Sorry for the gap in posting...have been trying to get on top of a whole pile of books that need to be read before the end of the summer!
The Bank of England recently announced that inflation was within its intended target of 2% +/- 1%. It has fallen from 2.8% in May to 2.4%, which is the lowest inflation rate since the end of 2009. However, while this seems like a rest-bite for the Bank, which has come under scrutiny lately for the Libor scandal, do we actually want an inflation target of 2%?
I am currently reading Paul Krugman's End This Depression Now! which suggests that we should actually have an inflation target of 4%, which was actually the rate of inflation during Ronald Reagan's second term in office when he presided over a period of economic recovery, often referred to as "Good Morning America." An inflation target of 4% is not ridiculously high, and fears of hyperinflation and the like are unnecessary.
Over my AS course, I have been taught that inflation is not desirable, and inflation can have serious negative consequences for an economy. However, if you take our current situation as a depression, higher inflation could be desirable for three reasons.
The first reason was published in an IMF report in 2012, where a chief economist reported:
"When the crisis started in earnest in 2008, and aggregate
demand collapsed, most central banks quickly decreased their policy
rate to close to zero. Had they been able to, they would have decreased
the rate further: estimates, based on a simple Taylor rule, suggest
another 3 to 5 percent for the United States. But the zero nominal
interest rate bound prevented them from doing so. One main implication
was the need for more reliance on fiscal policy and for larger deficits
than would have been the case absent the binding zero interest rate
constraint.
It appears today that the world will likely avoid
major deflation and thus avoid the deadly interaction of larger and
larger deflation, higher and higher real interest rates, and a larger
and larger output gap. But it is clear that the zero nominal interest
rate bound has proven costly. Higher average inflation, and thus higher
nominal interest rates to start with, would have made it possible to cut
interest rates more, thereby probably reducing the drop in output and
the deterioration of fiscal positions."
To summarise this idea, if we had started with a higher inflation target, when the crisis came about in 2008, we would have had more room to manoeuvre our interest rate target in order to deal with the crisis. As it was, the zero nominal interest rate was reached quickly, and I believe I would be right in saying this lead to us being in a liquidity trap, where 0% interest rate isn't low enough.
The second reason for a higher inflation target would be greatly beneficial to European nations such as Spain, where their wages are very uncompetitive in comparison to Germany. If they were not in the Euro, they could simply devalue their currency, but as that is not an option, they must enforce nominal wage decreases, which are always going to be highly unpopular. As the Economist reported, "If inflation is humming along at 4%, however, then real wages can adjust
downward more easily, simply by not keeping up with the price level. A
higher inflation rate is therefore consistent with greater labour market
flexibility and lower unemployment."
Another advantage of higher inflation is that the real value of debt would decrease the higher the inflation. This would be both beneficial to the government in terms of dealing with their debt, and private households. If we had higher inflation, then households would be encouraged to take out loans and increase demand for products now, as the real value of their debt would decrease in the future.
These arguments are just some food for thought, and there are many counter-arguments!
Wednesday 18 July 2012
Monday 9 July 2012
QE3- late but worth a mention
Sorry that this post is a bit late- been quite busy lately!
Well the Bank of England announced last week that it was to inject £50bn into the economy in its third round of Quantitative Easing. Surprisingly, I haven't seen that much coverage of the plan around the internet (most likely because the effects of this plan are already known), but Stephanie Flanders' analysis is both interesting and accessible:
"The Bank's monetary policy committee (MPC) voted to spend another £75bn on government bonds last October, and another £50bn in February - to make a grand total of £325bn since March 2009. The additional £50bn announced today will take it up to £375bn, though it's worth noting that the new money will be spent at a slower rate than before - over four months instead of three.
Some will see that slower pace as a hint that members of the MPC think this bout of easing will be less powerful than in the past - or perhaps that they are worried about possible negative effects of continuing the policy for so long. But the Kremlinology is less important than the fact that they have done it at all.
On the face of it, the Bank has not got a lot in return for the £125bn it has spent since the autumn, other than a pile of government IOUs.
The narrowest measure of the money supply - in effect, cash on bank balance sheets - has risen by 58% since September, as you'd expect when the Bank is handing their customers all that freshly created money in exchange for the purchased gilts. But there is not much sign of that getting out into the broader economy. Lending to households and companies has risen by just 0.2% in that time. (Thanks to Vicky Redwood, chief UK economist for Capital Economics, for pulling these numbers together for me. For those that care about these things, we're using the M4 measure of lending - excluding transactions between different parts of the financial system which otherwise distort the figures.)
Other things have also been moving in the wrong direction, from the Bank's standpoint. The pound has risen about 6%, on a trade weighted basis, since October, and the FTSE is only slightly higher.
Finally, borrowing costs for companies and households, if anything, have crept up. The Bank's own figures showed the average new mortgage rate creeping up to 3.75% in May, higher than in April and more than a third of a percentage point higher than at the start of the year.
Of course, you can blame the eurozone crisis for a lot of these unhelpful developments - maybe all of them. Without that extra liquidity sloshing around the financial system, Bank officials would say things would have been considerably worse.
As ever, the argument would be that the Bank cannot hope to control what is happening across the Channel, or prevent it from darkening the prospects for the UK. But it can do all it can to offset the upward pressure on bank funding costs and the downward effects on confidence. They would also point out that if their forecast shows inflation dipping below target in two or three years, the Bank can hardly sit on its hands.
All of that is true. But it is a striking reflection of our times that the MPC is continuing with more QE, three weeks after the Bank's governor and deputy governor admitted, in separate speeches, that asset purchases, on their own, were not enough.
Sir Mervyn King could scarcely be gloomier about the short-term outlook for the eurozone - and the UK. He repeated again recently that we were "only halfway through" the crisis - and warned that the economic situation had deteriorated dramatically in a matter of just a few weeks.
Yet, somehow, he and his fellow policy-makers at the Bank must convince the country, and the City, that more quantitative easing will meaningfully offset this gloom, and that further steps - like easing the liquidity requirements for banks, and the "funding for lending" scheme - will finally encourage banks to lend, and firms and households to borrow and spend. That's despite the fact that British banks are already holding idle liquidity worth around £500bn - about 30% more than regulators have formally required them to hold.
There might not be many other avenues open to our central bank in the current climate, but making that case is going to be a challenge, to say the least"
It strikes me, someone who is not a professional economist and has very limited economic knowledge, that although the Bank's policies can have some tangible impact, the real need for these policies is all to do with confidence. The effect of QE is to increase confidence of households and firms in banks. However, with a gloomy economic outlook, it seems as if the Bank need to do something radical if they want to have a real impact.
http://www.bbc.co.uk/news/business-18725082
Well the Bank of England announced last week that it was to inject £50bn into the economy in its third round of Quantitative Easing. Surprisingly, I haven't seen that much coverage of the plan around the internet (most likely because the effects of this plan are already known), but Stephanie Flanders' analysis is both interesting and accessible:
"The Bank's monetary policy committee (MPC) voted to spend another £75bn on government bonds last October, and another £50bn in February - to make a grand total of £325bn since March 2009. The additional £50bn announced today will take it up to £375bn, though it's worth noting that the new money will be spent at a slower rate than before - over four months instead of three.
Some will see that slower pace as a hint that members of the MPC think this bout of easing will be less powerful than in the past - or perhaps that they are worried about possible negative effects of continuing the policy for so long. But the Kremlinology is less important than the fact that they have done it at all.
On the face of it, the Bank has not got a lot in return for the £125bn it has spent since the autumn, other than a pile of government IOUs.
The narrowest measure of the money supply - in effect, cash on bank balance sheets - has risen by 58% since September, as you'd expect when the Bank is handing their customers all that freshly created money in exchange for the purchased gilts. But there is not much sign of that getting out into the broader economy. Lending to households and companies has risen by just 0.2% in that time. (Thanks to Vicky Redwood, chief UK economist for Capital Economics, for pulling these numbers together for me. For those that care about these things, we're using the M4 measure of lending - excluding transactions between different parts of the financial system which otherwise distort the figures.)
Other things have also been moving in the wrong direction, from the Bank's standpoint. The pound has risen about 6%, on a trade weighted basis, since October, and the FTSE is only slightly higher.
Finally, borrowing costs for companies and households, if anything, have crept up. The Bank's own figures showed the average new mortgage rate creeping up to 3.75% in May, higher than in April and more than a third of a percentage point higher than at the start of the year.
Of course, you can blame the eurozone crisis for a lot of these unhelpful developments - maybe all of them. Without that extra liquidity sloshing around the financial system, Bank officials would say things would have been considerably worse.
As ever, the argument would be that the Bank cannot hope to control what is happening across the Channel, or prevent it from darkening the prospects for the UK. But it can do all it can to offset the upward pressure on bank funding costs and the downward effects on confidence. They would also point out that if their forecast shows inflation dipping below target in two or three years, the Bank can hardly sit on its hands.
All of that is true. But it is a striking reflection of our times that the MPC is continuing with more QE, three weeks after the Bank's governor and deputy governor admitted, in separate speeches, that asset purchases, on their own, were not enough.
Sir Mervyn King could scarcely be gloomier about the short-term outlook for the eurozone - and the UK. He repeated again recently that we were "only halfway through" the crisis - and warned that the economic situation had deteriorated dramatically in a matter of just a few weeks.
Yet, somehow, he and his fellow policy-makers at the Bank must convince the country, and the City, that more quantitative easing will meaningfully offset this gloom, and that further steps - like easing the liquidity requirements for banks, and the "funding for lending" scheme - will finally encourage banks to lend, and firms and households to borrow and spend. That's despite the fact that British banks are already holding idle liquidity worth around £500bn - about 30% more than regulators have formally required them to hold.
There might not be many other avenues open to our central bank in the current climate, but making that case is going to be a challenge, to say the least"
It strikes me, someone who is not a professional economist and has very limited economic knowledge, that although the Bank's policies can have some tangible impact, the real need for these policies is all to do with confidence. The effect of QE is to increase confidence of households and firms in banks. However, with a gloomy economic outlook, it seems as if the Bank need to do something radical if they want to have a real impact.
http://www.bbc.co.uk/news/business-18725082
Wednesday 4 July 2012
Euro problems and solutions
To simplify the problems in the Euro, it is possible to say it was flawed from the beginning. The exchange rate at which the Euro countries went in to the single currency is unreasonable, and trying to force together these very differently structured economies has proved remarkably unsuccessful.
Common sense suggests that trying to force together different economies which are performing very differently together under one inflexible exchange rate just isn't going to work. It seems to me as if the grand plan of the Euro was to stop a WW3, but it appears to be happening at the cost of ecomonic collapse and significant hardships for citizens in many countries.
I think Amartya Sen (Guardian) sums this up nicely in one of his blog posts:
" The euro, with fixed exchange rates for all countries in the zone – economies that fall behind in the productivity race tend to develop lack of competitiveness in exports, as countries such as Greece, Spain or Portugal have been experiencing already. Competitiveness can, of course, at least partly be recovered through slashing wages and living standards, but this would lead to great suffering (much of it unnecessary), and generate understandable popular resistance. Sharp increases in inequality between regions can be remedied, to be sure, by large-scale migration within Europe (for example, from Greece to Germany). But it is hard to assume that persistent population inflow to the same countries would not generate political resistance there.
The inflexibility of fixed exchange rates of the euro is inherently problematic when the economic performance of countries continues to differ. A unified currency in a politically united federal country (such as in the US) survives through adjustment mechanisms (including large internal migration and substantial transfers) that cannot yet be a norm in a politically disunited Europe.
If European economic policies have been economically unsound, socially disruptive and normatively contrary to the commitments that emerged in Europe after the second world war, they have been politically naive as well. The policies have been chosen by financial leaders with little attempt to have serious public discussion on the subject.
Decision-making without public discussion – standard practice in the making of European financial policies – is not only undemocratic, but also inefficient in terms of generating reasoned practical solutions. For example, serious consideration of the kinds of institutional reforms badly needed in Europe – not just in Greece – has, in fact, been hampered, rather than aided, by the loss of clarity on the distinction between reform of bad administrative arrangements on the one hand (such as people evading taxes, government servants using favouritism, or unviably low retiring ages being preserved), and on the other, austerity in the form of ruthless cuts in public services and basic social security. The requirements for alleged financial discipline have tended to amalgamate the two in a compound package, even though any analysis of social justice would assess policies for necessary reform in an altogether different way from ruthless cuts in important public services.
The problems we are seeing in Europe today are mainly the result of policy mistakes: punishments for bad sequencing (currency unity first, political unity later); for bad economic reasoning (including ignoring Keynesian economic lessons as well as neglecting the importance of public services to European people); for authoritarian decision-making; and for persistent intellectual confusion between reform and austerity. Nothing in Europe is as important today as a clear-headed recognition of what has gone so badly wrong in implementing the grand vision of a united Europe."
http://www.guardian.co.uk/commentisfree/2012/jul/03/austerity-europe-grand-vision-unity
Common sense suggests that trying to force together different economies which are performing very differently together under one inflexible exchange rate just isn't going to work. It seems to me as if the grand plan of the Euro was to stop a WW3, but it appears to be happening at the cost of ecomonic collapse and significant hardships for citizens in many countries.
I think Amartya Sen (Guardian) sums this up nicely in one of his blog posts:
" The euro, with fixed exchange rates for all countries in the zone – economies that fall behind in the productivity race tend to develop lack of competitiveness in exports, as countries such as Greece, Spain or Portugal have been experiencing already. Competitiveness can, of course, at least partly be recovered through slashing wages and living standards, but this would lead to great suffering (much of it unnecessary), and generate understandable popular resistance. Sharp increases in inequality between regions can be remedied, to be sure, by large-scale migration within Europe (for example, from Greece to Germany). But it is hard to assume that persistent population inflow to the same countries would not generate political resistance there.
The inflexibility of fixed exchange rates of the euro is inherently problematic when the economic performance of countries continues to differ. A unified currency in a politically united federal country (such as in the US) survives through adjustment mechanisms (including large internal migration and substantial transfers) that cannot yet be a norm in a politically disunited Europe.
If European economic policies have been economically unsound, socially disruptive and normatively contrary to the commitments that emerged in Europe after the second world war, they have been politically naive as well. The policies have been chosen by financial leaders with little attempt to have serious public discussion on the subject.
Decision-making without public discussion – standard practice in the making of European financial policies – is not only undemocratic, but also inefficient in terms of generating reasoned practical solutions. For example, serious consideration of the kinds of institutional reforms badly needed in Europe – not just in Greece – has, in fact, been hampered, rather than aided, by the loss of clarity on the distinction between reform of bad administrative arrangements on the one hand (such as people evading taxes, government servants using favouritism, or unviably low retiring ages being preserved), and on the other, austerity in the form of ruthless cuts in public services and basic social security. The requirements for alleged financial discipline have tended to amalgamate the two in a compound package, even though any analysis of social justice would assess policies for necessary reform in an altogether different way from ruthless cuts in important public services.
The problems we are seeing in Europe today are mainly the result of policy mistakes: punishments for bad sequencing (currency unity first, political unity later); for bad economic reasoning (including ignoring Keynesian economic lessons as well as neglecting the importance of public services to European people); for authoritarian decision-making; and for persistent intellectual confusion between reform and austerity. Nothing in Europe is as important today as a clear-headed recognition of what has gone so badly wrong in implementing the grand vision of a united Europe."
http://www.guardian.co.uk/commentisfree/2012/jul/03/austerity-europe-grand-vision-unity
Libor Scandal
I recently read a post from Angus Armstrong, Director, Macroeconomic Research, NIESR regarding this Libor Scandal. I think he summarises the situation well...in much better terms than I am qualified to do.
I have quoted below a few paragraph's of his story to help give an understanding of the scandal:
My personal concern about this story is the effect on the reputation of the City and our banks. The speed with which we can deal with this situation will be fundamental in determining the international reaction to it. If we let this rumble on, which may be because we end up with a full legal, judge led inquiry, then we may face unforeseen repercussions which have an impact on the City.
If we were not in the middle of a financial crisis, at a time when bankers are still receiving large bonuses even though they are the cause of this chaos, then there would probably not have been as large a backlash as there has been.
I just hope the situation is dealt with efficiently, with any other banks involved being fined appropriately, and criminal charges brought as necessary.
http://notthetreasuryview.blogspot.co.uk/2012/07/libor-scandal-and-reforming-banking.html#more
I have quoted below a few paragraph's of his story to help give an understanding of the scandal:
"The damage to the City of
London of the revelations of manipulation in the London interbank market cannot
be overestimated. The City is the global centre of foreign exchange trading
(37% of global turnover), the home of the money markets and half of the $650
trillion global over-the-counter derivatives market.[1] The
London Interbank Offer Rate (LIBOR) is the benchmark interest rate on which
these transactions are priced, as well corporate loans and even mortgages. According
to the IMF’s Article IV Spillover Report
the UK's dominance in finance is reinforced by its "robust"
market infrastructure, including the setting of LIBOR - the global benchmark
interest rate.
LIBOR is not an
actual borrowing rate. It is a (trimmed) average of interest rates that banks
report that they could borrow funds
in a reasonable size just prior to 11am each day. So in periods of distress there is an
incentive for banks which borrow at typical rates (so not trimmed) to submit
lower interest rates to avoid this perverse signalling effect. Collusion could
be an even more powerful way of forcing interest rates lower. Moreover, modern
banks also hold very large positions in over-the-counter derivatives which are
priced relative to LIBOR. This creates a second direct incentive to influence
the reference rate."
My personal concern about this story is the effect on the reputation of the City and our banks. The speed with which we can deal with this situation will be fundamental in determining the international reaction to it. If we let this rumble on, which may be because we end up with a full legal, judge led inquiry, then we may face unforeseen repercussions which have an impact on the City.
If we were not in the middle of a financial crisis, at a time when bankers are still receiving large bonuses even though they are the cause of this chaos, then there would probably not have been as large a backlash as there has been.
I just hope the situation is dealt with efficiently, with any other banks involved being fined appropriately, and criminal charges brought as necessary.
http://notthetreasuryview.blogspot.co.uk/2012/07/libor-scandal-and-reforming-banking.html#more
General Introduction
I have decided to create this blog to repost and comment on blog posts from around the web. The focus will be on economic headlines, inevitably politics will feature too.
I hope that for anyone who does not have time to read many different blogs, this will provide one place you can come to see reactions to news headlines.
I hope that for anyone who does not have time to read many different blogs, this will provide one place you can come to see reactions to news headlines.
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