above could be achieved by a weaker euro against the renminbi. This would provide the boost to export revenue and reduce fiscal and external deficits.
Lower interest rates has a positive effect on debt servicing costs. As a % of exports foreign debt servicing has fallen from 20.8% in 2007 to 10.6% at the start of 2013. However there is concern about the longer term effects of lower interest rates and the impact it will have on the housing market in NZ. If the CPI is pushes up towards the 3% the RBNZ may be forced to increase interest rates which influences the strength of the NZD and debt servicing. Furthermore, because net debt continues to increase indefinitely in the historic trends scenario, financing costs also increase exponentially. Below are graphs showing NZ’s debt servicing costs and explaining the debt spiral.
In the NYT it was stated that Moody’s are predicting that a tighter fiscal policy – cuts in government spending and increased taxation – will slow economic growth for 2013 by about 1.2 percentage points and prevent the unemployment rate from falling to 6.1 percent by the end of the year. Where is the effect of QE on these figures?
Lately there has been a lot of media coverage about an Excel error by academics Ken Rogoff and Carmen Reinhart – co-authors of ‘This Time is Different’ – 2009. A student from University of Massachusetts tried to replicate one their models regarding growth rates when a country has a public debt of greater than 90% of GDP. Rogoff and Carmen stated that with this level of public debt growth in a country falls to a mean of -0.1%. However using the same data the student found that a figure of 2.2% was applicable in this context.
However Rogoff and Reinhart have been cautious about saying that high debt causes slower growth rates but it does highlight the validity of analysis connecting debt and austerity to growth rates. Adam Posen in the FT stated that the claim of a clear tipping point for the ratio of Government Debt to GDP past which an economy starts to collapse doesn’t hold. Following the second world war the US, UK, Belgium, Italy and Japan had public debt greater than 90% of GDP but there was not much of an effect on their economies. In Italy and of late in Japan stagnation in economies led to slowly rising debt levels. In the UK and US in the 1950’s growth returned and debt levels declined. What this is suggesting is
Slow growth is at least as much the cause of high debt as high debt causes growth to slow.
But a certain amount public debt is necessary for future development of any economy especially when you think about the construction of infrastructure and government spending on education. Both of which contribute to future growth and in theoretical terms move the production possibility curve outwards. This in turn creates growth and subsequently income for a government.
USA – Mad Spending v EU – Nervous Austerity
With one side of the Atlantic – USA – involved in quantitive easing (printing money) and the other – EU – with severe austerity, maybe somewhere in between would be a logical way to go about things. But is moderation a choice for policy makers when they have already gone so far down the track of their respective plans?
What can be concluded is that too much debt has costs for growth but the degree of those costs is dependent on the reasons for debt accumulated and what path the economy is actually taking.
The 10bn-euro (US$13bn) bailout of Cyprus’ economy, agreed by the EU and IMF, demands that all bank customers pay a one-off levy and has led to heavy cash withdrawals.
Under the currently agreed terms, depositors with:
* Less than 100,000 euros in Cyprus accounts would have to pay a one-time tax of 6.75%.
* More than 100,000 euros would pay 9.9%.
The BBC says the president may want to lower the former rate to 3%, while raising the levy on the larger depositors to 12.5%. Some EU source told Agence France-Presse there could be a three-way split on the level of levy, grouped into accounts holding less than 100,000 euros, between 100,000 and 500,000 and more than 500,000. The clip below is from Al Jazeera – it shows at one bank in the Limassol district, a frustrated man parked his bulldozer outside and threatened to break in.
Japan’s Prime Minister Shinzo Abe recently addressed parliament stating that he plans to reverse the trend of issuing bonds to raise money but raise more in taxes. Japan cannot beat deflation and a strong currency (yen) if it adheres to the same policy of the past decade.
However his speech comes after the announcement of a $226.5bn stimulus package earlier in the year and this when Japan already has some serious debt issues – public debt that is almost three times the size of the Japanese economy.. He also wants the Bank of Japan to maintain an open-ended policy of quantitative easing (QE) and a doubling of the inflation target – 2%. Hopefully the fiscal stimulus package accompanied by more QE will drive down the price of the yen which will make Japanese exports more competitive. He stated his three arrows of economic policy:
1. Aggressive Monetary Easing
2. Flexible fiscal spending
3. A growth strategy that would induce private investment
Who knows if it will work but Shinzo Abe stated that it is worth the gamble.
Another very useful clip from Paul Solman of PBS News. China has for quite a few years now gone down the route of government planning to keep economic activity buoyant. Assumptions have been made that in 10 years time there will be 200 cities in China with over 1 million people and 8 being over 10 million. However a recent blog post showed that there are ghost towns in certain areas of China with empty housing estates.
An example of artificially creating growth, as well as building ghost cities, is have a 7 year old bridge (built to last for 40 years) blown up and rebuilt. This generates jobs for construction industry including contractors for different aspects of the bridge. This likens to Keynesian policy where J.M.Keynes said that you should dig holes and fill them in to keep people employed. The Soviet Union found that central planning is good at mobilising resources, but is not good at sustaining innovation, or incentives that promote long-term growth. What China needs is more domestic consumption and move away from a reliance on government investment projects and export revenue. As ever Paul Solman explains things well.
The race for countries to devalue their currency (make their exports more competitive) has led to massive increase in monetary stimulus into the global financial system. We are all aware of the three rounds of Quantitative Easing from the US Fed and the indication that they would keep the Fed Funds Rate at virtually zero until 2015. To add fuel to the ‘dim embers’, in 2013 the US is going to inject US$1 trillion into the circular floe. However in China they have also embarked on some serious stimulus:
* More infrastructure development – US$60bn
* Additional credit – US$14 trillion in extra credit since 2009 (equal to entire US banking system)
Nevertheless even with all this artificial stimulus there might be some short-term growth but I can’t see it being sustainable when you consider the extent of global deleveraging. Also IMF figures show that the world saving rates are on the increase (* forecast):
With increased saving rates accompanied by significant austerity measures in many parts of Europe where is the consumer demand going to come from? Unemployment in Spain is 26% and predicted to hit 30% this year- more worrying is 50% of those under 25 are unemployed. Spanish protesters chanted “We don’t owe, we won’t pay” in a march against austerity. So in the US we have massive fiscal stimulus but across the water in Europe it’s all about “tightening the belt” and cutting government spending. Neither seems to be working and are we just putting off a significant downturn for a later date?
After a year in operation the Danish government recently announced that it was to abolish its tax on saturated fats. The idea behind the Fat Tax was to increased the price of unhealthy foods and therefore reduce consumption and improve the health of the population. However in practical terms the tax was a nightmare to administer as it not only targeted chips, burgers, hot dogs etc but also high-end food including gourmet cheeses. According to some critics this was to the worst example of the nanny state. The Economist reported some of the problems:
* Bakers were concerned with fat content in their cakes.
* Pig farmers said their famous bacon would cost more than imports.
* Independent butchers complained that supermarkets could keep their meat prices down as they could spread the cost of the tax across other goods.
* The tax applied on meat was imposed by carcass not per cut, which meant higher prices for lean sirloin steak as well as fatty burgers.
* Before the tax was imposed there was significant hoarding especially in margarine, butter and cooking oil
However there was also a surge in cross border shopping and a study estimated that 48% of Danes had done shopping in Germany and Sweden – sugary drinks, beer, butter etc were no doubt high on the shopping list.
Here is another classic from Merle Hazard – the Nashville country artist who sings about the world of finance. Here he sings about the Fiscal Cliff.
by Merle Hazard
It was a sunny day down in Washington. I took my Chevy out for a spin. While I was stopped at a light, I saw some cars to my right, and then what happened nearly did me in. House Speaker Boehner pulled his wheels next to Senator Reid’s, and then they got into an awful tiff. So Boehner said “Let’s fight,” and Reid said “Yeah, you’re right.” ”Let’s have a drag race to the fiscal cliff!”
Fiscal cliff The fiscal cliff is a danger zone. It’s where grown men go when budgets are blown. If our Senators cannot agree, they make Massive cuts automatically. When the budget talks have come to a halt, People go there and they threaten default. What will happen if we hit the fiscal cliff?
It was a game of chicken; I was really scared. I didn’t want anyone to die. But Boehner revved it up, and said “Keep taxes low,” and Reid said ”No, we must keep spending high.” And then it finally happened, what I always feared. And, yeah, it looked as bad as you would think. Our elected reps skidded out of control And drove their cars right over the brink.
Fiscal cliff The fiscal cliff is a danger zone. It’s where grown men go when budgets are blown. When our Congressmen cannot agree, Taxes go up automatically. When the budget talks have come to a halt, People go there and they threaten default. What will happen if we hit the fiscal cliff?
[Spoken] Well, officer, my memory of that day has never gone away. I often find myself thinking, “What if?” And what I’ve realized is that if they’d only been wise enough to compromise, well…
[Sung] They could have saved us from the fiscal cliff!
Fiscal cliff Wah wah wah, wah wah wah wah wah…
Thanks to Richard Wells for this video clip. With defeat in the US election Mr Burns explains the Fiscal Cliff at the Springfield Republican Headquarters. Worth a look.
Negotiations over the US Fiscal Cliff continue with hopes rising that a compromise will be averted. During the week, Fed Chairman Ben Bernanke said that the ‘fiscal cliff’ is a substantial risk to the outlook for America. However he also pointed out that if America’s fiscal issues could be sorted out then “the US economy might be in for a very good year” ahead. In negotiating with the Republicans to avoid the fiscal cliff, Obama has said that he will refuse to sign legislation that extends the current top rates on incomes over US$200,000 for individuals and US250,000 for couples. However he has asked for an extension of tax cuts to middle and low income earners.
From the chart below you can see that the main factor behind the fiscal cliff is the expiring of tax cuts.
With the US debt currently standing at 16 billion dollars and the prospect of a fiscal cliff – slashed spending and higher taxes – is it sustainable to keep on borrowing money? Historically Americans have preferred debt to taxes – you could say that it all started with the Boston Tea Party where they disposed of tea in the harbour because of the tax policy of the British government and the East India Company that controlled all the tea imported into the colonies. The video clip below from PBS News has MIT economist Simon Johnson talking about his recent book “White House Burning” which discusses the history of US debt – 225 years of it. He states that if we want to keep Social Security and Medicare we need to think how you are going to pay for it. The answer is NOT selling more debt to the Chinese but to pay the taxes to support social insurance programmes. He also mentions that if you go over the fiscal cliff in a disorganised way, with significant political confrontation, it will be a disaster. Quite simply the US government needs to acquire more tax revenue and bring its spending under control.
Free Exchange in The Economist debated this topic and went into detail concerning the Fiscal Multiplier. It refers to the change in GDP that is due to a change in government fiscal policy – taxes and spending. They use the following examples
Multiplier = 1.5 Government Spending down $1 = overall spending down = $1.5
Multiplier = 0.5 Government Spending down $1 = overall spending down = $0.5
Therefore the value of the multiplier is the crucial variable and a value that is greater than the level of GDP you maybe able to close the deficit but this results in a higher debt to GDP ratio than it started with. Estimates of the fiscal multiplier have been approximately 1% or below and the IMF have suggested that if you cut deficits by 1% of GDP it will have an impact of 0.5% of GDP – multiplier value of 0.5. What has been suggested is that:
Spending cuts may “crowd in” private-sector activity: if governments are using up scarce capital and labour then austerity creates room for private firms to expand. In open economies, austerity’s bite can be passed on to other countries through reduced imports. Most important of all, monetary policy can act as a counterweight to fiscal policy. Spending cuts that threaten to drag growth below a desired level should prompt monetary easing, limiting the multiplier.
However timing is everything and austerity measures now are not conducive to favourable outcomes for the following reasons:
1. With many economies implementing the same measures the impact can’t be deflected onto others.
2. Austerity measures normally might free up resources for private use but that mattered far less when unemployment and saving were high.
3. With interest rates at near-zero levels there was little scope for any additional monetary stimulus to offset the fiscal tightening. Monetary policy has run out of ammunition.
Another really good video from Paul Solman of PBS, this time he talks with Wall Street Journal journalist David Wessel about America’s debt. Some noteworthy facts include:
* 63 percent the government spent went out the door without a vote of Congress
* 20 percent of the federal budget is spent on defense – $700 billion last year, more than the combined defense budgets of the next 17 largest defense budgets of other countries
* Each aircraft carrier is $11 billion. This is enough to replace 750,000 shoulder, knee, and hip joints for people on Medicare.
* In 2011 the government took in $1.3 trillion in tax revenue, but the Treasury adds up the value of all the loopholes, deductions and credits, and they amounted to $1.1 trillion.