Posts Tagged ‘European Economies’

Output Gap in Eastern European Countries

July 6, 2017 Leave a comment

Output GapThe Economist had a very good graphic showing the difference between the actual and potential GDP in central and eastern European countries. In Romania a 16% rise in the minimum wage is likely to lift domestic demand and inflation whilst the Ukraine and Bosnia have problems with big negative output gaps where their GDP is well below their potential GDP.

Remember to mention the output gap when doing an essay that involves the business cycle. The output gap is the difference between demand and the economy’s capacity to supply. This is the difference between the ‘actual’ level of output (GDP) and the economy’s ‘potential’ level of output (potential GDP).

  • If the economy is running above capacity (GDP > potential GDP) the output gap is positive.
  • If the economy is running below its full capacity (GDP < potential GDP) the output gap will be negative.
  • There is a sweet spot which is where the level of output is consistent with stable inflation and full employment.

Remember that ‘potential’ output is not an upper limit on the level of output. Rather, think of potential GDP as the economy’s efficient level of output. Running the economy below potential GDP is inefficient because there are some resources that are not employed. Running the economy above potential GDP is also inefficient because resources are over-utilised (eg, machinery is being made to work too hard causing it to wear out too quickly).

While it is efficient to have the economy running at potential, quite often it does not. Resources can be over- or under-utilised, which will translate into inflationary or disinflationary pressure (over-utilisation will push future inflation up, while under-utilisation pushes future inflation down).

Business Cycle.png

The Exchange Rate Mechanism and the Bank of England

June 8, 2017 Leave a comment

I was teaching managed exchange rates with my AS Level class and couldn’t get away from the events in Britain on the 16th September 1992 – known as Black Wednesday. On this day the British government were forced to pull the pound from the European Exchange Rate Mechanism (ERM).


The Exchange Rate Mechanism (ERM) was the central part of the European Monetary System (EMS) and its purpose was to provide a zone of monetary stability – the ERM was like an imaginary rope (see below), preventing the value of currencies from soaring too high or falling too low in realtion to one another.

It consisted of a currency band with a ‘Ceiling’ and a ‘Floor’ through which currencies cannot (or should not) pass and a central line to which they should aspire. The idea is to achieve the mutual benefits of stabel currencies by mutual assistance in difficult times. Participating countries were permitted a variation of +/- 2.25% although the Italian Lira and the Spanish Peseta had a 6% band because of their volatility. When this margin is reached the two central banks concerned must intervene to keep within the permitted variation. The UK persistently refused to join the ERM, but under political pressure from other members agreed to join “when the time is right”. The Chancellor decided that this time had come in the middle of October 1990. The UK pound was given a 6% variation

Black Wednesday

Although it stood apart from European currencies, the British pound had shadowed the German mark (DM) in the period leading up to the 1990s. Unfortunately, Britain at the time had low interest rates and high inflation and they entered the ERM with the express desire to keep its currency above 2.7 DM to the pound. This was fundamentally unsound because Britain’s inflation rate was many times that of Germany’s.

Compounding the underlying problems inherent in the pound’s inclusion into the ERM was the economic strain of reunification that Germany found itself under, which put pressure on the mark as the core currency for the ERM. Speculators began to eye the ERM and wondered how long fixed exchange rates could fight natural market forces. Britain upped its interest rates to 15% (5% in one day) to attract people to the pound, but speculators, George Soros among them, began heavy shorting* of the currency. Spotting the writing on the wall, by leveraging the value of his fund, George Soros was able to take a $10 billion short position on the pound, which earned him US$1 billion. This trade is considered one of the greatest trades of all time.

* In finance, short selling is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to that third party. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than it received on selling them. Wikipedia.

Brexit and ‘Yes Minister’?

May 2, 2017 Leave a comment

In light of what has been happening in Europe recently here is a very amusing clip from the BBC series “Yes Minister” in which Sir Humphrey and Jim Hacker discuss Brussels and the notion of the UK trying to pretend that they are European. Also discusses why other European nations joined the common market in the first place.

European Structural Unemployment

July 29, 2014 1 comment

Here is a great graphic from the Wall Street Journal which identifies the structural unemployment, productivity levels and the unemployment rate. Structural unemployment refers to unemployment arising from changes in demand or technology which lead to an oversupply of labour with particular skills or in particular locations. Structural unemployment does not result from an overall deficiency of demand and therefore cannot be cured by reflation, but only by retraining or relocation of the affected work-force, some of which may find work at low wages in unskilled occupations. Structural unemployment is distinct from frictional unemployment, which is essentially a short-term phenomenon.

* Spain and Greece have been highlighted as economies with significant unemployment problems.
* Ireland although has high unemployment does have encouraging productivity levels compared to other EU countries
* Norway seems to have things right – low unemployment and high productivity
* Eastern bloc countries tend to have lower productivity levels.

Structural Unemp Euro

% Change – GDP per person – 1999 – 2014

January 13, 2014 Leave a comment

Useful graphic from The Economist that shows the % change in GDP from 1999 – 2014.
1999 was when the Euro currency was introduced and with Latvia joining the currency bloc at the start of this year that makes 18 members. Spain, Greece, Portugal and Italy have struggled since the GFC especially Italy – negative GDP. Germany’s GDP per person has increased by over 20% since 1999. Benefitting from export revenue in recent times with a weak euro.

GDP by country 1999-2014

CAP reforms unlikely to benefit New Zealand farmers.

July 1, 2013 Leave a comment

A move by the European Union to slash subsidies to farmers isn’t as big a deal as it sounds. The EU has announced cut to the subsidies it pays industrial scale farmers of up to 30% – this is part of the Common Agricultural Policy (CAP) which costs the EU tax payers 50bn a year and is 40% of the whole EU budget. This will be of little benefit to NZ farmers as they will still be denied access through tariffs and quotas on sheep, butter, cheese etc.

Objectives of CAP

At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.

CAP Int Price
Figure 1: The effect of an intervention price on the income of EU farmers.

The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.

Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.

Spain tries the German method to reduce unemployment

March 19, 2013 Leave a comment

If you look at the labour market in Spain you would think that it resembles the German economy 10 years ago when Gerhard Schroder was its leader. Schroder was responsible for labour reforms that ignited the German economy into one of the strongest in Europe.

Spain is relaxing labour laws and cutting public spending and there are some positive signs here in that labour unit costs are falling as result of greater productivity. However German’s vocational education sector was a significant factor in its improved performance as the education and training system is more job orientated. Furthermore, with austerity measures in place and more to follow – pressure from the EU to introduce yet another sales-tax rise – Spain will find it hard to generate any sort of growth. But if it does grow will it generate any reduction in unemployment? Because of labour reforms some economists now believe that only 1.5% growth is required to bring about net job creation rather than 2.5% as previous.

Spain Unem

%d bloggers like this: