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IMF World Evaluation from the FT

August 8, 2017 Leave a comment

Below is a very good video put together by the FT which summarises the recent IMF Report on the World Economy. Includes:

  • Better growth in China and the Euro zone makes up for slow US growth.
  • US infrastructure spending and tax reform still has to be approved by the senate.
  • Europe looking stronger than expected.
  • Emerging economies still face tough conditions.

Categories: Economic Cycle, Growth Tags:

The Ancient Art of Economic Forecasting

April 27, 2017 Leave a comment

I came across this piece from a colleague on economic forecasting. The article below appeared in the Sydney Metropolitan Press in the late 1920’s. Although economic cycles don’t run to an exact time period the graph below would indicate that this model is not too far out of kilter.

The top line = years in which panics have occurred and will happen again

The middle line = years of good times, high prices and the time to sell stocks

The bottom line = years of hard times, low prices and good times to buy stocks

The past panic century of dates are 1911, 1927, 1945, 1965, 1981, 1999, 2019. Except for 1981, these were all pretty good years to sell stocks – The Big Picture blog. 2016 suggests the top of the present cycle with 2019 being a year of panic.

“The Ancient Art of Economic Forecasting” – Sydney Metropolitan Press 1920’s

The attached graph professes to forecast the future trend of Australian business conditions, was first brought under the notice of the public in 1872. It was prepared by a Mr Tritch, whose origin and activities are shrouded in mystery.

The top line shows years in which panics have occured, and will occur again. Their cycles are 16, 18 and 20 years. The centre line shows the years of good times and high prices; the cycles are 8, 9 and 10 years. The bottom line shows the years of depressions and low prices; the cycles are 9, 7 and 11 years.

The panic which occurred in 1893 is shown in 1891. Nevertheless, that year witnessed the beginning of the depression. 1915, just after the war started was a year of depreciation, and 1919, the year following the cessation of hostilities, was a period charcterised by good times.

As this chart was published in 1872, it is interesting to note the forecast of the depression now existing. It will be seen that there has been a general upward trend since 1926 with the panic occuring in 1927 after the high is reached. The bottom of the depression is reached at the end of 1930 and the upward trend begins in 1931.”

Art of forecasting2.png

A2 Economics – Keynesians vs Monetarists

March 29, 2017 Leave a comment

Just been going through this part of the course with my A2 class and came across a table from some old A Level notes produced by Russell Tillson (ex Epsom College Economics and Politics Department) to help them understand the principal differences.

Housing bubble and zero sum game

July 24, 2016 Leave a comment

There has been a lot of talk in the media about an Auckland housing bubble and its impact on the New Zealand economy.  Below is a very informative graph I got from http://www.housepricecrash.co.uk which looks at the anatomy of a bubble.

Anatomy of bubble

Zero-Sum Game

When house prices are increasing rapidly we tend to feel better off but also have increased mortgage debt. House price inflation is a zero-sum game in that society as a whole does not benefit from a rise in house prices as those on the property ladder can only gain at the expense of prospective homeowners that cannot afford to enter the market. Over a short period of time house price inflation can provide a boost to economic growth if they deceive people into believing they are wealthier.

Positive-Sum Game

However, when a business invests it tends to have a positive-sum game in that if it employs 50 more workers that doesn’t mean that there are 50 other workers in the economy that are going to lose their jobs. This is real GDP growth rather than investing in property which tends not to generate growth as it is a finished asset – however some will argue that maintenance will always be needed.

Categories: Economic Cycle Tags:

Macro Conflicts in New Zealand

November 29, 2015 2 comments

Part of the Cambridge A2 syllabus studies Macro Economic conflicts of Policy Objectives. Here I am looking at GDP, Unemployment, and Inflation (improving Trade figures is another objective also). The objectives are:

* Stable low inflation with prices rising within the target range of 1% – 3% per year
* Sustainable growth – as measured by the rate of growth of real gross domestic product
* Low unemployment – the government wants to achieve full-employment

New Zealand Growth, Jobs and Prices — 3 Key Macro Objectives Inflation, jobs and growth

1. Inflation and unemployment:

From the graph above you can see that low levels of unemployment have created higher prices – demand-pull inflation. Also note that as unemployment has increased there is a short-term trade-off between unemployment and inflation. Notice the increase in inflation in 2010-2011 as this is when the rate of GST was increased from 12.5% to 15%. Also today we have falling inflation (0.4% below the 1-3% band set by the RBNZ) and unemployment is on the rise – approximately 6%

NZ Economy 2006-2015

2. Economic growth and inflation

With increasing growth levels prices started to increase in 2007 going above the 3% threshold in 2008. This suggests that there were capacity issues in the economy and the aggregate supply curve was becoming very inelastic. In subsequent years the level of growth has dropped and with it the inflation rate.

3. Economic Growth and Unemployment

With increasing levels of GDP growth unemployment figures have tended to gravitate downward. This was apparent between 2006-2008 – GDP was positive and unemployment did fall to approximately 3.6%. From 2009 onwards you can see that growth has been positive with unemployment falling. 2015 saw the unemployment rate rising with lower annual growth rate.

Smoothing out the boom bust cycles

November 4, 2015 Leave a comment

Below is a very informative video from the Reserve Bank of New Zealand about smoothing out the boom bust cycles in the New Zealand economy. There are some notes that follow which have been edited from the transcript.

Objectives macro prudential policy.

  • To build resilience of the financial system so that it can cope with the business cycle if it turns from boom to bust.
  • To be proactive in dampening the risk to begin with. This could include dampen the growth of credit, house prices or other asset prices. An example of this was in New Zealand in the late 1980’s – share market crash and the plunge in commercial property prices.

Macro Prudential Tool Kit – 4 Tools

1. Counter-cyclical capital buffer

This is where the banks are required to hold an extra margin of capital during the boom part of the cycle so that if the boom turns to bust the banks have an extra margin of capital that they can then call on to meet loan losses.

2. Sectorial capital overlay

This is very similar to a counter-cyclical capital buffer but it is about holding extra capital against a particular sector that the banks might be leaning to, for example the household sector, the farming sector, or potentially the commercial property sector.

3. Loan to value ratio for residential housing lending

This is a limit on the amount of high loan to value ratio lending or low deposit lending that the banks are able to do for the household sector. High LVR lending potentially fuels rapid house price growth and so that might be another reason why you would use that particular instrument.

4. Core funding ratio

This is a tool that has been a permanent fixture for the banks. There are a number of reasons why the core funding ratio might change. Potentially if the banks are facing an increase in risk, the Reserve Bank could require them to hold more core funding, funding that would be more likely to remain in the system during a downturn. By holding more of that stable funding, they’d be less likely to stop lending in a downturn because the funding would remain in the system.

Boom bust cycles are cycles in the economy and in the financial system are of course a fact of life. Macro-prudential policy certainly won’t prevent those cycles from occurring. What it will do is provide some cushioning to the cycle. It will hopefully clip the highs and the lows to some extent so that the flow of credit and the flow of financial services in the economy continue through time. It’s not about preventing the cycle or dampening it completely. It’s about taking some of the extremes out of the cycle.

Paul Mason interview on Radio New Zealand – “Pay People to Exist”

October 18, 2015 1 comment

Post Cap MasonYesterday on Radio New Zealand Kim Hill interviewed Paul Mason – Channel 4 economics correspondent – about his new book entitled PostCapitalism: A Guide to Our Future. The book gives a very radical and innovative view of history, and offers a vision of a post capitalist society.

Mason believes that after two centuries in which capitalism has dominated the western world, this economic system has become desperately dysfunctional: inequality is growing, climate change is accelerating and nations are beset with bad demographics, debt burdens and angry voters. He makes three assertions according to Gillian Tett of the Financial Times:

  1. “information technology has reduced the need for work” — or, more accurately, for all humans to be workers.For automation is now replacing jobs at a startling speed
  2. “information goods are corroding the market’s ability to form prices correctly”. For the key point about cyber-information is that it can be replicated endlessly, for free; there is no constraint on how many times we can copy and paste a Wikipedia page. “Until we had shareable information goods, the basic law of economics was that everything is scarce. Supply and demand assumes scarcity. Now certain goods are not scarce, they are abundant.”
  3. “goods, services and organisations are appearing that no longer respond to the dictates of the market and the managerial hierarchy”. More specifically, people are collaborating in a manner that does not always make sense to traditional economists, who are used to assuming that humans act in self-interest and price things according to supply and demand.

Radio NZHe also makes the point that we are going to live through a long transition from capitalism – the state and the market to post capitalism which is the state, the market and the shared collaborative economy. With technology taking a lot of the jobs in traditional industries in the UK he states that further development in this sector is not the way of creating new jobs. He talks about delinking work from wages by just paying people to actually exist – rather than tax to exist. He does come up with some very interesting thoughts and it is well worth listening to. Click below to hear the interview:

Paul Mason interview on Radio New Zealand

10 reasons why not to be so concerned about China’s stockmarket plunge.

September 26, 2015 Leave a comment

Last month the drop in the Chinese stockmarket – Shanghai Composite – sent alarm bells ringing around the world economy that the world’s second largest economy was in trouble. A recent Economist article (‘Taking a Tumble’ – August 29th 2015) suggest that all is not lost for the Chinese economy and the developed world should not be agitated. Several arguments were made to ease the concern of the West:

1. The Shanghai Composite in relation to the over all size of the Chinese economy is very small – 33% of GDP compared with over 100% in developed economies.
2. Stocks and the economic fundamentals are not strongly correlated – share prices increased 30% last year but this data didn’t reflect improved Chinese growth forecasts.
3. Less than 20% of Chinese household wealth is invested in shares.
4. The money borrowed by consumers to invest in the sharemarket amounts to just 1% of total banking assets – not significant.
5. For the Chinese economy the property market matters more than stocks and shares do. Housing and land account for the vast majority of collateral.
6. The service sector now accounts for a bigger share of national output than industry.
7. With regard to the fiscal position of the Chinese government things are looking quite positive. It aimed for a budget deficit of 2.3% of GDP this year, but as of July it was still in surplus, having raised more in taxes than it had spent. Therefore it has the ammunition if required to stimulate more growth.
China I and C8. The economy is rebalancing, albeit slowly, away from investment and towards consumption (see chart 3). China still has many more homes, highways and airports to build, but the trend away from them is unmistakable.
9. Economic growth is almost certainly lower than the rate reported by the government but it appears to be in the range of a soft landing.
10. The People’s Bank of China (central bank) still have room to cut rates – benchmark one-year lending rates are at 4.6%. Furthermore the required reserve ratios are at 18% for trading banks. The central bank has room to cut both rates whilst most developed countries don’t have that luxury.

Bad news for China’s trading partners

As a result, China’s appetite for commodities has probably peaked. That is bad news for companies and countries that prospered over the past decade by selling it mountains of iron ore, copper and coal – e.g. our cousins across the ditch in Australia. A decline in Chinese consumption would be of huge consequence: it absorbs about half the world’s aluminium, nickel and steel, and nearly a third of its cotton and rice.

The countries most exposed to shifts in China’s economy, meanwhile, are the commodity exporters who supply the raw materials for the steel girders and copper piping that have underpinned the construction boom.

Final thought
The plunge in the Chinese stockmarket was not evidence that the economy is on the edge. However, there are those that now doubt China as having such a safe economy.

What is the economy?

July 31, 2015 Leave a comment

A short animated video by the Reserve Bank which shows how the economy works. It also outlines the role of the Reserve Bank of New Zealand. Good for an introductory lesson.

Categories: Economic Cycle Tags:

What would happen if there was a Grexit?

July 3, 2015 Leave a comment

The Greeks vote on Sunday whether to accept a June 25 offer from the International Monetary Fund, European Union and the European Central Bank (collectively known as “the Troika”) to provide Greece with desperately needed bailout money. In exchange, the Troika demanded that Greece implement a list of tax increases, spending cuts, and economic reforms. If there is a no vote then there could be the following scenario.

Negatives
* Overnight the Greek authorities would have to circulate a new currency (most likely the Drachma)
* The Drachma would depreciate against the Euro – according to some analysts this would increase Greek debt from the current level of 175% to 230% of GDP.
* Interest rates would increase causing businesses to go bankrupt – some have indicated that this would be around 50% of businesses
* The risk of a run on the banks would mean that the monetary authorities would have to introduce controls on money flows – especially abroad.
* Social unrest would no doubt escalate in the short-term and many Greeks will leave the country (if they can afford it).
* The Greek government would find it difficult to raise funds from overseas as investors become more prudent and see Greek bonds as an even bigger risk than before.
* A devaluation will would do nothing to change Greece’s structural problems.
* The euro will lose credibility in the long run and its weaker members will be exposed to bank runs which will ultimately extinguish any chance of a recovery.

Positives
* A weaker currency would make Greek exports a lot cheaper and may resurrect the textile industry that collapsed a few years ago.
* However the biggest benefit would be the tourism industry where holidays would become very cheap relative to similar destinations in Europe.
* The Greek government could keep printing money to finance the promises made Alexis Tsipras’ government – maybe an inflationary threat.
* Interest rates would no longer be determined by the ECB and a more expansionary monetary policy could be implemented by Greek authorities to tackle the downturn.

We’ve been here before as Jeff Sachs mentioned in his piece from Project Syndicate.

Almost a century ago, at World War I’s end, John Maynard Keynes offered a warning that holds great relevance today. Then, as now, creditor countries (mainly the US) were demanding that deeply indebted countries make good on their debts. Keynes knew that a tragedy was in the making.

“Will the discontented peoples of Europe be willing for a generation to come so to order their lives that an appreciable part of their daily produce may be available to meet a foreign payment?” he asked in The Economic Consequences of the Peace. “In short, I do not believe that any of these tributes will continue to be paid, at the best, for more than a few years.”

The Greek government is right to have drawn the line. It has a responsibility to its citizens. The real choice, after all, lies not with Greece, but with Europe.

Below is a chart from Bloomberg Business explaining the outcomes.
Greek referendum

What do the Shanghai Stock Exchange and the Yangtze River have in common?

June 15, 2015 Leave a comment

One of my A2 students alerted me to the fact that the Yangtze River and the Shanghai Stock Exchange Composite Index (SSEC) in the post GFC period are quite similar in shape. Maybe the building of the three gorges dam led to a drop in the SSEC index.

Yangste and China Stock Market

Auckland housing market like the Dublin bubble?

May 25, 2015 Leave a comment

Between 2007 and 2010 house prices in Dublin fell by 56% and had a devastating effect on the banking system in Ireland. Is there going to be a correction in the Auckland housing market of a similar ilk?

Brian Gaynor touched on this in his column in the NZ Herald on the 16th May. Today there are some similarities to the boom in Dublin house prices and that of Auckland. These included:

1. The media painted a picture of escalating house prices and a property boom
2. Purchasers queuing overnight to buy a section or a newly built house
3. Banks offering cash incentives on home loans.
4. Very low mortgage interest rates
5. Auckland’s house prices have increased by 12.4% in the last 6 months. By comparison Dublin’s house prices never increased by more than 12% in any six month period during the boom.
6. Mortgage debt in New Zealand is now above $200 billion – doubling in 10 years. The majority of the debt being in the Auckland residential region. Consumer mortgage debt to disposable income in 2012 was 147% as compared to 58% in  March 1991. In Ireland Bank lending it was 175% in 2008. Graph below shows a graph highlighting Ireland’s exposure to debt.

bank lending EU 1997-2008

Bank lending to households and non-financial firms as a percentage of GDP for
Eurozone economies and the UK, 1997 and 2008

What is a property bubble?
Property bubbles grow as long as buyers are willing to borrow increasingly large amounts in the expectation that prices will continue to rise. This process inevitably hits a limit where borrowers become reluctant to take on what start to appear as impossibly large levels of debt, and the self-reinforcing spiral of borrowing and prices starts to work in reverse.

Central Bank easing on a global scale.

February 24, 2015 Leave a comment

Below is an image I got from the Business Insider site that shows the extent of monetary easing and tightening by Central Banks around the globe.

CBs Monetary Policy

Categories: Economic Cycle Tags:

WE THE ECONOMY – 20 short movies on economics

January 12, 2015 1 comment

WE THE ECONOMY website provides a series of short films that explain economic concepts or key features of the modern economy. Each of the 20 movies focuses on some aspect of the U.S. economy or on some economic concept. The films are grouped into five ‘chapters’ covering the basics of the economy:

What is the Economy?
What is Money?
What is the Role of our Government in the Economy?
What is Globalization?
What Causes Inequality?

Every 5-8 minute video is well worth watching and useful for the classroom. Below is the trailer – very professionally done and excellent reinforcement when teaching certain topics.

Russian economy – Priests to halt slide of Rouble?

December 12, 2014 Leave a comment

Russia OilWith oil prices heading to below $60 per barrel and inflation on the rise the Russian economy is bracing itself for some difficult times ahead. Oil is imperative to Russian growth rates and The Economist reported that in 2007, when oil was $72 a barrel, the economy managed to grow at 8.5%. Additionally between 2010 – 2013, when oil prices were high, the country’s net outflow of capital was $232bn – 20 times what it was between 2004 and 2008. See graph from The Economist.

But as oil prices drop so does the currency which mean imports become more expensive – the bigger the drop the more expensive they are. Russia imports a lot of goods – the value in 2000 was $45bn compared to in 2013 $341bn. This lower value of the Rouble fuels inflation and it is expected to reach 9% by the end of the year. To maintain peoples spending power the government will need to intervene in the economy and run bigger deficits.

But there is another problem a weaker Rouble makes debt servicing more expensive so in the long-term more money needs to be found. When there was a high oil price instead of increasing their reserves, money was spent on salaries and pensions and especially the armed forces where spending increased by 30% since 2008. One wonders why they spent so much on the Sochi Winter Olympics. However drastic steps are being taken to reduce the decline of the Rouble with priests blessing the servers at the Central Bank with holy water.

Russia CB

Data Response Question: The euro-zone cyclical stagnation

September 25, 2014 Leave a comment

Below is an article from The Economist that focuses on stagnation in the euro-zone economy. I have put together a worksheet on the passage that you may find useful.
—————————————————————————————————————

euro zone stagnationTHIS week’s figures for the euro-zone economy were dispiriting by any measure. An already feeble and faltering recovery has stumbled. Output across the euro area was flat in the second quarter. That followed a poor start to the year when the single-currency club managed to grow by just 0.2% (0.8% at an annual rate).

There were some bright spots in the bulletin of misery. Both the Dutch and Portuguese economies, which had contracted in the first quarter, rebounded, growing by 0.5% and 0.6% respectively. Spanish growth picked up from 0.4% in the first quarter to 0.6% in the second. But these perky performances were overshadowed by the poor figures recorded in the three biggest economies. Italy, the third largest, had already reported a decline of 0.2%, pushing it into a triple-dip recession. France, the second biggest, continued to stagnate. But the real blow came from Germany, the powerhouse of the euro zone, where output slipped by 0.2%.

The setback may reflect some temporary factors, as workers took extra time off after public holidays. German output was also depressed by a fall in construction, some of which had been brought forward to the first quarter thanks to warm weather. This effect should also be temporary. However, the tensions between Europe and Russia over Ukraine and the resulting sanctions may adversely affect German growth in the coming months.

The new GDP figures are yet more evidence that the euro-zone economy is in a bad way, not least since it has come to rely so heavily upon Germany, which had grown by 0.7% in the first quarter. It is not only that growth is evaporating; inflation is also extraordinarily low. In July it was only 0.4%, far below the target of just below 2% set by the European Central Bank (ECB). Consistently low inflation has prompted fears that Europe will soon slide into deflation. Prices are already falling in Spain and three other euro-zone countries.

Deflation would be particularly grave for the euro area because both private and public debt is so high in many of the 18 countries that share the single currency. Even if inflation is positive but stays low it hurts debtors, as their incomes rise more slowly than they expected when they borrowed. If deflation were to set in, the effects would be worse still: when prices and wages fall, debts, which do not shrink, become harder to repay.

The poor GDP figures will intensify pressure on the ECB to do more. Already in June it lowered its main borrowing rate to just 0.15% and became the first big central bank to introduce negative interest rates, in effect charging banks for deposits they leave with it. That has helped bring short-term, wholesale interest rates close to zero and has also weakened the euro. Both these effects will help to bolster the economy and restore growth.

As well as these interest-rate cuts, the ECB announced that it would lend copiously to banks for as long as four years, as long as they pledged to improve their own lending performance to the private sector. The plan, which resembles the Bank of England’s “funding for lending” scheme, has some merit but may not boost lending as much as expected due to the feeble state of the banks. It will also take a long time to work its way through the economy.

The ECB’s critics say that this is not enough and urge the central bank to introduce quantitative easing—creating money to buy financial assets. The ECB is likely to hold off; it seems to consider QE as a weapon of last resort. For his part Mario Draghi, the central bank’s president, urges countries like Italy and France to get on with structural reforms that would improve their underlying growth potential. Patience on all sides is wearing thin.

Questions

Read the article from The Economist and answer the questions below:

a) What happened to the GDP figures for the euro-zone economy in the second quarter for 2014? (2)

b) What have been the surprises in the contributions of the six countries mentioned in the articles? (3)

c) Although the GDP figures are dispiriting there is the indication that this is a temporary problem. Explain (2)

d) Comment on the level of inflation in the euro-zone and the target set by the European Central Bank (ECB). (4)

e) Why is deflation particularly grave for the euro area? (4)

f) Explain negative interest rates. Why has this policy been implemented by the ECB? (4)

g) What have the ECB’s critics suggested they should do and explain how this policy works. (4)

Categories: Economic Cycle, Growth Tags:

India’s economy needs an overhaul

June 24, 2014 1 comment

India’s new government have the challenge of trying to bolster its GDP from the industrial sector. For too long its economy has been going backwards with investment dropping and households shifting their money away from savings and into gold. The Economist identified 3 tasks for the incoming government:

1. Sort out the corrupt banks – bad debts have escalated and banks have chosen to “extend and pretend” loans to zombie firms. The cost of cleaning up the banks is estimated to be 4% of GDP. Healthy banks are needed to finance a new cycle of investment.
2. Stagflation must be dealt with – high inflation and high unemployment (see graph below). High borrowing has fueled inflation and consumers have run to the safety of gold as a store of value for their money. This has meant an increasing deficit in the balance of payments. The central bank is looking at introducing inflation targeting (1-3% in NZ)
3. Developing higher skilled jobs – a lot of Asian countries have benefitted greatly from low cost labour. With labour costs rising in China and 10 million people entering the labour force each year in India, there is a great opportunity to attract foreign investment. This is particularly prevalent when you consider that Japanese firms are now nervous about the on-going military tensions with China and therefore looking at other low cost countries.

For the Indian economy to move forward they will have to ensure investors that the factors of production – land, labour, capital – are reliable and at a competitive price.

Stagflation

Euro Zone’s Divergent Economies and Monetary Policy

June 1, 2014 Leave a comment

I got this image from The Economist and used it for a recent A2 Test on Macro-Economic conflicts. Recently the OECD and the IMF have urged the European Central Bank (ECB) to cut the bank’s main lending rate from the already low 0.25% to zero. How might this effect countries in the Euro-area? It will tend to impact euro zone countries differently because of where they are in the business cycle. If you look at the unemployment and inflation figures from the graph you see the following:

Unemployment
Austria 4.9%, Germany 5.1%, well below the EU average of 11.8%.
Spain 25.3% and Greece 26.7% very high unemployment.

Some countries have had unemployment dropped significantly during the period –
Latvia approx. 22% to 11.6
Estonia approx.. 18% to 7.8%

Inflation
Highest rate Malta &Austria 1.4%, Finland 1.3%
Lowest – Greece -1.5%, Cyprus -0.9%

Euro divergent economies

The loss of monetary sovereignty has its problems

Reducing the interest to zero is an expansionary monetary policy which is a tool to increase aggregate demand, economic growth and employment. Monetary Policy, which is determined by the ECB, will have different effects in different countries. The ECB responds to aggregate levels of inflation and unemployment, not individual country levels – Unemployment is 11.8% and Inflation is 0.5%. Therefore it is a one size fits all policy. However some member states maybe experiencing rising levels of inflation and lower levels of unemployment whilst others might be the opposite – falling levels of inflation and higher levels of unemployment.

Assume an EU member experiences an asymmetric shock. It will have a different inflation and unemployment rate than the rest of the EU. With the ECB setting a common interest rate for the whole area, countries have lost an important part of their monetary policy. This is a major problem if a countries economy is at a different stage in the business cycle. For instance in 2014, Austria and Germany are growing with falling unemployment and a further lowering of interest rates may not be the best option for them. This is in comparison to other countries who need lower interest rates and a more stimulatory environment. With low interest rates and falling unemployment, Austria and Germany could experience inflation levels above the 2% target of the ECB and also a tight labour market which could put pressure on prices. Furthermore a lower interest rate affects those who want to save money in those countries.

At the other end of the spectrum Slovakia, Portugal, Cyprus, Spain and Greece are experiencing deflation and very high levels of unemployment. They therefore require more stimulus through lower interest rates to try and boost growth and employment and get out of the dangerous deflationary cycle.

Other countries with low inflation and high levels of unemployment will benefit from the cut in interest rates – Ireland has had unemployment fall from approx. 15% to 11.8% and an inflation rate of 0.3%. Therefore monetary stimulus is warranted. However the interest rate whether expansionary, neutral, or contractionary is unique to where each country is in the business cycle. The loss of monetary sovereignty clearly poses problems for members states whose economy is out of line with the euro zone norm.

Secular Stagnation

January 9, 2014 Leave a comment

saving2The Free Exchange column of The Economist recently had an article which addressed the concern that in order to create or revive economic growth developed economies will just create a bubble environment. However this concept was around in the 1930’s as economist Alvin Hansen thought a slowing of both population growth and technological progress would reduce opportunities for investment. Savings would then accumulate and growth would slow unless the government intervened to bolster demand in the economy. Today interest rates are low and therefore saving has limited avenues to earn reasonable returns from productive investment opportunities. But according to The Economist this story doesn’t fit the current conditions for the following reasons:

1. There is at present an IT revolution
2. Private investment has recovered since the GFC and technology investments are doing very well.

But some investment managers are paid by the value of the share price and these get boosted in the short -run. This encourages them to put large amounts of cash into buy-backs, which raises stock prices, rather than into productive investments that might do more to boost growth.

Saving could also be seen as a reason for secular stagnation. High levels of saving reflect the reduction in consumption and this is thought to have come about by an in the increase in income inequality – high income households save more than those on lower incomes. In 2007 – 23.5% of all American income went to the top 1% of earners – the highest percentage since 1929. Research has shown that saving by the top 5% has been surppressing demand since the mid-1980’s. Carmen Rheinhart and Ken Rogoff in their book “This Time is Different” (which I have blogged on in previous posts) concluded that post war banking crises are followed by weak recoveries, whether or not they were preceded by a surge in income inequality.

Commodity prices drop but Aussie dollar holds firm

January 5, 2014 Leave a comment

Aus dollar Commod PricesSince the Aussie dollar was floated in 1983 its value closely followed that of its commodity exports – see graph from The Economist. However since 2003 commodity prices have increased 400% but the dollar rose by much less and no longer had a direct relationship to commodity prices. There are 3 possible reasons for this:

1. The deregulation of financial markets which facilitates the ease of currency trading
2. The current account deficit in Australia which got to 6.2% of GDP in 2007
3. Interest rates in Australia up to the GFC were realtively low compared to other developed countries

2011 saw commodity prices drop but the Aussie dollar has remained strong. As most economies employed a lose monetary policy and proceeded to drop interest rates aggressively after the GFC, the Aussie economy didn’t in fact go through a recession and its interest rates remained relatively strong – see below.

CB Interest Rate Nov 13

Although a weaker exchange rate could help the Aussie economy especially as it has been susceptible to the resource curse – the strength of the exchange rate and higher interest rates is already putting pressure on some industries, particularly the tourism, manufacturing, education exports and retail industries.

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