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.
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.
Below is a pdf download of a presentation on consumer behaviour that I did for our Yr12 and Yr 13 students last week. It focuses on the following:
Hedonic Treadmil – Paradox of Choice – Algorithms and Choice – Happy Money – Well-being around the world.
Click here to download. I particularly like these images.
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Part of the excellent Al Jazeera documentary series about Russia, which addresses the problems facing many Russians today. The global economic crisis, conflicts with neighbouring countries and the drop in oil prices all played their part in the demise of the Russian people. There is a very good interview with the former Central Bank Chairman Viktor Gerashchenk who held the position during Yelstin’s reign. He explains very simply how you grow your economy and that there must be money in the banks so that companies can borrow and invest. Buying US Treasury Bills was loaning money to the US and paying for their deficit. Meanwhile the infrastructure and public services declined rapidly causing a lot of anguish amongst the people. You can’t suddenly jump from a socialist system into the free market. Worth a look.
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.
Many thanks to A2 student Lara Hodgson for this superb cake that the class enjoyed this morning. Remember that the standard Keynesian consumption function is written as follows:
C = a + c (Yd) – where:
- C = total consumer spending
- a = is autonomous spending
- c (Yd) = the propensity to spend out of disposable income
Autonomous spending (a) is consumption which does not depend on the level of income. For example people can fund some of their spending by using their savings or by borrowing money from banks and other lenders. A change in autonomous spending would in fact cause a shift in the consumption function leading to a change in consumer demand at all levels of income. The key to understanding how a rise in disposable income affects household spending is to understand the concept of the marginal propensity to consume (mpc). The marginal propensity to consume is the change in consumer spending arising from a change in disposable income. The higher the mpc the steeper the gradient of the consumption function line. As you can imagine the consumption of cake was fairly rapid.
The VIX concept formulates a theoretical expectation of stock market volatility in the near future. The current VIX index value quotes the expected annualized change in the S&P 500 index over the next 30 days, as computed from the options-based theory and current options-market data. There has been significant financial market volatility over the last five years. A non-exhaustive list of risk events over this period includes:
- Greece debt crisis – 2012
- Chinese stock market shocks – August 2015 & January 2016
- Brexit – June 2016
- Election of Donald Trump as the US President – November 2016
Interesting to see that the Trump effect was limited when you compare it to Brexit, Chinese Stock market etc. Markets seem to be tolerant of the change in the President mainly due to:
- Trump’s pro-business stance, which brings expectations that he’ll cut corporate tax and deregulate aspects of the economy.
- Trump promised increased infrastructure spending which will inject more money into the circular flow which should increase aggregate demand.