Brian Fallow of the New Zealand Herald wrote a very informative article on the inflationary target that the Reserve Bank of New Zealand keeps missing – the CPI has been below the bottom of the bank’s 1 to 3% target band. Some will say that the RBNZ has been too tight with its monetary policy stance – maintaining high interest rates for too long. Assistant Governor John McDermott has defended the bank’s position for the following reasons:
- Nearly half the CPI consists of tradables where the price of goods is impacted by competition from outside New Zealand. For the last four years the global economy has been in a disinflationary environment caused by excess supply and in particular low commodity prices especially oil. Year ending September 2016 Tradables = -2.1%. This offset almost all of the +2.1% rise in non-tradables prices. See graph below.
- The recovery form the GFC has been quite weak and with the NZ$ strengthening (imports cheaper) accompanied by lower world prices has meant that import prices have been very low.
- The growth of the supply-side of the economy has been particularly prevalent which again has led to less scarcity and lower prices.
- Recent years has seen immigration boost the demand side of the economy but because the age composition is between 15-29 rather than 30-40 in previous years, the former has a much less impact on demand as they don’t tend to have the accumulated cash for spending.
- The RBNZ reckon that the output gap is now in positive territory (actual growth being higher than potential growth) which will start to put pressure on prices as capacity constraints become more prominent.
- Statistically with a weak inflation rate in the December 2015 quarter the December 2016 quarter is most likely to be higher as the percentage change is taken on the CPI of the previous year.
The spectre of deflation hitting the New Zealand economy does not seem to be a concern at this stage especially with the longer-term inflationary expectations being in the mid range of the target bank i.e. 2%.
You may remember a previous post I did on ‘WetheEconomy’ now there is ‘WetheVoters’ The site has 20 short films designed to inform, inspire and ultimately activate voters nationwide with fresh perspectives on the subjects of democracy, elections and U.S. governance.
Below is a parody of the television programme “Real Housewives” with a political and economics twist. It shows a good example example of the current political climate and some possible avenues for change. On the one side you have Jessica who is concerned with the government balancing its budget and Lara who believes that the government needs to spend more on infrastructure etc to stimulate the economy and creates jobs. She also uses the austerity measures in the EU as an example to support her opinion. Jessica does make the point as to who is going to pay for all this spending – our kids. Then there is Vanessa who is neutral although does get into trouble by informing Lara that Jessica thinks the government should increase defence spending. From this point it gets quite heated but they do make up. Enjoy!
In the A2 exam there is usually one multiple-choice question on Pareto Efficiency and part of an essay. The idea of Pareto Efficiency is named after the Italian Economist Vilfredo Pareto. For a given set of consumer tastes, resources, and technology, an allocation is Pareto-efficient, if there is no other feasible allocation that makes some people better off and nobody worse off. See also a previous post – Pareto Optimality and the perfect wave.
The figure above shows an economy with only two people, Susie and David. The initial allocation at A gives David QD goods and Susie QS goods. Provided people assess their own utility by the quantity of that they themselves receive, B is a better allocation than A which in turn is a better allocation than C. But a comparison of A with points such as F, D or E, requires us to adopt a value judgment about the relative importance to us of David’s and Susie’s utility. It is important to note from the figure the following:
- If you move from A to B or A to G it is a Pareto gain – A to B both Karen and John are better off. A to G Susie is better off, David no worse off.
- If point B or G is feasible then point A is Pareto-inefficient – more goods can be consumed
- A move from A to D makes David better off and Susie worse off. However we need to make a judgment about the relative value of David’s and Susie’s utility before we can comprehensively state that David is better off. Therefore the Pareto principle is limited in comparing allocations on efficiency – it only allows us to evaluate moves to the north-east and south-west
Therefore, we need look at the economy as whole and how many goods it can produce. In the Figure above the frontier AB shows the maximum quantity of goods which the economy can produce for one person given the quantity of goods being produced for the other person. All points on the frontier are pareto-efficient. David can only be made better off by making Susie worse off and vice versa. The distribution of goods between David and Susie is much more equal at point C than at points A or B. Note that:
Anywhere inside the frontier is Pareto-inefficient – some can be made better off without making the other worse off.
The economy should never choose an inefficient allocation inside the frontier. Which of the efficient points on the frontier (A, B, C) is the most desirable will depend on the value judgment about the relative value of David and Susie utility.
Source: Economics by Begg
Another good video from Paul Solman of PBS ‘Making Sense of Financial News’.
In his new book, “The End of Alchemy,” Mervyn King still worries that the world banking system hasn’t reformed itself, eight years after its excesses led to collapse. He states that it’s easy with hindsight to look back and say that regulations turned out to be inadequate as mortgage lending was riskier than was thought. Furthermore, you are of the belief that the system works and it takes an event like the GFC to discover that it actually doesn’t.
Paul Solman asks the question that a large part of the problem that caused the GFC was the Bank of England and the US Fed were not able to keep up with the financial innovation that was going on in both of these countries. King refutes this by saying that there were two issues that were prevalent before the GFC:
- Low interest rates around the world led to rising asset prices and trading looked very profitable.
- Leverage of the banking system rose very sharply – Leverage, meaning the ratio of the bank’s own money to the money it borrows in the form deposits or short-term loans.
Central banks exist to be lenders of last resort. Problem: Too big to fail. And that’s what began happening in England, just like America, in the ’80s and ’90s. There needs to be something much more robust and much more simple to prevent the same problem from happening again. King makes two proposals:
- Banks insure themselves against catastrophe by making enough safe, secure loans so they have assets of real value to pledge to the Central Bank if they need a cash infusion in a hurry.
- Force the banks to keep enough cash on hand to cover loans gone bad as during the crisis banks didn’t have enough equity finance to absorb losses without defaulting on the loans which banks have taken out, whether from other bits of the financial sector or from you and I as depositors.
He finally states that the Brexit vote doesn’t make any significant difference to the risks facing the global banking system. There were and are significant risks in that system because of the potential fragility of our banks, and because of the state of the world economy.
Geoff Riley did a very good post on Tutor2u that outlined the recent dispute between Tesco and Unilever. Marmite, PG Tips tea and Pot Noodles are among dozens of brands currently unavailable on Tesco’s online site due to this dispute with Unilever. Unilever raised its price by 10% in the UK to compensate for the sharp drop in the pound’s value.
Tesco is resisting the move and has removed Unilever products from its website. Unilever see the price increase as a “normal” reaction to shifts in currency values – since the Brexit vote there has been a 17% decrease in the value of the pound which has added to the cost of importing goods. The products currently absent from Tesco’s website also include Comfort fabric conditioner, Hellmann’s mayonnaise and Ben & Jerry’s ice cream. With the A2 exam looming here are some notes on Monopoly and Monopsony.
Monopoly and Monopsony theory
Monopoly. Perfect competition is not to be found in the real world and absolute or pure monopoly is also virtually impossible to achieve since it applies operating in the absence of competition (i.e. no substitutes). While it is not difficult for a firm to become a sole supplier it is extremely difficult to achieve a situation where there are no substitutes for the product. A more realistic definition of monopoly would be ‘a sole supplier of a commodity for which there are no good substitutes’. In fact the degree of monopoly power in the real world tends to be judged on the basis of the share of the total market accounted for by any particular supplier.
The graph below shows that at profit maximising equilibrium, output Qm is less than that in a competitive market (Qe), and the demand and supply (MC) curves do not intersect. Qe represents the Allocative Efficiency level of output and Pe the price. The shaded area therefore represents the loss of allocative efficiency or the deadweight loss.
Therefore monopolists restrict output and mis-allocate resources leading to a deadweight loss to the economy. However the government, using price controls, can force a shift from the preferred monopoly equilibrium (MC=MR) to one equivalent to the perfectly competitive equilibrium (MC=AR). At the less-preferred equilibrium, a monopolist’s supernormal profit may be either reduced or turned into a subnormal profit. In the latter case, a permanent subsidy may be necessary to keep the firm in business.
Monopsony. Two areas are worthy of mention, including the monopsony power of the large supermarkets (as stated above), who can dictate terms to smaller suppliers, and the monopsony power associated with buyers of labour in the labour market.
A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:
Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)
You will remember from the notes on the Perfect Labour Market that this is known as the profit maximising position.
From the perspective of the monopsonist firm facing the supply curve directly, if at any point it wants to hire more labour, it has to offer a higher wage to encourage more workers to join the market – after all, this is what the ACL curve tells it. However, the firm would then have to pay that higher wage to all its workers so the marginal cost of hiring the extra worker is not just the wage paid to that worker, but the increased wage paid to all workers as well. So the marginal cost of labour curve (MCL) can be added to the diagram.
If the monopsonist firm wants to maximise profit, it will hire labour up to the point where the marginal cost of labour is equal to the marginal revenue product of labour. Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.
In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.
Jeffrey Sachs wrote a very good piece in the Boston Globe regarding the way forward for the US economy. Some interesting data:
- 1.4% GDP between 2009-2015 when it was projected at 2.7%
- 81% of Americans experienced flat or falling incomes between 2005-2014
- 1980 – top 1% earn 10% of income
- 2015 – top 1% earn 22% of income
- 10% unemployment in October 2009 – dropped to 4.9% today. Mainly caused by those of working age leaving the labour force entirely.
- Employment relative to working age (25-54) in 2000 was 81.5%. In 2015 it was 77.2%
- US Treasury debt owed:
- – 2007 = 35% of GDP
- – 2015 = 75% of GDP
- – 2026 = 86% of GDP – forecast
- – 2036 = 110% of GDP – forecast
Issues with the US Economy
US manufacturing jobs have shifted overseas – remember NAFTA. Northern Mexico saw a huge influx of US companies as they took advantage of cheaper labour costs.
Automation – the advent of smart machines seems to be shifting income from workers to capital, driving down wages and leading to frustration of low wage workers.
As well as debt sustainability the US economy needs to shift its reliance on carbon-based energy to non carbon energy sources – hydro, wind, solar etc. Some have argued that the US has simply run out of big new inventions to sustain growth levels but ultimately the world has got to change its model as resources will eventually run out. We can’t keep relying on people buying more and more stuff to maintain growth or the Chinese building more cities and blowing up and rebuilding bridges.
Jeffrey Sachs argues that sustainable development works best when it focuses simultaneously on 3 big issues:
- Promoting economic growth and decent jobs
- Promoting fairness to women, the poor, and minority groups
- Promoting environmental sustainability.
US growth has tended to focus on economic growth and neglect inequality and environmental issues. Future growth needs to focus less on current consumption but investment in future knowledge, education, skills, health, infrastructure and environmental protection. Furthermore if the investment is carried out efficiently the economy can growth in an environmentally safe as well as being fair. Good investment requires two things:
- Planning – need to overcome complex challenges for our future – e.g. energy
- Public investment – replacement of a crumbling infrastructure – roads, bridges, water systems, seaports etc
Jeffrey Sachs recent research measured how 150 countries performed with regard to sustainable development and the progress that countries will need to make to achieve the recently adopted SDGs – see image below. The Scandinavian countries came in top – Sweden, Denmark, Norway – the US was 22nd out of the 34 high-income countries whilst Canada was 11th.
Click the link below for an article on income inequality from the Boston Globe by Jeffrey Sachs
Remember to mention the output gap when doing an essay that involves the business cycle. The output gap is the difference between demand and the economy’s capacity to supply. This is the difference between the ‘actual’ level of output (GDP) and the economy’s ‘potential’ level of output (potential GDP).
If the economy is running above capacity (GDP > potential GDP) the output gap is positive. Conversely, if the economy is running below its full capacity (GDP < potential GDP) the output gap will be negative.
Remember that ‘potential’ output is not an upper limit on the level of output. Rather, think of potential GDP as the economy’s efficient level of output. Running the economy below potential GDP is inefficient because there are some resources that are not employed. Running the economy above potential GDP is also inefficient because resources are over-utilised (eg, machinery is being made to work too hard causing it to wear out too quickly).
While it is efficient to have the economy running at potential, quite often it does not. Resources can be over- or under-utilised, which will translate into inflationary or disinflationary pressure (over-utilisation will push future inflation up, while under-utilisation pushes future inflation down).