The Turkish Economy, like many emerging economies, is suffering from a declining currency – the Lira. This is partly due to the US Federal Reserve expecting to increase interest rates over the next few months – higher interest rates tend to increase the value of a country’s currency. With a falling lira the cost of Turkey’s imports has increased which has fed through into inflation – this is at the same time that the economy is contracting. The dilemma for the Central Bank of the Republic of Turkey (CBRT) is whether to increase rates and stabilize the currency or to lower rates to boost economic growth.
With an election in June this year the Turkish President Recep Tayyip Erdogan wants the CBRT to lower rates and thereby stimulating economic growth. This he feels would increase GDP from its current rate of 1.7% but more importantly assist him and his Justice and Development party to a fourth straight election victory. However the CBRT has been lowering interest rates in an environment when the inflation rate is above the 5% target as well as a falling lira (see chart from The Economist) – this month they have kept interest rates at 7.5%. Erdogan has criticised the central bank for their lack of aggression in cutting rates and accused the central bank governor and his team of “treason.” It seems that this outburst has in itself caused the lira to fall and the currency to hit an all time low against the US$ earlier this month. Erdogan believes that cutting interest rates will reduce inflationary pressure which goes against all the evidence from central banks globally and mainstream economics.
If Erdogan does get to serve a fourth term who would bet against him trying to claim back some of the central bank’s independence and have government play a more influential role in controlling interest rates.
Source: The Economist
In explaining the G20 to my class I came across an amusing piece from Clarke and Dawe of the ABC in Australia.
What is the G20? The G-20 is made up of the finance ministers and central bank governors of 19 countries and the European Union:
Argentina Australia Brazil Canada China European Union France Germany India Indonesia Italy Japan Mexico Russia Saudi Arabia South Africa Republic of Korea Turkey UK USA.
They recently met in Brisbane and Clarke and Dawe put together their own version of what the G20 is.
Here is another clip from Seinfeld which is an example of moral hazard and imperfect information.
Jerry’s car is stolen, so he rents a car. The rental company doesn’t give him the car he reserved; he gets a small economy car. They ask if he wants insurance, and he replies, “Yes, because I’m going to beat the hell out of this car.” Source: Seinfeld Economics
The accelerator theory states that investment is determined by the RATE AT WHICH INCOME, AND HENCE OUTPUT, CHANGES OVER TIME. The principle states simply that unless the rate of increase in consumption is maintained, the previous level of investment will not be maintained.
This theory assumes that firms try to maintain some constant relationship between the level of output and the stock of capital required to produce that output. In other words, we assume a constant capital-output ratio which can be expressed in either physical terms or money terms. The accelerator helps us to understand how small changes in demand in one sector can be magnified and spread throughout the economy. The example below assumes that the firm starts with 8 machines each year and 1 machine wears out each year and that each machine can produce 100 units of output per year. In the second year, demand rises for capital goods rises by 200% (from 1 to 3). When the rate of growth of demand for consumer goods slows in year 4, demand for capital goods falls. In year 6 demand drops and they is no requirement for any investment.
Limitations of Accelerator:
* Firms can meet output with stocks – may not need investment
* Changes in technology may mean firms don’t need to invest in as much capital as before
* Firms need to be convinced that demand is long-term to warrant investment
* Limited supply of technology available
Below is a great video from “We the Economy”.
On the heels of the financial crisis, Wall Street for some has become synonymous with corruption and greed. Director Joe Berlinger takes us to the epicenter of the financial world – the New York Stock Exchange – to learn how Wall Street really influences the economy and impacts all of our lives.
Part of the CIE A2 macro syllabus focuses on the wage price spiral which relates to the Phillips Curve. Here are some excellent notes that I picked up from Russell Tillson in my early days teaching at Epsom College. As from previous posts, the Phillips Curve analysed data for money wages against the rate of unemployment over the period 1862-1958. Money wages and prices were seen to be strongly correlated, mainly because the former are the most significant costs of production. Hence the resulting curve purported to provide a “trade-off’ between inflation and unemployment – i.e. the government could ‘select’ its desired position on the curve.
During the 1970’s higher rates of inflation than previously were associated with any given level of unemployment. It was generally considered that the whole curve had shifted right – i.e. to achieve full employment a higher rate of inflation than previously had to be accepted.
Milton Friedman’s expectations-augmented Phillips Curve denies the existence of any long-run trade off between inflation and unemployment. In short, attempts to reduce unemployment below its natural rate by fiscal reflation will succeed only at the cost of generating a wage-price spiral, as wages are quickly cancelled out by increases in prices.
Each time the government reflates the economy, a period of accelerating inflation will follow a temporary fall in unemployment as workers anticipate a future rise in inflation in their pay demands, and unemployment returns to its natural rate.
The process can be seen in the diagram below – a movement from A to B to C to D to E.
Friedman thus concludes that the long-run Phillips Curve (LRPC) is vertical (at the natural rate of unemployment), and the following propositions emerge:
1. At the natural rate of unemployment, the rate of inflation will be constant (but not necessarily zero).
2. The rate of unemployment can only be maintained below its natural rate at the cost of accelerating inflation. (Reflation is doomed to failure).
3. Reduction in the rate of inflation requires deflation in the economy – i.e. unemployment must rise (in the short term at least) above its natural rate.
Some economists go still further, and argue that the natural rate has increased over time and that the LRPC slopes upwards to the right. If inflation is persistently higher in one country that elsewhere, the resulting loss of competitiveness reduces sales and destroys capacity. Hence inflation is seen to be a cause of higher inflation.
Rational expectations theorists deny Friedman’s view that reflation reduces unemployment even in the short-run. Since economic agents on average correctly predicted that the outcome of reflation will be higher inflation, higher money wages have no effect upon employment and the result of relations simply a movement up the LRPC to a higher level of inflation.
John Cassidy wrote a piece in The New Yorker which focused on the US Fed targeting the threat of bubbles rather than inflation when implementing policy instruments. In the mid 1990’s and early 2000’s the Fed set interest rates based on the supposed threat of inflation. However price rises never materialised so the low interest rates fueled borrowing especially for purchasing property.
In the past, expansionary monetary policy (low interest rates) would have acted as a catalyst to the real danger of a wage price spiral in which rising wages and prices become self-reinforcing, pushing inflation up. This was very apparent in the winter of 1974 in the US when inflation reached 12% and 15% by 1980. But today with the annual rate of inflation in the US at less than 2% for the past three years the threat of another wage price spiral is fairly dormant. It was forecast that that wage and price inflation would start to rise but average hourly earning rose by just 0.1% in January. Over the course of the past year, it has risen by 2%, which is a very modest rate of increase.
Economists have never been able to pin down the jobless rate at which inflation takes off—the so-called NAIRU, or Non-Accelerating Inflation Rate of Unemployment. Theoretically, the concept makes sense. Empirically, it’s extremely elusive, because it depends on many other things, such as the rate of productivity growth, tax rates, the labor-force participation rate, and the level of unionisation.
However higher wages will eventually surface with a tight labour market but the real dilemma for the Fed is the tradeoff between cheap money and financial instability. Keep interest rates too low for too long and you ignite another asset bubble or raise interest rates to alleviate the bubble risk but dampen growth in the economy?