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Types of Macroeconomic Policies

August 30, 2017 Leave a comment

Just been doing some revision with my CIE AS class and discovered this diagram on macro policies. Mind maps like this are very useful ways of revising topics.

Fiscal policy can be distinguished from monetary policy, in that fiscal policy deals with taxation and government spending and is often administered by an executive under laws of a legislature, whereas monetary policy deals with the money supply, lending rates and interest rates and is often administered by a central bank.

Supply-side policies are mainly micro-economic policies aimed at making markets and industries operate more efficiently and contribute to a faster underlying-rate of growth of real national output

Macro Policies.png

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Reserve Bank of Australia – Neutral Rate

August 20, 2017 Leave a comment

An article in the Sydney Morning Herald last month looked the Reserve Bank of Australia (RBA) and the neutral interest rate. For almost a year the RBA has kept Australia’s official interest rate at 1.5% and uses this instrument to control the overnight cash rate to try to manage the economic activity of an economy. EG.

Expansionary = Lower interest rates = encourages borrowing and spending
Contractionary = Higher interest rates = slows the economy down with less spending

How do we know that 1.5% is either expansionary or contractionary? Central banks indicate what they believe is the neutral rate of interest – this is a rate which is defined as neither expansionary or contractionary. In Australia the neutral is estimated to have fallen from 5% to 3.5% since the GFC. RBA deputy governor, Dr Guy Debelle, explains that the neutral rate aligns the amount of nation’s saving with the amount of investment, but does so at a level consistent with full employment and stable inflation. In Australia this equates to 5% unemployment and 2-3% inflation.

Aus - Neutral rate

The level of a country’s neutral interest rate will change with changes in the factors that influence saving and investment.

More saving will tend to lower interest rates
More investment will tend to increase interest rates

Debelle indicates that you can group these factors into 3 main categories:

1.The economy’s ‘potential’ growth rate – the fastest it can grow without impacting inflation.
2. The degree of ‘risk’ felt by households and firms. How confident do they feel about investing. Since the GFC people are more inclined to save.
3. International factors – with the free movement of capital worldwide global interest rates will influence domestic interest rates.

“We don’t have the independence to set the neutral rate, which is significantly influenced by global forces. But we do have independence as to where we set our policy rate relative to the neutral rate.” Dr Guy Debelle

QE unwind? Yeah right

August 18, 2017 Leave a comment

Another very informative clip from the FT. Some of the salient points include:

  • Since the global financial crisis the Bank of England, US Fed, Bank of Japan and European Central Bank have bought assets and printed US$12 trillion.
  • Can interest rates return to what has been normal in the past – say 5% instead of close to 0%.
  • US Fed plans to shrink its balance sheet later this year – monthly reduction US$6bn in its assets. But this is a very small amount when you consider that the Fed holds US$4.5 trillion
  • But this is not happening elsewhere. Bank of Japan and European Central Bank are still printing money and buying assets. With Brexit the Bank of England faces huge uncertainties regarding their balance sheets.
  • Interest rates will remain low partly due to: ageing population, low productivity growth and a savings glut. This has reduced the attractiveness of capital spending.

DW Documentary – “The Money Deluge”

July 11, 2017 Leave a comment

Below is a recent documentary from Deutsche Welle (DW – Germany’s international broadcaster) on the impact of exploding real estate prices, zero interest rate (see graph below) and a rising stock market. The higher income groups are benefiting greatly from these conditions but how does it effect middle income earners especially those in retirement. The DW documentary addresses these issues and explains how money deals have become detached from the real economy. Worth a look.

For years, the world’s central banks have been pursuing a policy of cheap money. The first and foremost is the ECB (European Central Bank), which buys bad stocks and bonds to save banks, tries to fuel economic growth and props up states that are in debt. But what relieves state budgets to the tune of hundreds of billions annoys savers: interest rates are close to zero.

The fiscal policies of the central banks are causing an uncontrolled global deluge of money. Experts are warning of new bubbles. In real estate, for example: it’s not just in German cities that prices are shooting up. In London, a one-bed apartment can easily cost more than a million Euro. More and more money is moving away from the real economy and into the speculative field. Highly complex financial bets are taking place in the global casino – gambling without checks and balances. The winners are set from the start: in Germany and around the world, the rich just get richer. Professor Max Otte says: “This flood of money has caused a dangerous redistribution.

ECB Rates.png

Those who have, get more.” But with low interest rates, any money in savings accounts just melts away. Those with debts can be happy. But big companies that want to swallow up others are also happy: they can borrow cheap money for their acquisitions. Coupled with the liberalization of the financial markets, money deals have become detached from the real economy. But it’s not just the banks that need a constant source of new, cheap money today. So do states. They need it to keep a grip on their mountains of debt. It’s a kind of snowball system. What happens to our money? Is a new crisis looming? The film ‘The Money Deluge’ casts a new and surprising light on our money in these times of zero interest rates.

When the NZ Official Cash Rate exceeds the US Fed Rate.

July 1, 2017 Leave a comment

With Janet Yellen increasing the US Fed Rates to 1 – 1.25% and Graeme Wheeler keeping the OCR at 1.75% it is anticipated that the US Fed Rate will eventually become higher than the OCR. What impact might this have on the New Zealand dollar?

With higher rates (or expected higher rates) in the US money flows will be attracted into the US with higher interest rate returns. This is referred to as ‘Hot Money’ and for international investors there are significant amounts of money to be made.

A higher interest rate in the US would mean a higher return from saving in a US bank. Therefore, New Zealand investors may sell NZ dollars and buy US dollars so that they can gain more interest from their savings. This increased demand for US dollars will push up the value of the US dollar against the NZ dollar.

RBNZ v Fed Rates.png

However it is not just interest rates that influence Hot Money. In 2011the Swiss Franc appreciated on the back off the turmoil in the Eurozone as investors saw the currency as a safe haven. The NZ dollar and the AUS dollar appreciated for similar reasons post the Global Financial Crisis.

Problems of hot money flows

Hot money flows can be destabilising. A rapid rise in the currency can harm a countries with exports become more expensive and imports becoming cheaper. However the latter might be favorable depending on the import content.

Hot money flows can create excess liquidity fuelling a future asset boom and creating more long-term problems.

Trump’s tax cuts likely to have limited impact on growth

May 14, 2017 Leave a comment

Donald Trump has indicated that the US economy needs a big tax cut to stimulate some growth and aggregate demand –  C+I+G+(X-M). His rationale is that with consumers having greater income they will spend consume more (C) and businesses keeping more of their profits will invest more (I). He is even so confident that the tax cuts won’t put a dent in the overall tax revenue of the government. However economists are suggesting that the US economy is already growing as fast as it can and in order to improve its growth rate it needs to investment in productivity.

D Pull Inflation.jpegNevertheless, US tax cuts in the 1980’s under Ronald Reagan proved to be very effective in stimulating aggregate demand but the economic environment then was different to that of today. The 1980’s was an era of stagflation with the US experiencing 10% unemployment and inflation reaching 15%. Since the GFC in 2007 growth has been positive and unlike the 1980’s unemployment has been falling  – from 10% in Oct 2009 to 4.4% in April 20178. Tax cuts are all very well when you have high unemployment but with the rate falling to under 5% companies may find it difficult to respond to the greater demand for goods and services by taking on workers to increase supply. Tax cuts would then lead to an increase in inflationary pressure (see graph) which is turn would prompt the US Fed to increase interest rates.

ProductivityTrump’s plan would also increase the Federal deficit and borrowing from the government. This would put upward pressure on interest rates for the private sector which reduces the potential for further growth. As noted earlier the area that needs to be addressed is productivity, with a shift of the LRAS curve to the right – see graph.

Categories: Growth, Inflation, Interest Rates Tags: ,

Global Liquidity Trap

April 4, 2017 Leave a comment

The FT had an excellent article back in April last year that covered many concepts which are a part of Unit 4 of the CIE A2 Economics course. It covers the liquidity trap, deflation, MV=PT, circular flow, Monetary Policy, Quantitative Easing etc.

The article focuses on the liquidity trap with Monetary Policy being the favoured policy of central banks. However by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth.  The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Liquidity Trap

Normally lower interest rates lead to:

  • savers spending more
  • capital being moved into riskier investments
  • cheaper borrowing costs for business and consumers
  • a weaker currency which encourages exports

But when interest rates go negative the speed at which money goes around the circular flow (Velocity of Circulation) slows which adds to deflationary problems. Policymakers pump more money into the circular flow to try to stimulate growth but as price fall consumer delay purchases, reducing consumption and growth.

The article concludes by saying Monetary Policy addresses cyclical economic problems, not structural ones. Click below to read the article.

The global liquidity trap turns more treacherous.

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