Deflation – Benign and Malevolent

May 29, 2017 Leave a comment

Just been covering this area with my AS class and below are some notes. First of all, we need to be clear as to what we mean by deflation. It is a fall in the general price level and must not be confused with falls in a few specific prices, such as for televisions and cars.

Economists distinguish between ‘benign’ deflation and ‘malevolent’ deflation.

‘Benign’ deflation usually stems from technological advances which bring down the price of products. Computer chips would be a good example and I am sure that you can think of others where goods that were initially very expensive have fallen in price as technology has progressed. As a result of the fall in these prices, real incomes have risen.

‘Malevolent’ deflation is the real problem. Here the money supply falls, aggregate demand falls and serious economic consequences may result.

The Consequences of Deflation
1  As aggregate demand falls, firms will find it difficult to sell their products, stocks will begin to rise and less production will be necessary. Firms may try at first to cut costs by wage reductions, but this strategy will be fiercely resisted by workers. The cuts, however, will become inevitable. Even this may not be sufficient and as the demand for goods and services falls, the demand for workers will fall and unemployment in the consumer goods and services industries will rise. The multiplier can work in reverse as well, so an initial fall in spending can trigger further falls in aggregate output.
2  Also, with consumer demand falling, firms will face decreased profits and also have poor expectations of future profitability. There is also a negative accelerator: falling GDP (a recession) hurts business profits, sales, cash flow, use of capacity and expectations. This in turn discourages investment.
3  As firms may have borrowed to invest in capital equipment in the past they will now be faced with the problem that the return on their capital spending is well below what they anticipated. With falling demand but borrowing costs rising in real terms as a result of falling prices, bankruptcies are likely to be a feature of deflation.
4  ‘Negative equity‘ is likely to depress consumer spending as people find that the value of their house falls and their debt or mortgage becomes larger in real terms.
It is the last that could be the real killer. Modern western economies have been built on an ever-rising quantity of debt. In the last decade, borrowers could rely on rising prices to inflate away the real value of their debts; now for the first time since the depression of the 1930s there is the looming threat of debt deflation, where the burden of debt grows bigger rather than smaller. It also means that real interest rates can’t be negative, and so are undesirably high. That spurs yet more repayment of loans so that the liquidation defeats itself.

In terms of policy, the risk of debt deflation will mean that economic policies remain looser for longer and even if inflation  remains low and recovery will be hesitant. However if the global economy fails to respond to the stimulus, they don’t have an awful lot left to offer. With deflation there is mention of a classic Keynesian liquidity trap.

The Liquidity Trap
This is a situation where monetary policy becomes ineffective. Cutting the rate of interest is supposed to be the escape route from economic recession: boosting the money supply, increasing demand and thus reducing unemployment. But John Maynard Keynes argued that sometimes cutting the rate of interest, even to zero, would not help. People, banks and firms could become so risk averse that they preferred the liquidity of cash to offering credit or using the credit that is on offer. In such circumstances, the economy would be trapped in recession, despite the best efforts of monetary policy makers.
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.

liquid_trap
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. Consequently, monetary policy under these circumstances is futile.

Final thought
Today the threat of deflation seems to have passed us by but the world was looking at a major global slowdown and it was not a matter of how much things were slowing, but it was how much they were going backwards. The most disconcerting fact was that all the easing of interest rates by central banks didn’t really change that outlook. Besides, with the severe threat of deflation there was a need to preserve the firepower in case the economy needed more stimulating. Like when an individual is besieged by many attackers while holding limited ammunition, each shot is used sparingly. But with little ammunition left what was next?

Categories: Deflation

Economics Study Skills: Essay Writing

May 26, 2017 Leave a comment

With increasing numbers of students struggling to write well structured essays in economics I decided that they needed some guidance and therefore produced a booklet on how to plan and structure your essay – link to download at the bottom of the post. It looks at how you integrate the following into your essays  whether at CIE or NCEA Scholarship level and shows examples.

Knowledge and understanding – Demonstrate knowledge and understanding.

Application – Interpret and apply knowledge and understanding to information presented in written, numerical or graphical form.

Analysis – Analyse economic issues and arguments, using relevant economic concepts, theories and information, and communicate conclusions in a clear, reasoned manner.

Evaluation – Critically evaluate economic information, arguments, proposals and policies, taking into consideration relevant information and economic principles and distinguishing facts from hypothetical statements and value judgements.

It also contains – the box plan – 12 different sentence types (see below) – command words – PREC Point Reason Example Concluding sentence.

12 sentence types.png

I have taken some material from Dr Ian Hunter’s publications and would recommend the books he has for sale on the Write That Essay website.

Click the link below to download the booklet.

Essay Writing for Economics

Categories: Exam revision Tags:

A2 Economics – The Laffer Curve

May 24, 2017 Leave a comment

New to the A2 syllabus last year was the Laffer Curve. PBS Economics correspondent Paul Solman explores the question of just how high U.S. tax rates should or shouldn’t be and examines the relationship between economic activity and tax rates. There is a good explanation of the Laffer Curve which is the relationship between economic activity and tax rates.

In between, a smooth curve representing Laffer’s pretty simple idea: Somewhere above zero percent and below 100 percent, there is a tax rate where government will collect the most revenue in any given year. Now, the Laffer Curve applies to everyone, but the top so-called marginal rate is only relevant to the rich. It’s now 35 percent on all taxable income in excess of about $380,000 a year. Does that 35 percent rate maximize total tax revenue for the government?

Milton Friedman, Milton Keynes, Milton Schuman and Maynard Keynes

May 21, 2017 Leave a comment

Below is a very funny clip from Yes Minister where Humphery is advising Sir Desmond about the possibilities of making the Minister make the decision that they want him to make. However the start has Sir Desmond getting a little confused with his economists and giving his reason for buying the Financial Times.

Categories: Eco Comedy

China – a blessing or curse for Developing Countries of Africa?

May 20, 2017 Leave a comment

I recently read in the New York Times Magazine a very interesting article on China and how it has built up enormous holdings in poor, resource-rich African countries. Although it may seem as a blessing to the local economy it does have its drawbacks. You can read the full article here but I have edited it for students doing Development Economics topic at A Level.
—————————————————————
Everywhere you look on the globe China’s presence can be felt, driven by its insatiable demand for resources and new markets as well a longing for strategic allies. In 2000 China had 5 countries as their largest trading partner but that has increased today to more than 100 countries including New Zealand, Australia and the USA.  Although there has been a slow down in China, President Xi Jinping has indicated that over the next decade approximately $1.6 trillion will be put into infrastructure and development throughout Asia, Africa and the Middle East. This is serious money that makes a bold statement as to their intentions globally.

China hasn’t held back in trying to secure sufficient resources to keep their economy going. Besides oil and gas China’s state-owned companies have bought mines around the world eg:

  • Peru – copper
  • Zambia – copper
  • Papua New Guinea – nickel
  • Australia – iron ore
  • South Africa – iron ore
  • Namibia – uranium

However as the Chinese economy slowed recently the demand for imports of commodities dropped thus impacting on some of these commodity exporting countries – in particular mines in Western Australia, Zambia and South Africa have been forced to close.

When China met Africa
You maybe aware of a previous blog post in which I talked about the DVD documentary  ‘When China met Africa’ which focused on Chinese investment in Zambia – a very good look at the micro environment that businesses operate in.  Investment in Africa by the Chinese started in 1976 with a 1,156 mile railroad through the bush from Tanzania to Zambia but it wasn’t until the 2000’s that Chinese authorities realised that there was a need for resources to fuel its own internal growth. With this in mind Chinese companies were given free reign to go and seek these resources.

With the end of the Cold War and the Middle East becoming a major conflict area, the US involvement in Africa started to dwindle. Furthermore with the Trump administration raising doubts about free trade agreements and global warming there is an opportunity for China to push its own initiatives and push for global leadership. A Trans Pacific Partnership without the US is very appealing to the Chinese authorities as it allows to become a dominant player in negotiations with other members.

husab mine.jpegChina tends to provide no-strings financing that, unlike Western aid, is not conditional on human rights, clean governance or fiscal restraint. The Namibian finance minister welcomed China as an alternative but although the Chinese want you to be masters of your own destiny and dictate what you want, there are conditions which doesn’t necessarily make their presence truly beneficial. Namibia has seen significant Chinese investment especially in the Husab Uranium Mine ($4.6bn) the second largest uranium mine in the world. It is estimated that it will increase Namibia’s GDP by 5% when the mine reaches full production although almost all of the uranium will go to China for nuclear energy and thereby reducing its dependence on coal. Approximately 88% of China’s energy comes from fossils fuels, 11% from hydropower, solar and wind and only 1% from nuclear power. In order to reach clean energy goals and lose the mantle of chief polluter in the world, China has put a lot of emphasis on nuclear power and they have 37 nuclear reactors with another 20 under construction. The aim is to have 110 reactors by 2030 and become an exporter of nuclear-reactor technology.

The Chinese company China General Nuclear (CGN) has a 90% stake in the mine with the Namibian government 10%. Although Namibians are benefitting from all the infrastructure investment by the Chinese they have saddled the country with debt and have done little to reduce the 30% unemployment rate – Namibia has one of the most unequal societies in the world. In China independent unions are essentially illegal but Namibians have the Metal and Allied Namibian Workers Union (MANWU) which accused Chinese state-owned companies of paying Namibian workers only one third of the minimum wage and also using Chinese workers for unskilled jobs that by law should be going to Namibians. As the unions’s secretary said “the Chinese will promise you heaven but the implementation can be hell”. Also scandals involving Chinese nationals  include tax evasion, poaching endangered wildlife, money laundering have done little to enhance the mood of locals.

Over the last decade China has got a reputation for pillaging and pilfering the natural world with its growing demand natural resources as well as the illegal wildlife trade. Chinese businesses have had public backlash over their proposals that could do damage to the environment. One company wanted to clear a 30,000 acre forest so that it could plant tobacco – the soil in the forest is totally unsuitable for this purpose. Another wanted to set up donkey abattoirs to meet China’s demand for donkey meat and skin whilst a Nambian-based Chinese company requested to capture killer whales, penguins, dolphins and shark in Namibian waters to sell to aquatic theme parks in China. Under pressure from activists the Chinese firm withdrew their request.

Is China the World’s New Colonial Power?

Categories: Development Economics Tags: ,

J.Cole and the Hedonic Treadmill

May 15, 2017 Leave a comment

Below is a very good video from rapper J.Cole in which he talks about the insatiable demand for material things and how it will never make people happy.

Affluent youth in the USA have rates of depression and anxiety which is more than twice the national average. Wealth has been linked to high rates of depression, anxiety, psychosomatic issues and self-mutilation. It seems that the very wealthy have the same problems as the rest of us but only on a much larger scale. A research paper from Boston College entitled “Secret fears of the super-Rich found that the top fears of the rich are:

  1. The rich need increasing amounts of money to make them feel financially secure.
  2. They feel isolated and don’t share their concerns or stress as they will sound ungrateful.
  3. Thy worry that their children will become spoilt by inheriting so much wealth or resentful if its too little.
  4. You are unsure if your friends genuinely like you or your money
  5. There is constant dissatisfaction with consumption as something better / new is always being launched. They can’t get off the hedonic treadmill
  6. Parents are concerned that money will rob their children of ambition and getting a job.

“ONE OF THE SADDEST PHRASES I’ve heard,” Kenny says of his time counseling the wealthy, is when the heir to a fortune is told, “‘Honey, you’re never going to have to work.’” The announcement is often made, Kenny explains, by a rich grandparent to a grandchild—and it rarely sounds as good to the recipient as to the one delivering it. Work is what fills most people’s days, and it provides the context in which they interact with others. A life of worklessness, however financially comfortable, can easily become one of aimlessness, of estrangement from the world. The fact that most people imagine it would be paradise to never have to work does not make the experience any more pleasant in practice.

The Atlantic 

 

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