China’s youth unemployment – a mismatch

Reading about the high levels of youth unemployment in China there has been a move to encourage university graduates to take jobs in areas outside their degree e.g. manual work. China Central Television has published profiles of university graduates who have made their money doing manual work like selling street food or farming rather than embarking on a career in their area of study at university. Graduates though are criticising the Government on social media in not creating enough jobs for the growing youth population. Unemployment for those between the ages of 16 and 24 has reached close to 20% in contrast to the overall rate of approximately 5%. Traditionally a university education has been a way of improving your standard of living but it seems that a degree is no longer a way out of poverty. This year 11.6m college graduates are expected to enter the labour market but China-based employers are expected to offer fewer jobs than the previous year. Although a mismatch is usually referred to in structural unemployment you can assume that Chinese university graduates have the skills to do manual work but not the desire.

The International Labour Organisation (ILO) highlighted some of the many ways that countries could tackle the youth employment challenge:

• Recommending that government policies support employment and lift aggregate demand, including public employment programmes, wage and training subsidies, sectoral programmes, counter-cyclical fiscal policies and youth entrepreneurship interventions.
• Labour-market training and work experience programmes targeting young people so that they don’t leave the labour force. To achieve this there needs to be quality apprenticeships, informal or formal, is another solution for ensuring school-to-work transition. In countries where apprenticeship systems are strong, youth unemployment rates are no higher than those for adults.
• Forging partnerships for scaling up investments in decent jobs for youth. Combining the strength of international organisations, governments, employers and workers to implement global policies can really make a difference.

Source: Financial Times – China urges jobless graduates to ‘roll up their sleeves’ and try manual work. 23 April 2023

Sign up to elearneconomics for comprehensive key notes with coloured illustrations, flash cards, written answers and multiple-choice tests on Unemployment that provides for users with different learning styles working at their own pace (anywhere at any time).

Advertisement

New Zealand’s tight labour market but do all benefit?

Figures out yesterday show that unemployment in New Zealand remained at 3.4% which makes for a very tight labour market. One wonders if this figure is beyond the maximum sustainable levels with the RBNZ worried about the pressure on private sector wages feeding into inflation. The RBNZ would like labour market pressures to ease – i.e. they want unemployment – as this should bring down inflation. However on 18th May the government deliver the Budget and no doubt there will be some fiscal stimulus that the RBNZ will need to be aware of – Expansionary Fiscal Policy vs Contractionary Monetary Policy. It seems the Government want to put money into the circular flow especially as it is election year but the RBNZ want to keep inflation between 1-3%. Ultimately it is Politics vs Economics.

Full employment doesn’t mean all workers benefit
Full employment has normally been the concept that has been used to describe a situation where there is no cyclical or deficient-demand unemployment, but unemployment does exist as allowances must be made for frictional unemployment and seasonal factors – also referred to as the natural rate of unemployment or Non-Accelerating Inflation Rate of Unemployment (NAIRU). Full employment does suggest that the employee has a lot of bargaining power as the supply of labour is scarce relative to the demand. In theory a tight labour market should lead to higher wages and improved conditions of work as the employer has less labour to chose from. We have seen in the labour market incentives for employees in recommending potential candidates for vacancies in the company. Other incentives for potential employees include shorter working weeks, hiring bonuses and special leave days.

Michael Cameron’s article in The Conversation suggest that this doesn’t apply to all workers. A lot depends on the bargaining power of the worker and the elasticity of supply of labour. If the supply is very inelastic for a particular job (higher skilled) it is harder and most likely more expensive for the employer to find an alternative worker. This is evident when unemployment is low as the worker can easily look around at other job opportunities. On the contrary if the supply of labour is more elastic (lower skilled jobs) the worker has less bargaining power and the employer will have more potential workers to chose from. The graph below shows the elasticity of supply of labour – high skilled has a steeper curve (inelastic) whilst low skilled as a flatter curve (elastic)

Source: Economicshelp

ANZ New Zealand Labour Market Review | March 2023 Quarter
Michael Cameron writes in The Conversation

Labour Market – notes for CAIE & NCEA Level 2

Wage Rate:- The price of labour as determined by market supply and demand.
The demand for labour is said to be derived demand: – the demand for labour is dependent on the demand for the goods & services produced. Key factors that affect the quantity of labour supplied:-

• age of population
• non-wage factors
• wages
• Difficulty in acquiring qualifications – eg. doctors
• social attitudes to employment
• discrimination

Change in Demand for labour Change in Supply of labour

Wages
A more realistic version of the market model measures the price of labour in real wages rather than in nominal or money wages. The difference is that nominal wages are the actual dollars that are paid for any job while real wages are a measure of the ability of those dollars (earnings) to buy goods and services. Therefore real wages consider the purchasing power of your income.

Sticky Wages
Actual wages will rise much more easily than they will fall. Labour markets are extremely rigid when it comes to reducing wage levels. Several factors encourage wages to stick at higher levels and so prevent the market from clearing, as shown in ‘Supply and Demand Applications’ and below.

Equilibrium and Real Wages

A = Employed B = Involuntary Unemployment C = Voluntary Unemployment

Some of these factors occur through the natural operation of the labour market.

• Strong trade unions can operate as ‘monopoly suppliers’ of labour. This keeps wages above the equilibrium equilibrium. Fewer workers are hired.
• Hiring cheap labour may backfire on employers. This labour may not have the same level of skills as that of the firm’s existing workforce. This will increase costs for the firm if it has to provide too much training. Existing workers therefore hold the balance of power and can demand higher wages.
• The idea that a job has a certain worth, an intrinsic value regardless of the action of demand and supply, can keep wages above equilibrium.
• The influence of humanity values can be strong. It is easy to pay less for resources other than labour.

Some factors are imposed on the market by the government.

• Legislated minimum wages prevent the market from clearing. Although these wages aim to protect the incomes of those in the lower paid jobs, the result is fewer jobs for those same workers.
• Welfare benefits can be over-generous and this may discourage the unemployed from seeking jobs.

Causes of recessions and how do you manipulate the economy for a ‘soft landing’?

Below is a very good video from CNBC that covers the main causes of recessions – overheated economy, asset bubbles and black swan events. Good analysis of soft and hard landings as well as the wage price spiral effect.

“History teaches us that recessions are inevitable,” said David Wessel, a senior fellow in economic studies at The Brookings Institution. “I think there are things we can do with a policy that makes recessions less likely or when they occur, less severe. We’ve learned a lot, but we haven’t learned enough to say that we’re never going to have another recession.” As the nation’s authority on monetary policies, the Federal Reserve plays a critical role in managing recessions. The Fed is currently attempting to avoid a recession by engineering what’s known as a “soft landing,” in which incremental interest rate hikes are used to curb inflation without pushing the economy into recession.

What will higher unemployment figures in NZ mean for monetary policy?

Although still low New Zealand’s unemployment figures today registered an increase of 0.1% to be at 3.4%. The labour market is still tight but there are signs that the reduction in job ads and monthly filled jobs are putting less pressure on the market. This may mean that the RBNZ, who sets monetary policy, sees that aggregate demand is starting to ease indicating a less aggressive stance with interest rates. With inflation at 7.2% and still well above the policy target agreement of 1-3%. the RBNZ might increase the OCR this February by 0.5% which is a reduction on the the previous increase of 0.75% on 23rd November. That would leave the OCR at a peak of 5.25% by May. However if high inflationary expectations become the norm the RBNZ might have to become more aggressive in its policy. Below is a mindmap on monetary policy which might be useful for revision purposes.

Source: ANZ Research 1st February 2023

Adapted from: A Level Economics Revision – Susan Grant.

Sign up to elearneconomics for comprehensive key notes with coloured illustrations, flash cards, written answers and multiple-choice tests on Monetary Policy that provides for users with different learning styles working at their own pace (anywhere at any time).
 

How well do we understand inflationary expectations?

In looking at the causes of inflation, textbooks will cover demand-pull and cost-push but not go into much detail about inflationary expectations. If the consumer believes that prices of goods are going to increase this will have an impact on future price levels and the wage demands – a self-fulfilling prophecy.

Higher wages = Higher labour costs = Higher prices

Jerome Powell, US Fed Chairman, has made four 0.75 percentage point hikes in a row is an aggressive monetary policy to reduce inflation. Yesterday’s increase of 0.5% takes the bank’s benchmark lending rate to 4.25% – 4.5%, a range that is the highest since January 2008. He also alluded to inflationary expectations:

“We can’t allow a wage-price spiral to happen,” he said. “And we can’t allow inflation expectations to become unanchored. It’s just something that we can’t allow to happen.”

So how do you measure inflationary expectations? Policymakers use surveys at different times to monitor households’ and firms’ beliefs about prices. Furthermore, in order to try and shape consumer expectations central banks are very transparent as to their forecast of inflation and future interest rate changes.

How well do we understand households’ expectations? An article in the IMF Finance & Development (September 2022) looked at a deeper understanding of how consumers think about inflation. There seems to be a disagreement between consumers and policy makers with the former relying on the price change in a few products like coffee and petrol as an overall indicator of a country’s inflation rate. Past experiences —such as living through events such as the 1970’s oil crisis, the stagflation years of the late 1970’s, the Global Financial Crisis 2008, stock market crash of 1987 (Black Monday) etc, can influence peoples understanding of inflation for years to come. For instance if you lived through the stagflation years you are you more likely to be less optimistic about controlling inflation?

Andre et al (2022) recent research set out to see if economic policy (fiscal and monetary) and economic events result in the same expectations by laypeople and experts. They focused on unemployment and inflation and distributed surveys to 6,500 households and 1,500 experts. The survey asked respondents to consider four hypothetical shocks to the US economy:

• a sharp increase in crude oil prices
• a rise in income taxes,
• a federal government spending increase,
• a rise in the Federal Reserve’s target interest rate.

All respondents were given the current figures for inflation and unemployment and were asked to give their forecast of their movement over the following year after being given news about one of the four shocks. Interestingly laypeople believed that an increase in interest rates and income taxes would increase inflation which is contrary to what economics textbook models show – see Chart 1. The difference of opinion seems to stem from the interpretations of demand versus supply models see Chart 2. The experts used theoretical models and economic toolkits whilst the laypeople were more likely to rely on personal experiences, political views and a different interpretation – i.e. they look at supply-side issues:

higher interest rates = higher costs for firms = increase in prices to maintain profit margins = inflation↑

Experts take the view that it is a demand-side issue:

higher interest rates – higher cost of borrowing for consumers = less borrowing = inflation↓

Central Banks look to make communication more accessible

Central banks are now trying to, not only make communication accessible, but also much easier to understand. For example the European Central Bank (ECB) has built a presence around social media platforms using simpler language to explain the impact of interest rates on inflation.

Economic models depend on ‘rational expectations’ according to which households base their individual decisions—on how much to save, consume, and work—on expectations about the uncertain future state of the economy.

Source: Hall of Mirrors: How Consumers Think about Inflation by Carlo Pizzinelli
IMF F&D September 2022

Sign up to elearneconomics for comprehensive key notes with coloured illustrations, flash cards, written answers and multiple-choice tests on Inflationary Expectations that provides for users with different learning styles working at their own pace (anywhere at any time).
 

New Zealand and Global Economy update.

New Zealand Economy

As we approach the external exam season it is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question. Indicators that you might want to mention are below.

• New Zealand’s gross domestic product (GDP) expanded by 1.7 percent in the June 2022 quarter, above market expectations.
• Coming from record low interest rates the RBNZ has recently increased the OCR by 50 basis points (0.5%). They did consider 75 basis points.
• A current account deficit of $7.1 billion was recorded in the June 2022 quarter, compared with a deficit of $8.8 billion in the previous quarter (in seasonally adjusted terms)
• Annual inflation remains high globally, with annual inflation within the OECD averaging 10.3 percent in August.

Global Economy – October 2022

Notice that global interest rates are on the rise as the countries tackle the current inflationary problem. Within OECD member countries, annual inflation ranged from 3% in Japan to 80.2% in Turkey. Global inflation is expected to moderate next year but likely to remain above inflation targets in many economies – RBNZ 1-3%. However with the tight monetary conditions expected to remain in place until mid 2023 GDP growth will be subdued.

Use elearneconomics for immediate personalised feedback on Monetary Policy and Interest Rates with tasks designed for true student-centred learning and understanding that improves students results and grades. 

Inflation and potential drivers

Interesting set of charts here that I picked up from Mauldin Economics. The left hand chart shows annually from 2019 and 2021 inflation change against the change in government disbursements. Countries with larger stimulus packages tended to experience greater inflation acceleration. Compared to other countries New Zealand had the largest fiscal stimulus with a disbursements gap of approximately 19% indicating that government spending and transfers increased sharply relative to pre-pandemic trends.

The right panel of that graphic plots inflation vs. the change in employment. A positive
unemployment gap implies that a country’s labour market has yet to recover from the pandemic recession. Across countries, the size of the inflation acceleration is negatively correlated with the unemployment gap, suggesting that differences in labour market slack account for a significant part of the cross-country variation in inflation acceleration.

Source: Mauldin Economics

Is there stagflation in the global economy?

Below is an interesting graphic from the FT which shows GDP and Inflation over the last couple of years in New Zealand – you can select other countries as well and it is good to compare different parts of the world. Note that NZ’s inflation and GDP is lower than the global average. You would normally experience stagflation when the stagnant growth is accompanied by high levels of unemployment – NZ has 3.3% unemployment. However the labour markets globally are very tight with just today British Airways cancelling 10,000 flights due to labour shortages.

If you look at Japan you will see very little difference between GDP and Inflation and you could say they may be eventually coming out of a deflationary period.

The site is very good and has various interactive graphs – Global Inflation Tracker

Are we actually in recession and is a wage-price spiral on the cards?

For the majority of textbooks a recession is defined as two consecutive quarters of negative GDP. Whilst a lot of economies might technically go through this objective measure in the next year it is a rather strange economic environment that we live. I don’t recall a recession that coincides with record level unemployment, high consumer spending and a huge number of job openings which in turn has led to wage increases. Recession is usually associated with the opposite – high unemployment, low to nil wage growth and little spending. Therefore the economy isn’t in the usual boom-bust cycle but more of an intentional slowdown. Central banks need to get inflation under control by reducing aggregate demand through higher interest rates. Consumer prices, especially in food and energy, rising faster than wages but with wages rising there is a risk of a wage-price spiral. In order to get the inflation down most central banks only have the tools of interest rates and bank liquidity with both currently in the tightening phase.

New Zealand Employment Data – 3rd August 2022

Today’s figures labour data statistics in New Zealand were interesting to say the least. Although unemployment went up 0.1% to 3.3% against expectations it was wage growth of 7% that really stood out and reflected a really tight labour market almost matching the CPI of 7.3%. This is a major concern for the RBNZ the labour market appears to be the major driver of inflation and the threat of a wage-price spiral is very real. A self-perpetuating inflation cycle could cause domestic inflation in New Zealand to remain high, even if global pressure start to ease. In previous periods of inflation the RBNZ got help in the form of redundancies that forced numbers of consumers to cut their spending. This is unlikely in such labour market conditions and what can be sure is that the OCR will be on the rise again and is likely to increase to 4% by the end of the year.

Theory behind the wage-price spiral

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.

New Zealand labour market post COVID

Below are figures and a graph for the NZ labour market from 2020 – 2022. Although the unemployed figures have fallen to 3.2% of the working population, the drop in those actively looking for work – participation rate – have fallen by a similar amount. The number of those employed increased although matched by the change in the working age population. This gives the impression that people who were previously unemployed in 2020 have not got a job, but are not making themselves available for work. Notice the difference in the graph between the growth in employment and the unemployment rate from 2020 onwards. Also the majority of extra jobs in the economy have been full-time roles as employers struggled to find labour.

Below is a flow chart that shows how you calculate the participation rate, unemployment rate etc with some older figures. This is important for MCQ as well as essays on the labour market.

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Unemployment. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

The Beveridge Curve and COVID-19

There are those that see the problem of unemployment in most economies (but especially the US) as a structural issue. This refers to the mismatch between the jobs that are available and the skills that people have. Cyclical unemployment can be reduced by boosting demand – dropping taxes and increasing government spending (fiscal policy) and lowering interest rates (monetary policy). However, if unemployment is mainly structural patience is needed to wait for the market to sort things out, and this takes time.

The Beveridge curve is an empirical relationship between job openings (vacancies) and unemployment. It serves as a simple representation of how efficient labour markets are in terms of matching unemployed workers to available job openings in the aggregate economy. Economists study movements in this curve to identify changes in the efficiency of the labour market. It is common to observe movements along this curve over the course of the business cycle. For instance, as the economy moves into a recession, unemployment goes up and firms post fewer vacancies, causing the equilibrium in the labor market to move downward along the curve (the red arrows in the figure above). Conversely, as the economy expands, firms look for new hires to increase their production and meet demand, which depletes the stock of the unemployed – see graph below.

Careful analysis of Beveridge Curve data by economists Murat Tasci and John Lindner at the Cleveland Federal Reserve shows that it’s behaving much the way it has in previous recessions: there are as few job vacancies as you’d expect, given how desperate people are for work – see graph below. The percentage of small businesses with so-called “hard-to-fill” job vacancies is near a twenty-five-year low, and open jobs are being filled quickly. And one recent study showed that companies’ “recruiting intensity” has dropped sharply, probably because the fall-off in demand means that they don’t have a pressing need for new workers.

The Beveridge Curve and COVID

The graph below shows the Beveridge Curve pre and post covid. The pre-covid curve is a typical which relates to theory above, however the post-covid curve has become a lot steeper in showing that changes in the unemployment rate are not as responsive to changes in the vacancies. If the matching process between workers and firms becomes less efficient,  employers need to post more vacancies to fill a given number of positions. In terms of the model, an outward shift of the Beveridge curve can therefore be explained by a decline in match efficiency. Since match efficiency has declined, any reduction in unemployment now requires a much higher job opening rate than before the pandemic. During the pandemic, job creation has become more difficult, and firms have had to recruit more aggressively to find workers. Looking forward, a reduction of the unemployment rate to pre-COVID levels would require job openings to be at twice the level they were before.

Source: Revisiting the Beveridge Curve: Why has it shifter so dramatically. Economic Brief October 2021

 

Global Economic Outlook

Below is a look at economic conditions in leading global economies. Unemployment is surprising low and with the rise in the cost of living (see inflation figures) this should put pressure on wages. The unemployment rate within the OECD area fell to 5.2% in February, the first time it has fallen below the pre-pandemic unemployment rate (which was recorded in February 2020). The unemployment rate within the OCED had peaked at 8.8% in April 2020.

Inflation, Unemployment and Interest Rates
Annual inflation within the OECD area rose to 8.8% in March 2022, its highest annual increase since 1988. Energy prices have risen by over a third during the past year, while food prices have risen by ten percent within the OECD area. Most central banks have already commenced a tightening programme with the on-going threat of inflation. The Australian Reserve Bank commenced tightening their cash rate in early May, increasing the cash rate by 25 basis points to 0.35%. It is expected that the RBNZ will increase the OCR by 50 basis points next week.

Outlook
If you look at conditions in the major economies you find the following:

• China – limited growth potential with severe lockdowns
• USA – higher interest rates could lead to a bust scenario
• Euro Zone – cost of living crisis
• Emerging markets – food crisis / famines.

With the indicators looking at recessionary conditions the best news for the global economy would be a withdrawal from Ukraine by Russian troops and an end to a zero-Covid strategy in China. These actions should reduce food and energy prices and therefore save government spending on raising benefits and subsidising food and energy. Economists are fairly optimistic that we will avoid a recession in 2022 as they still have the tools to stimulate if things get worse. However with no end in sight for the Ukraine conflict and interest rates on the rise a recession is on the cards.

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation and Unemployment. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

Plenty of jobs but no workers.

The COVID pandemic has been prevalent in the global economy for just over two years now but although there seems to be plenty of job opportunities where is the available labour? According to a recent report from the IMF there are various reasons for this:

• Reduced labour force participation: disadvantaged groups, the low-skilled, older workers, or women with young children—have yet to fully return to the labour market.
• The pandemic: health concerns and favourable pension plan valuations have contributed to a lot of older workers departing the labour force
• Worker preference: workers are moving away from some low-pay jobs. A lot workers in contact -intensive, physically strenuous and less flexible jobs are moving into other areas or have left the labour force.
• Occupational mismatch: due to COVID some industries and firms have cut back on production due a lack of demand for their products/services or can’t function in the pandemic environment. As a result in a mismatch between those that are looking for work and the requirements of the labour market.
• Border restrictions means limited immigration: this has led to large shortages of labour especially in primary industries and other low-paid jobs
• Changing job preferences: COVID-19 affected hospitality work in particular and although the industry maybe recovering health concerns may be discouraging workers from keeping such jobs and job seekers from taking them up, leaving many vacancies unfilled

Source: Deloitte Insights – The global labor shortage

For more on Unemployment view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

Could war in Ukraine lead to economic crisis?

From Al Jazeera – Counting the Cost. Main discussion points:

• Ukraine and Russia are expected to experience a severe recession this year. But the sanctions imposed on Russia and the increasing energy price can inflict inflation on other countries.
• IMF to cut its growth forecast on the Global Economy.
• Russia to turn to the Chinese Yuan to survive and are counties dumping the US$ as the global reserve currency?

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation and Exchange Rates. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

Stagflation – 1970’s v Today

The Financial Times had a good piece about the current state of the global economy and the likeness of the stagflation of the 1970’s. Using that article and other sources I have attempted to differentiate between what was happening then and the current situation with the war in the Ukraine. With oil still having an impact in an economy today this could be the catalyst needed for more greener technologies but this is not going to help in the short-term. Therefore, for global oil prices to stabilise there needs to be an increase in the output of OPEC countries and the likes of Venezuela which could add 400,000 bpd to oil output – the US has been in talks with President Maduro. However, there is a dilemma here in that you may reduce oil prices by getting Venezuela to increase production but you are also assisting an authoritarian regime that is closely linked with Russia.

Source: War brings echoes of the 1970s oil shock. FT 12th March 2022

Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.

Economic Theory v Economic Reality

Invariably I get the question in class “Does this economic theory actually happen in the real world?” We then proceed to discuss upward sloping demand curves, trickle down theory, the GFC and the fact that few economists saw it coming and how Japan ran a massive stimulus programme but inflation was stagnant.

Most theories in economics rest on the premise that people, companies, and markets behave according to the abstract, two-dimensional illustrations of an introductory economics textbook, even though the assumptions behind those diagrams virtually never hold true in the real world. To understand economics you have to understand human nature.

Below is a table that I found in James Kwak’s book “Economism”. It takes theories found in most introductory economics textbooks and suggests what actually might happen to these theories in the real world.

For more on secondary school economics courses view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

Global Stagflation and the threat to democracy.

In my economics classes this week one cannot get away from what is happening in Ukraine and the impact of that geopolitics will have on the global economy. Already I wrote a blog post on Russian interest rates and the collapse of the rouble but what are the challenges ahead for the global economy?

Before the invasion central banks worldwide were tightening monetary policy (interest rates) to reduce the increasing inflation pressure in their economy’s. The price of oil has increased to over US$105 adding to the inflationary problem as policy makers still have to deal with the slow recovery from the COVID pandemic. However the US Federal Reserve (US Central Bank) and the European Central Bank (ECB) have indicated that they intend to continue with their tightening policy of 25 basis points (0.25%) increase in interest rates this month but may have to be less aggressive in their future tightening. Their major concern now is that the war in Ukraine has increased the chances of a period of stagflation – stagnation and inflation at the same time. Therefore it is important that central banks are more sensitive to tightening their monetary policy as adding the Ukrainian crisis (with higher oil and food prices) to the present supply chain issues would increase the chances of stagflation and a significant downturn in the global economy.

Stagflation
In economic textbooks there are two main cause of inflation – Demand Pull and Cost Push (see graph below).

Source: Eleareconomics

The inflation that New Zealand is mainly experiencing is of a cost push nature especially when you look at the recent CPI figure of 5.9%. The major driver of this inflation is:

• 30.5% rise in the cost of petrol
• 15.7% rise in the associated cost in buying a new dwelling.
• 4.1% increase in the food group

What you notice from the graph is that when the AS curve shifts left not only does inflation increase but also output and employment decrease. The last major stagflationary period was during the oil crisis years of 1973 (oil price up 400%) and 1979 (up 200%) – see video below from the Philadelphia Fed.

But when will these cost pressures ease in New Zealand? With a 5.9% inflation rate employees will put significant pressure on employers for wage increases and this is when there is already a very tight labour market (3.2% unemployment).

Final thought
2022 is going to be a very difficult year for the economy with both demand and supply issues:
Demand: higher inflation will mean a tightening of interest rates which will reduce spending and increase the debt burden.
Supply: higher energy costs, supply chain problems, increase in material costs and availability of parts for industry.

Add to this the war in Ukraine and we are in for a rocky ride. However the possible suffering is necessary if it nullifies the threat on global democracy.

For more on Stagflation view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

OCR – LSAP – FLP = New Zealand’s Monetary Policy Toolkit

Below is a useful flow diagram from the ANZ bank which adds Large Scale Asset Purchases (LSAP) and Funding for Lending Programme (FLP) to the Official Cash Rate (OCR – Base Rate)

LSAP – this is the buying of up $100 billion of government bonds – quantitative easing
FLP – this gives banks cheap lending based on the Official Cash Rate – could be about $28 billion based on take up
OCR – wholesale interest rate currently at 0.75%. Commercial banks borrow at 0.5% above OCR and can save at the Reserve Bank of New Zealand (RBNZ) at 1% below OCR.

With FLP and more LSAP this will mean lower lending rates and deposit rates. This should provide more stimulus in the economy and allay fears of future funding constraints making banks more confident about lending. Add to this a third stimulus – an OCR of 0.75%. Although there is currently a tightening policy the rate is probably still stimulatory. The flow chart shows the impact that these three stimulus policies have on a variety of variables including – exchange rates – inflation -unemployment – consumer spending – investment – GDP. Very useful for a class discussion on the monetary policy mechanism.

For more on Monetary Policy view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.

How tight is the New Zealand labour market?

The New Zealand unemployment rate of 3.2% doesn’t reflect how tight the labour market is – there were 93,000 people unemployed in the December quarter in seasonally adjusted terms. In setting the Official Cash Rate (OCR) the RBNZ consider the labour market and look at a number of indicators. The figure below shows the range of indicators and how they have been performing since 2000.

Note:
Yellow (inner) circle = worst outcome since 2000,
Orange (outer) circle = best outcome since 2000,
Dark blue = current outcomes,
Light blue = 2019 Q4, when the RBNZ saw employment as “at or slightly above” maximum sustainable employment.

Looking at the number of average hours worked the lockdown has seen employers reduce hours of work rather than laying off workers which puts them in a good position for when the country changes alert levels. With COVID restrictions easing unemployment could have further to fall (forecast 3%) and this can only serve to increase the wage negotiating power of the employee. As well as the fact that labour will be more scarce, the level of inflation is on the way up and employees will want to maintain their purchasing power. These factors will most likely lead to higher wages. While there is no shortage of downside risks on the demand side of things as interest rates rise (globally) and the housing market cools, there’s also no quick fix on the labour supply front. It’s also worth bearing in mind that the labour market tends to lag activity by quite some months.

Source: ANZ Bank New Zealand Weekly Data Wrap – 5th November 2021