Friday, June 13, 2014

How to deal with an ageing population

An ageing population means the government needs to spend more (on pensions and health care) it will also receive lower income tax.

If the government does nothing it will experience a rise in the structural budget deficit. This has many problems

1) Resource crowding out. government borrow from private sector so private sector have less to spend and invest. Furthermore the private sector is usually more efficient than government

2) Financial crowding out.
To Borrow more money the government may need to increase interest rates, to make sure people buy enough debt. The problem is that this will put upward pressure on general interest rates and causes lower spending and growth in the economy.

3) Increase the national debt and annual interest payments. Italy already borrows over 100% of GDP. The effect is that a high % of GDP goes on servicing the debt, which will only increase over time.

4) It will require higher taxes or lower spending for future generations.

Policies to deal with an Ageing Population



Option ONE Make people work longer.

This could involve increasing the retirement age from 65 to 70. From an economic point of view this is beneficial because it leads to more tax revenue (people will pay income tax for longer) and more consumer spending. Also, the government can delay paying pensions saving substantial funds. Also, increasing the retirement age increases the supply of labour; this could be a benefit in labour markets where there is a shortage of skilled (experienced) workers.

The main problem with this policy, is that it will be highly unpopular, especially from people who are nearing retirement age. People may say the government is going back on its word to provide pensions at a certain age. In the UK, the government has pledged to increase the retirement age to 67, but this will not come in for a long time and therefore does not tackle the short term debt.

Another problem with increasing the retirement age is that it will affect different types of workers differently. A manual labourer will find it difficult to keep working until 70. But, for an office worker it will be easier. Also, many well paid workers will be able to afford to take a private pension early.

Option TWO - Increase income tax

If the government increase income tax rates, they will increase tax revenue to pay for the higher pension bill. However, higher income tax may lead to lower work incentives. It may discourage people from living in a certain country. Because income tax is relatively low in the UK, a higher rate may not reduce incentives that much; however, there is a high opportunity cost of taxing for pensions. Pension spending does not increase productivity in the economy.

Option THREE - Means tested pensions.

This means pensions are targeted just to those on low incomes, and those who do not have a private pension. This helps to reduce inequality and reduce the total cost of pensions.

However, it creates a very big incentive for people not to save and avoid getting a private pension. This is because if you did save, you would receive little from the government. Therefore, in the long run it may make the situation worse


Option FOUR - Encourage private pensions

Governments could make it obligatory for firms to provide a private pension. Alternatively, they could give more generous tax breaks for private pensions. This is good for reducing the governments pension burden. The concern is that some people may not have sufficient private pension provision when they retire. Therefore, there is still a need for government provided means tested pensions.

Related pages

Saturday, May 24, 2014

Benefits of European Union

The European Union is a political and economic union of 28 countries. Originally formed in 1958 by six countries (then the EEC), the EU has expanded in terms of size and integration. The aim of the EU is to promote European harmony through creating a single market, enabling the free movement of goods, services and people.

Some of the benefits of the European Union include:

Broad political and legal benefits
  1. European harmony - European Union countries are no longer at loggerheads like they were in the past. With the exception of civil war in Yugoslavia (which wasn't in the EU at the time), Europe has managed to heal the divisions which were so painfully exposed in the two World Wars in the Twentieth Century. The EU was awarded the Nobel Peace Prize in 2012 for helping to promote peace and international co-operation. Many Eastern European countries are keen to join the EU because they feel it will help promote economic and political stability.
  2. Legal and human rights. The EU has a strong commitment to human rights, preventing discrimination and the due process of law. This makes the EU attractive to countries, such as the Ukraine who wish to share in similar legal and human rights.
  3. Prospect of membership has helped modernise countries, such as Turkey. The Copenhagen Criteria for EU membership enshrine commitment to human rights, rule of law and market economy. The prospect of gaining membership of the EU, encourage countries to implement human rights legislation.
Economic benefits

  1. EU is one of strongest economic areas in the world. With 500 million people, it has 7.3% of the world's population, but accounts for 23% of nominal global GDP.
  2. Free trade and removal of non-tariff barriers have helped reduce costs and prices for consumers. Increased trade to the EU creates jobs and higher income. Over 52% of UK exports are to the EU. Trade within the EU has increased 30% since 1992.
  3. According to one study - over ten years (1993-2003), the Single Market has boosted the EU’s GDP by €877 billion [£588 billion]. This represents €5,700  [£3,819] of extra income per household.
  4. A paper, Campos, Coricelli, and Moretti (2014) used the synthetic counterfactuals method (SCM) pioneered by Abadie and Gardeazabal (2003). The red dotted line shows estimated GDP if the country had not been a member of the EU. This shows that even more prosperous EU countries, such as the UK have benefited from higher GDP as a result of being in the EU.


  5. Removal of customs barriers mean 60 million customs clearance documents per year no longer need to be completed, cutting bureaucracy and reducing costs and delivery times
  6. Countries in the EU, are amongst the highest positions in the Human Development Index (HDI)
  7. Poorer counties, such as Ireland, Portugal and Spain have made significant degrees of economic development since they joined the European Union. A report suggests that  over the period of the 1980s and 2004 enlargement, there are substantial positive pay-offs of EU membership, with a gain in per capita GDP of approximately 12% for poorer countries. (Vox - how poorer countries benefit from EU)
  8. Social cohesion fund. This has invested in poorer areas of the EU to help reduce regional disparities. For example, Ireland benefited from the EU social cohesion fund (over €6 billion of investment in education and infrastructure spending)
  9. EU structural funds to help Eastern European economies develop will benefit the UK in the long term because as they become more affluent, they will be able to buy more UK exports.
  10. The European Union has attracted greater inward investment from outside the EU. Inward investment grew from €23 billion  [£15.4 billion] in 1992 to €159 billion [ £106.5 billion] in 2005. The UK is the 5th largest source of inward investment in the world, and being a member of the single market is an important factor in encouraging Japanese firms.
    he European Social Fund (ESF)
Labour and free movement of people
  1. Free movement of labour and capital have helped create a more flexible economy. For example, UK and Ireland have benefited from the immigration of Eastern European workers to fill labour market shortages in certain areas, such as plumbing, nursing and cleaning. 
  2. Far from 'taking jobs', migration has helped increase productive capacity and makes a net contribution to tax revenues. (see impact of net migration)
  3. Free movement of labour also enables British people to live and work in Europe. Roughly 1.6 million British citizens live in the EU outside the UK (UNCTAD World Investment Report 2010)
  4. EU has enabled people to travel freely across national boundaries making trade and tourism easier and cheaper. According to the European Commission, more than 15 million EU citizens have moved to other EU countries to work or to enjoy their retirement.
  5. 1.5 million young people have completed part of their studies in another member state with the help of the Erasmus programme. The possibility to study abroad is considered positive by 84% of EU citizens. (benefits of EU)
  6. Easier to use qualifications in different member countries. This makes it easier to work abroad without having to retrain in different national qualifications.
  7. Mutual recognition of safety standards and rules have helped reduce costs for firms. This has encouraged the development of small and medium business who rely on low cost of exports.
  8. Social charter enshrines protection for workers such as maximum working week, right to collective bargaining and fair pay for employment. 
  9. European Arrest Warrant (EAW) scheme has made it easier to track criminals across the European continent.
Environmental benefits of the EU
  • The EU have raised the quality of sea water and beeches, by implementing regulations on water standards 'Bathing Water Directive'. 92% of tourist locations now meet minimum water quality standards. (Clean water at Europa.eu)
  • Tackling global warming. In 2006, the (EU) committed to reducing its global warming emissions by at least 20 percent of 1990 levels by 2020. The EU has also committed to spending $375 billion a year to cut greenhouse gas emissions by at least 80 percent by 2050 compared to 1990 levels. (global warming pdf)
  • Tackling acid rain. Environmental treaties which have sought to deal with European wide environmental problems such as acid rain. The EU has set strict restrictions on emissions of pollutants, such as sulphur, and other causes of acid rain. (BBC Link)
Consumer benefits of the EU
  • EU competition policy has harmonised regulation of monopoly and cartel power within Europe. The EU competition policy seeks to avoid abuses of cartels / monopoly / dominant market power and protect the interest of consumer. There has been successful deregulation of airlines, electricity and gas markets.
  • The EU has reduced the price of making mobile phone calls abroad. In 2007 EU legislation set maximum charges for making and receiving calls.  The EU also agreed with 14 mobile phone manufacturers to create standard design for chargers from 2011 in order to make life easier for consumers and reduce wastage. In 2014, it is has voted to scrap roaming charges which will drastically reduce the cost of using a mobile phone abroad. (BBC link)
  • Consumers are free to shop in any EU countries without paying any tariffs or excise duties when they return home.
So what have the EU ever done for us, apart from straighten all those pesky bananas? (youtube Life of Brian)


Related

Thursday, January 9, 2014

UK economy forecasts for 2014

After faltering for several years, the UK economy shows signs of real recovery, with rising spending, investment, exports and even manufacturing growth. At the start of 2014, there seems to be a virtuous circle of falling unemployment, falling inflation, and rising GDP.

After one of the longest and deepest recessions on record, these signs of economic growth are definitely welcome, yet it is far from a return to normality. Real GDP is still 2% below its 2008 peak, and the economy is being propped up by zero interest rates, quantitative easing and a strong housing market. Stagnant wages and poor productivity growth have led to one of the most prolonged periods of declining living standards in memory. Although there is economic recovery, there is still a fear that the recovery is unbalanced, and that the UK economy could be derailed by problems in the Eurozone and future government austerity measures.

I have produced an in depth look of the UK economy in 2014 on my other blog.

Quick forecasts for 2014

  • Economic growth 2.5% (BBC link)
  • CPI Inflation - 2.4% (gov.org - average of forecasts)
  • Unemployment - 7%
  • Current account deficit - £ - 48bn
  • PSNB - £ 88bn
  • House prices - 8% (Rightmove) IHS Global Insight (8%)
  • Interest rates - 0.5%  (on hold whilst unemployment is above 7%) PWC
  • Average earnings - real average earnings expected to decline for 6th year according to PWC

Reasons to be optimistic in 2014

  • There are strong signs of economic growth, with the possibility of growth rates returning to the UK's long run trend rate of 2.5%. This will cause a virtuous circle of higher investment and spending.
  • Signs of recovery in manufacturing and exports, give the hope of a more balanced economy
  • The UK economy has signs of flexibility to prevent rising unemployment we are seeing on the continent.

Reasons to be pessimistic in 2014

  • The economy is still weak and requires propping up with ultra loose monetary policy
  • The EU economy is still very fragile and could cause damage to the UK economy in 2014.
  • Elements of the recovery suggest it may not be sustainable, especially the mini housing boom, and the widening trade deficit
  • Prospects of more austerity in 2014 could derail the recovery before it is strong enough.

Wednesday, November 6, 2013

Q.E. is it a timebomb waiting to happen?


A reader asked for my take on this BBC radio programme (30mins) on Q.E. I really don't know what will happen when Q.E. ends, but this is my summary of programme and thoughts on Q.E. so far.
 

Risks / Criticisms  of Q.E.
  • The new inflow of money into commercial banks from quantitative easing has encouraged banks to use this extra money through greater risk taking. 
  • Bond traders have benefited from making large profits out of the Bank of England by manipulating the bond market.
  • Because government debt is being financed by quantitative easing, the government has less market discipline to think about reducing fiscal deficits
  • Quantitative easing has been a stealth method of reducing the value of the Pound and Dollar – and therefore making UK exports cheaper. Some commentators call this currency manipulation (or currency wars).
  • The increase in money supply has led to an unexpected rise in commodity prices, such as oil, leading to cost-push inflation.
  • By depressing interest rates, quantitative easing has wiped out people’s return on savings
  • Quantitative easing is causing inflation in the UK, and when the velocity of circulation rises, these extra bank balances will be lent – causing a possible inflationary surge.
  • The scale of quantitative easing could make it impossible to sell bonds back to market and this will damage the UK’s ability to borrow in the future.
  • Evidence in US, suggests even raising the possibility of tapering could cause damage to the bond market, and higher interest rates rates. 

Defence of Q.E.
  • There is no real evidence that there has been a surge in risky bank lending. – A more potent criticism of Q.E. is perhaps that it did so little to increase commercial bank lending.
  • We need fiscal expansion not austerity. It is a very good thing if Quantitative easing has reduced the need for austerity and immediate measures to cut budget deficits.
  • No currency manipulation. It is hard to accuse the UK of currency manipulation when we have a current account deficit of nearly 3% of GDP.
  • Inflation has not been a macro-economic problem since 2008. The main macro-problem has been significant fall in GDP and unemployment. The Bank of England are correct to concentrate on these real problems.
  • Europe inflation still too low. Inflation in the ECB is 0.8% – that is still low and creates the risk of deflationary pressures. This suggests the ECB have done too little money creation and have pursued too tight monetary policy.
  • Unemployment in the Eurozone is 12%, significantly higher than the UK. UK unemployment may well be higher, if we hadn’t pursued quantitative easing.
  • Future inflationary surge? It is true that if the velocity of circulation rises, there could be inflationary pressure. But, given the level of unemployment and spare capacity in the economy, the inflationary surge is hard to see.
  •  More on Risks vs Benefits of Q.E.

UK Recovery - weak or strong?

There are different ways of looking at the UK recovery. Firstly, we can look at the damage done to the economy since the peak in 2008.

real-gdp-00-13q3


In Q3 2013 GDP was estimated to be still 2.5% below the peak in Q1 2008. From peak to trough in 2009, the economy shrank by 7.2%. This is an unprecedented length of economic stagnation – compare this recession to great depression of 1930s.


Could recovery have come earlier?

There is a strong case that the signs of recovery in 2009/10 could have been maintained with more careful policy.

possible-trend


A strong bounce-back

economic-growth-uk-ons-quarter
Another way of looking at the recovery is to concentrate on 2013. This looks much more promising, with the economy expanding 1.8% in the first three quarters. After five years of declining GDP, this is a great relief. The government might use this ‘strong recovery’ as vindication for their policies of austerity.

Criticism of German economic policy

Recently, the US Treasury criticised German economic policy. They argue that German’s export led growth model and anaemic pace of domestic demand is damaging to European and global growth.

“Germany’s anaemic pace of domestic demand growth and dependence on exports have hampered rebalancing at a time when many other euro-area countries have been under severe pressure to curb demand and compress imports in order to promote adjustment,”
“The net result has been a deflationary bias for the euro area as well as for the world economy.” (BBC link)

germany-pigs0

It might seem a bit of a paradox for the US to criticise other countries economic policies, when their own arguments about the debt ceiling threatened to push the US and global economy back into recession. But, why is the US criticising German economic policy and is it justified?

 US deficit

budget-deficit-46-13

The surprising decline of the US budget deficit.

A level

Readers Questions
 Quick links
And now for something completely different

Friday, October 25, 2013

Recent blogs and links

 Some recent blogs from economicshelp.org:


To what extent can the government help boost domestic industry and manufacturing?

"In recent weeks, several politicians have talked about their desire to help UK manufacturing and boost industrial production. It may be a noble endeavour to try and boost UK industry and rebalance the economy away from financial services to manufacturing. But, how practical is it for the government to actually boost manufacturing output?"

industrial-production-1970-2012

UK House prices

If you're stuck for something to write about, you can always have a look at the crazy world of the UK housing market. Why UK house prices are set to rise, despite being over-priced already. - UK house prices

Should we worry about national debt?

One of the big questions of the past few years -   Governments have been borrowing for centuries. The figures for national debt are staggering. In the US, National debt is over $11 trillion. In the UK, debt is over £1.1 trillion. From a personal perspective, we are brought up to believe debt is a bad thing, and therefore people frequently worry that national debt is too high. But, how much should we worry about these levels of national debt? ... - Should we be concerned about national debt?

Also: post on UK national debt updated - now 76% of GDP)

Explaining the fall in UK unemployment



unemployment-percent-79-present

UK unemployment edged down to 7.7% - a 'relatively' 'good' figure,  given the extent of the economic downturn in the past 5 years. What is going on with UK unemployment?

Technology

Readers questions
A Level help

Thursday, October 10, 2013

Should we worry about national debt?

Governments have been borrowing for centuries. The figures for national debt are staggering. In the US, National debt is over $11 trillion. In the UK, debt is over £1.1 trillion. From a personal perspective, we are brought up to believe debt is a bad thing, and therefore it often feels worrying that national debt can be so large. But, how much should we worry about these levels of national debt?

One argument says that an increase in the national debt doesn't cause any problems. What happens is that by borrowing we merely enable the present taxpayer to enjoy a higher disposable income now rather than in the future. A cut in the national debt, would mean higher taxes now, rather than later. Therefore, national debt is just a way to spread national output amongst different generations. To understand national debt, it is important to remember how it is financed. Government debt is essentially a transfer from one part of the population to another. (Who owns national debt?)


Historical national debt

Furthermore, National Debt has been much higher in the past. During the Second World War, the national debt of the UK and US, reached very high figures of over 150% of GDP. In the UK debt in the late 1940s reached over 200% of GDP. This is an example, of how a country can borrow during times of a national crisis and pay back the debt over a period of time. Therefore, national debt can be an effective way to deal with economic shocks such as recessions, financial crisis and world wars.
It is worth bearing in mind that in the 1940s, as well as paying for post war reconstruction the UK set up the NHS and welfare state. - There was no austerity panic in the 1940s! The high government debt levels of the 1940s and 1950s were not a barrier to the post war boom years of the 1950s and 1960s which saw record levels of economic growth.

Therefore government debt is not necessarily a barrier to economic growth and prosperity. But, it is also important to point out that there is no guarantee that borrowing 150% of GDP will always lead to two decades of economic prosperity. The UK nearly went bankrupt in the late 1940s, and was saved by a loan from the US. see: Why could UK borrow so much in the 1940s, and could we do the same again?

Growth and Debt

Another factor is that economic growth usually makes it easier to pay back national debt. If GDP increases faster than national debt, then we need a smaller % of incomes to pay the debt interest payments. If GDP growth averages 2.5% a year, then increasing national debt by 2.5% means we will spend the same percentage of income on debt payments (assuming constant interest rates)
  • An analogy. When I took out a mortgage loan of £140,000, I was left with mortgage payments of £800 a month. In 2004, this was nearly 40% of my income. However, if my income increases by 3% a year. In 20 years time, it will be much easier to pay that mortgage payment of £800, it will hopefully be 15% of my income. To buy a house, it makes sense to borrow a mortgage and pay back over 30-40 years.
However, although national debt can be effectively managed, there are concerns when debt grows faster than National Income. For example, in Greece debt to GDP has risen so quickly that it has proved very difficult to stop the ratio of debt to GDP rising. (partly because spending cuts to reduce the deficit, caused lower GDP)

The fear for Eurozone economies, such as Italy, Portugal and Greece is not the levels of government borrowing, but the very poor prospects for economic growth. If the economy is stagnant, debt to GDP will continue to rise. If the economies were growing strongly, it would be much easier to reduce the debt to GDP ratio. (See also: Eurozone crisis)

Does higher borrowing cause higher bond yields?


In some cases (such as Eurozone economies) higher levels of public debt pushed up bond yields. Higher bond yields are damaging to the economy. It increases the cost of debt interest payments and is a reflection investors are nervous about the liquidity of government debt. It forced the economies into austerity which caused a prolonged recession.

However these countries with rising bond yields were in the Euro and did not have a Central Bank to buy bonds and ensure liqudity. In fact in 2012, the ECB took effective action to bring down bond yields (through unlimited purchases)

Countries with their own currency and Central Bank (e.g. UK and US) have the ability to purchase bonds and ensure liquidity. In the UK, the sharp rise in government debt between 2007 and 2012, led to a fall in bond yields. This shows that higher borrowing doesn't have to translate into higher bond yields.

 UK Bond yields and UK borrowing

Rise in net borrowing (annual budget deficit) didn't cause bond yields to rise. 

Why is there greater demand for government debt in a recession?

The UK has seen a fall in bond yields during the recession of 2008-12. This is because, in a recession, private sector saving rises. Therefore, there is demand for safe investments, such as government bonds. In a recession, people don't want to take risks, therefore demand for shares and private investment tends to fall. In a recession, government borrowing doesn't tend to cause crowding out. Government borrowing is merely mopping up private sector saving.

From a Keynesian perspective, government borrowing can help to boost aggregate demand and offset the fall in Aggregate Demand. In a recession, borrowing can provide a boost to economic growth and therefore, help improve tax revenues.

Possible reasons to be concerned about government borrowing

1. Structural deficit. If government borrowing reflects a fundamental disequilibirum between spending and tax revenue then this may lead to unsustainable debt levels in the future.

2. If borrowing is to finance welfare payments with an increased level of dependency. Paying pensions and health care to an ageing population, will do nothing to facilitate economic growth and improve tax revenues, and it will become more difficult to finance the national debt. Some are concerned that countries like Japan have a high debt (over 220% of GDP), but also a rapidly ageing population which will put even more pressure on Japanese debt levels.
  • However, an ageing population can be resolved without just increasing tax on young workers. The retirement age can be increase to keep the same% of population in workforce.

3. Inflationary Pressure. There is a concern that higher levels of national debt can cause inflation. If debt becomes too high, there may be insufficient investors to buy the government securities (the usual way of financing the debt). Therefore, the government may be tempted (or forced) to fill the shortfall in revenue by printing money. Printing money and increasing the money supply, will lead to inflation. The problem with inflation, is that it devalues the value of bonds, people will sell bonds, leading to higher interest rates on bonds and higher debt interest payments. If investors see inflation is getting out of control, people will not want to hold bonds. Foreign investors will sell their securities and this will cause a devaluation in the currency. This is particularly a problem for the US, where foreign countries hold a high % of the national debt.The hyperinflation of Germany in 1922-23 was caused by the government printing money to finance reparation payments to the allies.
  •  However, it should be pointed out, this hyperinflation is quite rare and only occurs if the government prints money recklessly without regard to the fundamental economic situation. Quantitative easing in 2009-12 didn't cause inflation in the UK and US. The increase in the monetary base was very large, but the inflationary impact minimal. - Inflation and quantitative easing.
4. Crowding Out. It is argued that if government borrowing increases, it will cause crowding out of the private sector. If the private sector buy bonds it means the private sector has less funds for private sector investment. Also, if borrowing increases, interest rates may rise. Higher interest rates also reduce private sector spending and investment.
  • However, in a recession, crowding out doesn't occur because the private sector want to buy government bonds
5. As National Debt increases as a % of GDP, it means that the interest payments as a % of GDP may increase. Therefore, higher levels of taxes have to be spent on just financing the national debt.



However, this doesn't necessarily occur. The UK has seen fairly stable interest payments as a % of GDP, despite rising debt levels. In a recession, bond yields tend to fall, therefore it becomes cheaper to borrow. See debt interest payments

Conclusion - should we worry about government debt?

It depends when and why the government are borrowing. In a recession, with a fall in private sector demand, a rise in government borrowing is beneficial for maintaining aggregate demand in the economy. If private sector spending fell and we also tried to reduce government borrowing, we could see a precipitous fall in aggregate demand, and a deep recession. See: Austerity can be self-defeating.

If the government is borrowing to finance public sector investment, then this can lead to improved economic growth and better tax revenues in the future.

When should we worry about government debt?
  • If the government increases debt during a period of economic growth - the higher borrowing is likely to crowd out the private sector and lead to a decline in private sector investment.
  • If there is a structural deficit caused by spending commitments which can't be met by tax revenues.
  • If the government responds to higher debt by printing money; this can cause inflation. e.g. case of Zimbabwe, Germany 1920s. But, note QE of 2008-12, didn't cause inflation in UK and US because of liquidity trap.

Related

Tuesday, September 17, 2013

New site and new optimism?

In the past few weeks, I've been working on a new version of the website and new shop facilities. These technical changes usually end up taking three times longer than you want. But, hopefully, I've now finished - leaving more time to write economics and less time chasing up web developers.

Visit new homepage and new shop - If you see any minor problems, I'd be grateful if you let me. know.

UK recovery

economic-growth-uk-ons-quarter


The UK economy has experienced the most prolonged decline in real GDP on record. GDP is still lower than before the start of the great recession in 2008. This unprecedented recession has been prolonged – despite a sharp depreciation in the Pound, and a raft of unconventional monetary policies. However, recent statistics suggest there are some reasons to be more hopeful and the UK economy is starting to recover with better stats in GDP, and manufacturing output. Yet, despite the recovery, many analysts still worry that the economy is unbalanced and could be vulnerable to a further economic downturn in Europe and the rest of the world. More on the UK recovery

I'm sure the government will be giving itself a lot of credit for the recovery over the next few months. But, it is worth bearing in mind GDP is still below its peak. Be suspicious of anyone who uses monthly growth figures to prove or disprove the success of particular economic policies. If you have a severely depressed economy, eventually there will be some kind of recovery. But, that doesn't mean vindication of policies which prolonged the recession.

Unexpected wealth can be bad for an economy

I’m currently reading A History of the World by Andrew Marr (it’s a good read so far). There’s an interesting chapter about the consequence of Spain gaining a large quantity of gold and silver from the Incas during the Sixteenth Century. Almost overnight, Spain became very rich taking home unprecedented quantities of gold and silver. Yet, there's a pretty good thesis that this 'easy money' held back the Spanish economy over the next few centuries. A salutary reminder that easy wealth  can create it's own problems. Perhaps karmic justice for stealing other people's gold too.

What happened to the Spanish gold from the Incas?

Why are UK House prices so high?

real-trend-house-prices


In the past five years, we have had a devastating global credit crunch, the longest and deepest recession since the 1930s (if not worse). Across Europe, we have seen mass unemployment and in countries like Spain, Ireland and Portugal, the housing market has seen up to 50% falls in house prices. Yet, despite this financial and economic upheaval, UK house prices have bucked the trend and avoided a major collapse that many were predicting as the credit crunch hit.

The perennial dinner party conversation starter - why are UK house prices so high?

Short blog posts

Thursday, July 11, 2013

UK economy - time to hope of recovery?

There is a welcome sign of optimism in the UK. We've waited 77 years, but last Sunday we finally had a nice hot sunny day at Wimbledon. Politicians were also in the seventh heaven of delight falling over themselves to get a mug shot of themselves with Andy Murray. With the British lions triumphant in Australia, and a British rider leading the Tour de France, it seems like the glory days of London 2012 are being relieved. (there was an Olympic bounce in GDP in 2012, perhaps this bounce could return?)

Even the economy seems to be sending positive news. The IMF recently revised upwards their forecast for UK economic growth in 2013. Old favourites like UK house prices and consumer spending have risen, giving renewed hope of economic recovery. But, as John Cleese once remarked 'It's not the despair I can't stand, it's the hope' (hopes for UK economy)

With all this buoyancy and optimism, it's tempting to brush aside some more unwelcome economic news
manufacturing-2000-2012

Not least - falling manufacturing output, falling investment, a widening trade deficit, spending financed by a rapid drop in the saving ratio, future UK austerity to come). The UK picture has all has the hallmarks of a very unbalanced recovery. But, I suppose, an unbalanced recovery is at least better than no recovery at all.


 savings-ratio-q1-2013


There are many challenges ahead, not least the precarious nature of many people's disposable income. A small rise in rates, could see a precipitous drop in discretionary income. Real wage growth has disappointed for several years. Falling investment for several years leaves low productive capacity.

It's no comfort, but Europe is doing much worse. Unfortunately, the UK recovery is really threatened by events across the channel. The Eurozone crisis may have moved off the front pages, but the threat of debt default, and the continued reality of mass unemployment stalk the continent. It is not something that will  be able to be brushed off with a touch of bond buying. Unfortunately, the longer the crisis drags on, the more difficult a resolution becomes.

A readers questions asks whether aggressive quantitative easing could solve the problems of countries like Greece. I don't really feel qualified to answer this one. But, it would be a start in the right direction. But, I can't get over the rather unhelpful thought that it was really need to be tried 4 years ago.

Other posts

Balanced and unbalanced economies. Unfortunately, the UK makes a very good case study for an unbalanced economy

uk-v-eu-gdp


Stats on EU economic growth - trying to navigate the ECB statistic database is only for the brave or foolhardy.
saving-rates-base-fixed-instant
Impact of funding for lending on bank rates - mortgage rates falling. Good news for some!

Monday, July 1, 2013

The decline of UK manufacturing - and falling interest rates

The announcement of the Fed Reserve about potential ending of Q.E. has caused a rise in US bond yields. However, UK savers have seen a significant fall in deposit rates.

saving-rates-base-fixed-instant


The fall in saving rates means that bank rates are now closer to base rates. One factor in pushing bank rates lower is the Funding for Lending scheme - though unfortunately, we haven't seen an increase in credit and lending to business.

Still, it has provoked a debate about what the end of quantitative easing may look like.





Also, savers may well be asking - when will interest rates rise? and when they do rise, how much will they increase by? - For savers, it's not particularly good news. But, mortgage holders will be happy with short-term outlook. - when will interest rates rise?

It does explain why mortgage repossession rates in the UK are low. But, should rates rise, many homeowners may find themselves in difficulties.

Rather worryingly, the UK economic recovery is relying on the old favourites of - higher consumer spending and rising house prices. The fall in mortgage rates has caused an increase in house prices. The government is helping people to buy by making credit more easily available, but this doesn't address the more fundamental problems in the economy.

base-rates-saving-rates 
The fall in the saving rate in the past couple of quarters is quite stark. (Though ONS stats do have a habit of being revised at a later date. e.g. GDP stats and double dip recession, that wasn't really)


Another surprise was to see how much the saving rate has fallen in the past six months. A sign that real income growth is still very weak, and rising consumer spending is financed partly by lower savings.


industrial-production-1970-2012


For the past 20 years, I've heard politicians and policy makers of all shades talk about the need for a stronger UK manufacturing sector - an attempt to end the long-term decline.

Firstly, the decline in the UK manufacturing needs to be put into context. It is definitely a smaller share of the market. But, in absolute terms is still growing. Manufacturing employment has fallen, but this is partly due to a rapid rise in productivity.

Also, an attempt to boost manufacturing could be self-defeating. There is no reason why the UK has to fight a losing battle against lower cost Asian competitors. But, given the UK's tendency to rely on consumer spending, the tendency to boom and bust and the persistent current account - a stronger exporting and manufacturing sector would definitely help the economy to be more balanced.

more detail at - The relative decline of UK manufacturing

Apart from de-industrialisation and the decline in manual labour, another big change in the UK labour market involves the increase in flexibility - and the increased uncertainty of work




base-rates-saving-rates


To what extent do interest rates determine saving rates?

Economics explained


Friday, June 21, 2013

From economic defeatism to joining the Euro


Recent  blog posts include:
  • Economic defeatism - 'Liquidate the banks, liquidate the rottenness out of the economy!' - In economics, there is often a mindset that we have to sit back and endure economic hardship, it harks back to the strange political appeal of austerity. However, there is always a choice - when a policymaker talks of the necessary economic pain, it is usually based on misguided macro-policy. 'It need not be like this.'
  • ZLB - Zero lower bound rate explained  - effectively when interest rates fall to zero and can't be cut anymore. What the ZLB means for economies, and what can be done to overcome the ZLB
  • Flexible fiscal and monetary policy - a look at how we might shape future fiscal and monetary policy learning from mistakes of past five years.
  • Pensioners better off, young people worse off - perhaps time to end free bus travel for OAPs and give it to the unemployed instead?
  • Latvia to join the Euro - is there really any case to risk joining the Euro club and risk prolonged depression and unemployment like several existing Euro members?
  • If the UK had been in the Euro, how would the UK economy be faring now? - It's hard to see anything but a worse situation.
EU employment rates 
EU employment rates. Unemployment upto 12%

Economics explained

  • Shock therapy - Want to move to a free market economy? Shock therapy says it's best to do all in one go. Radical reforms make the change, whatever the cost - a mixture of results from chaos of Russia to relative 'success' of Poland.
  • Does government debt lead to slower economic growth? - a look behind the theory of a controversial topic.
  • Securitisation - what it is and  how it contributed to the credit crunch

Readers Questions


debt-under-labour

External links

Friday, June 14, 2013

UK Housing Market

The housing market is said to be one of the most popular topics of conversation at dinner parties. In the UK, this is for good reason. Houses are by far the biggest form of household wealth and have a big impact on consumers and the economy.


real-trend-house-prices

This graph shows two main features of the UK housing market.
  • House prices are volatile with frequent booms and busts.
  • Despite volatility, and even adjusted for inflation - UK house prices have been on a strong upward trend since the 1930s.

Main factors affecting house prices

  • Supply. UK house prices have stayed relatively high (despite recession and credit crunch) because of a shortage of supply. Ireland and Spain have seen much bigger house price falls because they have large excess supply.
  • Interest rates. The UK housing market is sensitive to changes in interest rates. Higher interest rates in the early 1990s made mortgages unaffordable and caused a big drop in house prices.
  • Economy / unemployment. A recession and rising unemployment usually causes lower demand for buying houses and a fall in price. (falling house prices also tend to deepen the recession)
  • Mortgage availability. In the boom years of 2000-07, banks were keen to lend and they relaxed their lending criteria, enabling more people to get a mortgage. But, the credit crunch meant banks had to tighten their lending criteria making mortgages difficult to get (even though interest rates were low)
  • see more at: factors affecting housing market

Why are UK house prices so volatile?

house-price-inflation-1970-2013

UK house prices have been highly volatile in the past few decades. On the one hand this is unexpected. People don't buy and sell houses like a commodity. But, in practise, house prices are volatile for a number of reasons.
  • Inelastic supply. It takes time to build houses - with rising demand, supply often can't keep up. This pushes prices up.
  • Change in credit conditions. Mortgage availability can vary depending on the state of the banks and financial markets.
  • Changing interest rates. Interest rates are used to control inflation, but a rise in interest rates has a big effect on demand and affordability.
  • Changes in confidence. In the boom years, we see landlords buying to let and demand rises. When prices fall, people don't want to buy for fear of negative equity.

Why are UK house prices so expensive?

house-prices-1952
 (graph showing nominal house prices)

UK house prices are very expensive. Despite the credit crunch, UK houses are still less affordable in 2013 than at the end of the Lawson boom in the 1980s.
ftb-house-pirce-earnings

If we look at the affordability of mortgage payments, buying a house looks more affordable because interest rates are much lower in the 2010s, than in the 1990s. But, with house prices nearly 7 times average earnings in London, buying a house is out of the question for many first time buyers.  Generally, mortgage companies only lend 3-4 incomes. It is too difficult to raise a deposit. Why are house prices so expensive?

1. Demand rising faster than supply. The UK fails to build enough houses to meet growing demand. This is related to strict planning legislation and the frequent local opposition to building new houses. Home building was also hard hit by the credit crunch. See more at Supply of houses

housing-completions
 2. Squeezing onto the property market. As well as a shortage of supply, people try very hard to buy a house despite its expense. For example, some young people may benefit from generous loan or help from their parents to help get them on the property ladder. London has seen strong demand from overseas buyers; parts of the countryside has seen the purchase of second homes, pushing house prices higher.

Housing market crashes

If the UK had a boom in housing builds, we may have had a similar experience to Ireland. In the boom years, Irish house prices rose 300%, but between 2006 and 2012, house prices collapsed, falling more than 50%. The main difference is that Ireland were building record numbers of houses, leaving a glut in the property market. Irish boom and bust. See also boom and bust in US housing market

How does the Housing market affect the rest of the economy?

Housing is the biggest form of personal wealth in the UK. Changes in house prices have a significant effect on UK household wealth and confidence. If house prices are rising, homeowners can gain extra cash through re-mortgaging their house and spending the extra equity (this was a feature of the 1980s and 2000s boom). Therefore, rising house prices tend to increase consumer spending. However, if people see falling house prices, they lose capacity to re-mortgage and also consumer confidence tends to fall, leading to lower spending. Falling house prices in 2009 and 1990 were key factors in contributing to the recessions of those periods.

see more at:  Housing market and economy

Government intervention in the housing market

Ideally, the government would overcome market failure in the housing market. This would involve:
  1. Increasing supply to overcome fundamental shortage.
  2. Protecting green belt land
  3. Ensuring minimum standards of house building and ensuring tenants get a fair deal
  4. Seeking to avoid house price volatility.
However, 1 and 2 conflict. The government often say they want to build new houses, but this is often politically unpopular with local protests against the building of new houses. Governments often focus on helping first time buyers, through government backed mortgages - but this has been criticised for not solving the fundamental problem house prices are too expensive, and just encourages greater debt levels.

Related posts on the housing market

Wednesday, May 29, 2013

Abenomics vs economic orthodoxy

The main feature of the first half of 2013 is to see an increasing divergence of the prospects between Europe and other developed economies such as Japan and US (with the UK  caught in between - the UK is still limping along, not quite able to enable a strong recovery, but avoiding the worst of the EU recession.

Some popular blog posts of past week:

Abenomics - Is the Japanese experiment of expansionary monetary and fiscal policy a template for other developed economies? The initial Japanese growth of 2013 shows great promise. But, Japan has seen many false dawns in the past. A look at how Abenomics works, and the criticisms of the approach.

Plan B for the UK economy  - The IMF suggest a modest plan B for the UK economy.

UK Debt - It continues to rise...

Eurozone inflation


Would it help to have a higher inflation rate? A big debate at the moment is the merits of targeting higher inflation. To many economists, the idea of targeting higher inflation is reckless, and risks undermining the past decade of hard work. To other economists, higher inflation would play a role in escape the stagnant growth and debt deflation which is paralysing Europe at the moment.

m3-m4


Money supply in credit crunch and recession - A readers question about the role of the money supply in the recession. The money supply rose in 2008 and 2009 due to quantitative easing, but there was a sharp fall in the velocity of circulation meaning the money supply figures were misleading. In 2010-12, we saw a drop in the money supply - an indicator of the severity of the recession.

Variable or fixed rate mortgage? - A personal look at the best mortgage given current interest rate predictions.

How successful have Central Banks been in managing economy? - In 2007, many Central banks were patting themselves on the back for keeping inflation low and growth positive. Since the credit crunch, we are now evaluating the role of Central Banks in a very different light.

UK economy in the 1930s - Interestingly it wasn't all doom and gloom.

1930s-economic-growth

Towards the end of the decade there was a strong recovery, at least in the south and around London. Helped by devaluation and targeting higher inflation.Those were the days when you could buy a house in London for less than £400. But, although unemployment rates nationally were not as high as you might imagine, to be unemployed in the 1930s was to experience real poverty.

Tuesday, May 7, 2013

Problems with the Euro

The Euro is a bold experiment to create the largest currency area in the World. However, the current Euro crisis have revealed deep flaws in the structure of the single currency

The Euro involves:
  1. A single currency within the Eurozone area.
  2. A common monetary policy. Interest Rates are set by the ECB for the whole Eurozone area.
  3. Growth and Stability Pact. In theory there are limits on government borrowing, national debt and fiscal policy. However, in practice member countries have often violated the strict limits on government borrowing.

Problems of the Euro

  • Interest rates not suitable for whole Eurozone. A common monetary policy involves a common interest rate for the whole eurozone area. However, the interest rate set by the ECB may be inappropriate for regions which are growing much faster or much slower than the Eurozone average. For example, in 2011, the ECB increased interest rates because of fears of inflation in Germany. However, in 2011, southern Eurozone members were heading for recession due to austerity packages. The higher interest rates set by the ECB were unsuitable for countries such as Portugal, Greece and Italy.

  • The Euro is not an optimal currency area. If a state in the US, such as New York ,was in recession, workers in New York could move to New England and get a job. However, in the Eurozone this is much more difficult; it involves moving country and possibly learning a new language. There are more barriers to the movement of labour and capital within a diverse region like Europe. Therefore, an unemployed Greek can't easily relocate to Germany. see: Two Speed Europe

  • Limits Fiscal Policy. With a common monetary policy it is important to have similar levels of national debt, otherwise countries may struggle to attract enough buyers of national debt. This is a growing problem for many Mediterranean countries like Italy, Greece and Spain who have large national debts and rising bond yields.

  • Lack of Incentives. It is argued that being a member of the Euro protects a country from a currency crisis. Therefore, there is less incentive for countries to implement structural reform and fiscal responsibility. For example, in good years Greece was able to benefit from very low bond yields on its debt because people felt Greek debt would be secured by rest of Europe. But, this wasn't the case, and Greece were lulled into a fall sense of security.

  • No scope for Devaluation. Since the start of the Euro, several countries have experienced rising labour costs. This has made their exports uncompetitive. Usually, their currency would devalue to restore competitiveness. However, in the Euro, you can't devalue and you are stuck with uncompetitive exports. This has led to record current account deficits, a fall in exports and low growth. This has particularly been a problem for countries like Portugal, Italy and Greece.

eu-currentaccount

This shows the effects of Eurozone members becoming uncompetitive. Very high current account deficits.
  • No Lender of Last Resort. The ECB is unwilling to buy government bonds if there is a temporary liquidity shortage. This makes markets more nervous about holding debt from eurozone economies and precipitates fiscal crisis. See: Problems of Italy - why Italian bonds increased despite having a much lower budget deficit than UK.

bonds
Italy bond yields rose despite a primary budget surplus
unemployment

Eurozone members have seen a rise in unemployment

  • Divergence in bank rates. In theory, the Eurzone creates a common interest rate. However, in the credit crisis of 2010-13, we see rising bank rates for peripheral Eurozone countries, like Italy and Spain. Small and medium sized firms faced higher borrowing costs than in 2005, even though the ECB cut the main base rate. This suggests that the ECB was unable to loosen monetary policy when needed. See more on credit policy

Experience of EU Fiscal Crisis


The great recession of 2008-11 showed the vulnerability of Euro member countries to a common monetary policy. Because they can't devalue and also ask the Central Bank to buy government securities they are at much greater risk of a liquidity crisis.

Because of fears over liquidity crisis, bond yields rose from Ireland, Spain, Portugal and Greece. As a result these eurozone countries were forced into pursuing spending cuts, and accepting higher interest rates. But, this led to a vicious cycle of lower growth and lower tax revenues.

See: Why UK bond yields stayed low compared to Euro members

Problems for UK Economy

UK economy has additional problems which make joining the Euro a bad idea.
  • Housing market. Many in the UK have a mortgage which is a big % of their disposable income. This is related to the high cost of buying houses in the UK.
  • Variable Mortgages In the UK more homeowners have variable mortgages. These two factors means UK consumers are very sensitive to changes in the base rate. If the ECB kept interest rates higher than the UK needed it would create serious problems in the UK. Arguably to join the UK would need to reform its housing market and reliance on variable mortgages.
Related Posts on the Euro

Tuesday, April 23, 2013

Economic update April 23rd

Mrs Thatcher's recent passing has created an unsurprising interest in re-evaluating her period in office. From an economic perspective, it is possible to look at the changing British economy from many different angles. There were definitely winners and losers in the 1980s.
The biggest losers were undoubtedly the 3 million unemployed. The winners were stereotypically living in the south east, homeowners, working in the finance sector, buying shares in privatised industries. Whether the British economy was left in a better place is still debated today. But, one thing is certain, for good or ill - the economy is very different, and there is no going back to pre 1979.

Essay here on economic impact of Mrs Thatcher 

Unemployment since Mrs Thatcher

UK Unemployment 

Inflation and interest rates

inflation-interest-rates-1945-2011


more on Mrs Thatcher perspectives

Arguing over the past is one thing, but a more pressing concern is the economic policy of Europe.
How much is government borrowing influenced by economic growth?

This is very important in the current debate, as Europe seeks to reduce borrowing, without really considering impact and importance of economic growth



growth+borrowing

Also the effect of borrowing on bond yields and debt interest payments

Economic shorts
  • Zero-hour contracts - Mrs Thatcher would probably have approved, but how does it affect workers who increasingly find themselves with zero guaranteed hours?
gdp-constant-market-prices

Irish economy summary - From boom to bust. Is Ireland really a model austerity nation?
The Irish housing market saw one of the greatest boom and busts in the world.

Thursday, March 28, 2013

Ireland - success or failure?

Ireland is often put forward as a model of austerity.

March 2010: “Greece has a role model, and that model is Ireland” — Jean-Claude Trichet

December 2011: “As European leaders scramble to overcome the Continent’s debt crisis, many are pointing to Ireland as a model for how to get out of the troubles.”

March 2012: “Confidence is returning to Ireland and to Europe. The Irish economy is turning the corner. ” — Jose Manuel Barroso.

(Ireland recovers and recovers, P.Krugmanhttp://krugman.blogs.nytimes.com/2013/03/22/ireland-recovers-and-recovers-and-recovers/)

Yet, the evidence is mixed with unemployment at 14% and a very uneven economic recovery.



gdp-constant-market-prices

You can make your own mind up here: Irish economy summary.

You can always look for evidence that supports your opinions. But, it's a tough time for the unemployed in Ireland.

irish-unemployment-rate