Longest Recession Since Great Depression

Economic statistics in the US still look very grim. GDP figures in the first quarter of 2009 show an annual rate of decline equal to - 6.1%. This follows on from a fall of -6.3% at the end of 2008. It also means the longest period of declining output since the Great Depression. The US entered recession before the UK. It does not bode well if the UK is to follow the US path (which has occured up until now.)

At least the US experienced a promising rise in consumer spending. Also inventory lists have fallen dramatically meaning that firms may be forced to start increasing stock. This would lead to rising output.

In the UK, consumer confidence improved to the best levels since August 2007 and problems of Northern Rock. A study by GfK NOP found consumers’ economic expectations for the next year is still in negative territory at -15, but this reflects an improvement of 16 points from -31 in March. This increase in confidence has occured despite rises in unemployment and falling average wage growth. (maybe the survey was taken on a sunny day?)

Related

• Implications of 2009 Budget (with video)

Why Do Governments fail?

How To Deal with Very Large Debt

With borrowing forecast to top at least £175bn next year and national debt as a % of GDP forecast to rise to 80% what options does that leave future chancellors?

Options for Dealing with Public Sector Debt

1. The Borrowing is Necessary. National Debt at 80% of GDP is not the highest in the world nor is it unprecedented for the UK; during war, the UK has borrowed over 200% of GDP. If we seek to reduce debt too quickly, it could push any fragile recovery back into recession, cause more unemployment and this would only aggravate public borrowing. Running a fiscal deficit is an effective way to boost AD and help the economy recover. It is this economic recovery which is the key to restoring public finances.

• However, borrowing from the markets will not be easy in this climate. The UK faces grave international competition from other countries with large debts. Investors may have less confidence in holding UK debt if they fear the inflationary impact of quantiative easing. If markets lose confidence in the government's ability to pay, it could affect sterling and make it very difficult to borrow - creating a crisis in the UK.

2. Rely on Monetary Policy. To boost economic recovery, it would be better to rely on monetary policy - low real interest rates, quantitative easing. This can boost spending, prevent deflation without the problem of having to borrow. This could mean interest rates stay low during any recovery as fiscal policy tightens. In the worst case scenario quantitative easing could be used to inflate away the UK debt, but, this would lead to a collapse in Sterling and effect confidence in the UK for many years to come.

• Quantitative easing remains unchartered territory. It could be inflationary and it is difficult to predict its impact

3. Savage Cuts in Public Spending. The government may be forced to roll back past spending commitments to health and education. Projects like a replacement for trident e.t.c could be delayed indefinitely.

4. Raise Retirement age. To deal with increased demands on government spending, the government could immediately raise the retirement age. This would significantly cut spending on pensions and improve tax receipts. But, it would be politically unpopular to say the least. However, this policy may have been necessary even without the current crisis. (Demographic Time Bomb)

5. More Sin Taxes. One of the few tax sources not to fall in a recession is cigarette, petrol and alcohol. The government could increase these because demand is relatively inelastic.

Maybe the government need to do a combination of all of these, though I doubt they will appear in many political manifestos in the forthcoming election...

Impact of 50% Income Tax Rate in UK

I would love to pay the 50% income tax rate - I mean a salary of £150,000 would be a pretty good achievement for an economics teacher! But, putting aside by emotive support of high taxes on the rich - Does it make economic sense?

Firstly, the UK have had much higher income tax rates, in the past. In the 1970s, top income earners faced income tax rates of 80% plus. But, it was argued that with these kind of tax rates it encouraged many to leave the UK and find lower tax regimes.

Laffer Curve.



The Laffer curve offers a very simplistic model.

• If tax rates are 0% the government get no tax revenue.
• If tax rates are 100% the government get no revenue because what is the point of working if all the income is taxed?
• Therefore, there must be a tax rate at which increase the tax rate causes a fall in tax revenue e.g. because people start to work less.
• The difficult question is knowning where this tipping point is. Is it 50%, 60% or 70% marginal tax rates.
  

The Effect of Higher income Tax

1. Substitution Effect. Higher tax encourages people to work less because work is less attractive.
2. Encourages Tax Avoidance. Higher income tax gives a greater incentive for high earners to look for innovative ways to avoid paying tax. e.g. forming a company and paying yourself dividends rather than income.
3. Live in countries with lower income tax rates.
4. Disincentive for companies to invest in UK
5. Earlier retirement
   
6. Higher income tax will reduce VAT revenues as high earners have less to spend

• Income effect. If people target a certain income - a higher tax rate may make them work harder to maintain their target income. This explains why higher income tax rates don't always cause people to work less

The crucial issue is what is the rate that causes people to go and live in Switzerland or retire early? It depends on the individual and there is much conflicting empirical evidence about the impact of higher tax rates.

The government hope the new tax rates will raise a net of £2.4 billion. The total gross could be £7 billion. However, the IFS claim the impact on tax revenues could even be negative. It is hard to predict, to some extent it may depend on the strength of the economy and whether there are less jobs in that income tax bracket. But, even the most optimistic predictions of tax receipts mean it will only make a small dint in the forecast £175bn annual deficit.

Forecast for National Debt - Why Increase?

Just recently, I was teaching students about the chancellor's golden rule of borrowing - the rule that governments should not borrow more than 40% of GDP. Also over the course of the economic cycle, annual government borrowing should not exceed 3% of GDP. It was only quite recently this was frequently referred to by the government with a sense of pride. But, given the current state of finances, it will be one of those concepts the government will try to keep locked in a cupboard like an embarrassing old relative.


This year we are facing borrowing of over 12% of GDP and a public sector debt rising towards 80% of GDP (and this is with HM Treasuries optimistic forecasts)

The UK does not have the highest National Debt as a % of GDP (list of countries) but it has experienced one of the most rapid deteriorations. It is this rapid deterioration that has spooked the markets more than anything - it gives the impression the government are losing control. And it doesn't help the government's forecasts soon start to appear overly optimistic.

Why Has Debt Risen So Sharply?

Ambitious Spending Plans. For a brief time Labour pursued tight spending plans. This led to a brief budget surplus in 2000. However, the Labour Government then decided to increase real spending on health and education significantly. It was this large increases in spending that caused the UK to have a budget deficit of 2.7% of GDP even at the end of the economic boom in 2007.

Collapse in Tax Revenues. The scale of the recession (output fell a record 1.9% in the first quarter) and falling asset prices has hit tax revenues drastically. Government forecasts for tax revenues assumed full employment, rising house prices and growing tax receipts. But, the recession has caused the opposite.

• Falling House prices and lower number of property transactions have reduced stamp duty
• Rising unemployment and lower bonuses have hit income tax. 16% of the total income tax is paid by the top 1% of earners. It is these earners, especially in the city who have been hard hit by the credit crunch so income tax receipts have fallen.
• Lower corporation tax. Falling profits leads to declining corporation tax
• Bankruptcys. Rising number of bankrupt firms have led to large numbers of tax bills being left unpaid.
• Lower VAT. Lower spending in addition to VAT cut to 15% have led to a fall in tax revenue.

The Sin taxes of petrol, alcohol and cigarettes are some of the few taxes that have not decreased in the past year.

Rising Unemployment. Unemployment costs the government in terms of jobseekers allowance, other benefits like housing benefits and lost income and NI allowances.

Rise in Economic Inactivity. In addition to rising unemployment there has been a rise in the number of economically inactive. Since 1997, the number not working (but not classed as unemployed) has risen by 250,000. For example, this could include incapacity benefit, sickness benefit.

Long Term Demographic Trends. Long term demographic trends will not help the UK deal with future debt burdens. The UK population is slowly ageing creating a bigger dependency ratio

Expansionary Fiscal Policy. To Deal with the Downturn the government cut some taxes and increased spending. This fiscal expansion amounted to 1.1% in November and an extra 0.5%. But as a % of the total rise in national debt, this fiscal expansion looks relatively small. Highlighting how disastrous the collapse in normal tax receipts have been

Bank Bailouts. The government have had to spend billions on buying shares in failing banks. According to the IMF, Britain has already spent nearly 20% of GDP on bailing out the banks. (Guardian)

Related

• National Debt

Dismal Economic Forecasts

So Alistair Darling didn't even try to put a positive spin on the UK economy. But faced with the uncompromising economic data, he didn't really have much alternative.

I guess he could have boasted the UK is no longer the sickest economy in the G20.

• Germany - forecast of -5.7% Growth for this year
• Japan - forecast of - 6.2%)
• UK - forecast of -3.5% (though IMF forecast -4.1%)

Yet, the government's forecasts for 2010 still look overly optimistic. The Treasury predict growth of 1.25% in 2010 and 3.2% in 2011. As we mentioned in - Slow Economic recovery. It is hard to imagine how a quick bounce back could materialise - especially given need to restrain borrowing in future years. Given the state of economy, the IMF's forecast of -0.4% growth in 2010 looks far more realistic.

The problem with over optimistic growth forecasts is that it means government borrowing will probably be higher than the Treasury want to admit as well.

This year borrowing was £90bn, Next year it will soar to £175bn or nearly 12% of GDP (the highest peacetime borrowing requirement ever)

National Debt will rise from 50% now to a peak of 80% in 2013/24 (though some fear national debt could reach 90%)

It is not the highest debt in the world, and we have had worse figures in the past. Nor is there any real alternative to government borrowing. (If the chancellor was seeking to balance the budget at a time such as this, the recession could be devastating.) But, it does represent a very quick deterioration making the governments past 'golden rules' look meaningless. It will also mean future chancellors have many difficult choices, especially with demographic factors placing stress on future borrowing.

Budget Deficits and Inflation

The US has experienced its first period of deflation for over 55 years. Retail prices recently fell 0.4%. Yet, despite strong deflationary pressure, the deepest recession since the 1930s and falling asset prices, some economists are fearful of inflationary pressure in the US.

Why Threat of Inflation in a Period of Recession?

At the moment, the US is in a protracted recession. Falling output and falling demand has put a downward pressure on prices. Therefore, even though the monetary authorities have been increasing the money supply (through quantitative easing and buying toxic loans), inflation has not appeared.

In fact, it seems a paradox that money supply (M2) is growing 15%, yet inflation is absent. This is because in a recession, the velocity of circulation falls, meaning the impact of rising money supply adjusted for velocity of circulation is low. (see: Money Supply and Inflation in US)

It is a similar situation in the UK, where the Money supply is rising quickly, but adjusted for velocity of circulation, it is not inflationary.

However, the problem will come when the economy recovers and the banks desire to resume normal lending. The velocity of circulation will rise and this will magnify the effects of the increased money supply. Due to monetary intervention in the US, the excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now. (source: FT)

Therefore, there is a risk that any recovery may be much more inflationary than is usual. It could prove a difficult balancing act for the Federal Reserve to remove all the excess liquidity they are creating now.

Budget Deficits.

The problem is exacerbated by the rise in government borrowing in both UK and US. US national debt as a % of GDP is likely to rise from 70% of GDP to over 80%. UK public sector debt is currently 47%, but on the worst forecasts, it could also rise close to 80% of GDP. High levels of debt could put more pressure on the government to finance the debt by increasing money supply. The recent failed gilt auction doesn't bode well.

If budget deficits are financed by selling bonds they don't have to cause inflation. In the developed world budget deficits are rarely inflationary because markets are usually willing to buy government bonds which are seen as a rock solid investment. It is mainly in developed economies where markets are reluctant to buy debt, that budget deficits can cause high inflation (e.g. like Zimbabwe) But, if markets become fearful of UK and US ability to pay back, it may become much harder to finance gilt sales increasing risk of having to resort to money supply measures.


At the moment, I think the UK and US will be able to finance their deficits without resorting to printing money. But, the markets appetite for government debt could get saturated as borrowing around the world increases.

Dealing with the excess rise in money supply may prove more difficult. However, since a weak economic recovery is forecast, inflationary pressures may prove to remain muted.

Also, it is a fair point that worrying about inflation in the deepest recession since the great depression is to get your priorities wrong. The most immediate concern is the scale of the downturn and the prospect of deflation. But, it is a tricky balance and the impact of higher borrowing, quantitative easing on future inflation is hard to predict with any confidence.

Also, we could mention that falling prices are due to a temporary effect of falling oil and food prices.

Related

• Problems of Government Borrowing
• Money Supply and Inflation
• What is more likely inflation or deflation?

Weak Economic Recovery

At times of gloom we tend to fasten on to glimmers of hope with an over eagerness. For example, data showing a small recovery in the housing market may prove to be a temporary blip in a more protracted downturn. Yes, there was a slight rise in mortgage lending in March, but, it was from a depressingly low level. If the economy does manage to recover this year, then it is likely to be a weak and fragile recovery.

The Recovery will be weak because:

• There is no pent up demand. In the last recession, 1991, interest rates rose very high reducing spending. Therefore when interest rates were cut, people could spend more. Now, in 2009, interest rates are close to 0%, they can only go up. Also after a decade of borrowing, consumers are likely to try and increase their saving rates for a substantial time.
• Housing Market could continue to depress demand. I would anticipate house prices to continue to fall for at least 12 months. Hopefully the pace of decline may slow, but, price to earnings are still high, and banks still reluctant to lend.
• Balance Sheets. The primary cause of the recession is bad balance sheets at banks leading to a contraction in bank lending. The recession, with the inevitable repossessions and bankruptcies has added to their problems. It will take a long time for banks to improve their balance sheets and gain the confidence to return to normal lending criteria.
• Government Debt. The government has been forced to increase borrowing sharply to finance bank bailouts, fiscal expansion + automatic stabilisers of recession. In 2010, 2011, the government will have no room for further fiscal expansion and may have to increase taxes sooner than economic conditions would warrant.
• Prospect of Deflation. Deflation would definitely depress consumer spending for a long time. I would anticipate the UK and US would avoid deflation due to their policies of increasing money supply, but, it might be an issue for the EU.
• Global Downturn. The recession has been global in its impact leading to a sharp reduction in world trade
  

The economic recovery will be slow, and there is even a chance of a double dip recession. But, at the moment I think many would just take any kind of recovery.

Recent Posts

• When do Recessions end?

Why Do We Fall for Bubbles?

One feature about unsustainable asset bubbles (boom and busts) is the regularity with which they occur. Housing boom and busts are common in UK. Often we see a mania for a certain type of investment only for it to implode - e.g. from Tulip mania in the 16th Century to the 20th Century dot com bubble, it seems consumer rationality often falls by the wayside at the prospect of a quick buck.

Why is It Difficult To Spot Asset Bubbles?

We don't like Bad News.

Perhaps human nature is inherently optimistic. Or maybe it is just greed - people would rather hear forecasts of rising wealth rather than grim warnings.

The Herding Effect.

Psychologists have often noted a herding effect. The strongly held belief that the majority must be right. If market sentiment is bullish on a commodity - who am I to go against all those specialists?

Bubbles create their own momentum.

Rising asset prices changes peoples behaviour. When house prices are rising mortgage companies have more incentive to sell mortgages with small deposits. Banks feel more optimistic so become more willing to lend. Rising asset prices encourages speculators into the market creating a self fulfilling prophecy of rising prices.

Short Termism

Many people in the chain are not thinking about long term sustainability. Mortgage salesmen get commission for selling mortgages and they are more concerned with short term performance related pay rather than long term sustainability of the mortgage. Bankers often get commission for making short term profit, but don't lose money if the market goes down. A bubble commodity gives chance of huge bonuses. But, if bubble collapses, bankers don't have to pay it back. It becomes a one way bet. You benefit from bubble - and someone else (i.e. taxpayer) loses when the bubble bursts

It's Different this Time.

When price to earning ratios skyrocketed for internet stock, warning bells should have started to ring. It looked like a classic stock bubble. But, people believed or wanted to believe that the internet meant different rules applied.

When house prices rose in UK 1997-2006, many pointed to low interest rates, shortage of supply, demographic factors to suggest house price to income ratios could rise above long term averages.

Fundamental Gullibility.

People just like the prospect of making a quick buck. And bubbles can be a way to do it. People just think they will be able to sell at the right time.

Lack of Information.

When many ordinary people buy a house, they don't think in terms of long run house price to income ratios. They want to buy a house to live in it. If this means getting a mortgage 5 times salary then this is what they will have to do. They aren't buying to benefit from rising house prices, they just want to get on property ladder.

It's Not Difficult to Spot.

People do spot credit bubbles, housing bubbles, it's just people don't give negative warnings much attention.

Related

• Boom and Bust economic cycles
• Boom and Bust in US Housing market
  

Problems of Unemployment

With UK unemployment forecast to rise to 3.2 million by 2010 - what will the economic and social costs be?

1. Lower incomes for the unemployed. Although insulated by unemployment benefits (and other benefits like housing benefit) many will see a substantial drop in income which makes paying bills and loan repayments difficult. It will force a change in lifestyle for many.

2. Rise in Home Repossessions. The rise in unemployment will cause a rise in home repossessions. This is one of the most stressful and painful experiences for those concerned, but, also will lead to further house price falls and losses for banks making future lending difficult.

3. Negative Mulitplier Effect. The unemployed will spend less causing a further fall in consumption and lower economic growth. This makes economic growth more difficult

4. Cost to Government. Higher unemployment leads to an increase in spending on benefits. The government also receive less income tax and VAT. This is particularly problematic because of the unemployment concentrated in high paying finance jobs. The impact will be a sharp rise in public sector borrowing

5. Demotivation. There is strong evidence long periods of unemployment make it difficult for the unemployed to re-enter the labour market. Older workers who are unemployed often end up leaving the labour market altogether, sometimes moving to other benefits like sickness or disability allowance. - creating disguised unemployment

6. Social Instability. The high unemployment of the early 1980s shocked the country in being a contributory factor behind riots such as the Brixton riot. Here the unemployment was highly localised. But prolonged unemployment can be a trigger to social unrest.

7. Unemployment can take a long time to fall. Unemployment is said to be a lagging indicator. Even when economy recovers unemployment is likely to keep rising. This is known as the hysteresis issue. - Periods of high unemployment create a higher natural rate of unemployment (underlying rate of unemployment) - certainly a feature of the 1980s.

Fantasy Economics

What Would You Do If You Were Chancellor of Exchequer?

For mock interview practise I often ask students what they would do if they were chancellor of exchequer. It's such as open ended question they often struggle to know where to start.

What I Would Do?

Integrate National Insurance and Income tax. The UK tax system is too complicated. There's no reason NI and income tax have to be separated. It's not as if the government have been investing national insurance contributions into a giant pension fund for when the baby boomer generation retires...

Pigovian Taxes. This is a tax based on the principle that taxes should be based on external costs. E.g. The biggest problem facing the world is global warming. The biggest cause is coal powered electricity generation. Therefore, I would put a large tax on coal powered electricity and use the tax revenue to subsidise carbon free electricity generation

I would also tax more - Fatty / unhealthy foods, Petrol, Lorries and anything which created external costs to society.

Give Firms incentives to make workers shareholders in the company they work for.

Current Crisis. It's hard to know what else could be done in the current crisis. At the moment, it is necessary to run a large budget deficit to provide a fiscal boost. But, the fall in tax revenue has been so sharp there is little room for further fiscal expansion. Boosting growth will have to come from monetary policy. This is a fine line to tread.

I know one thing I would definitely be doing if I was chancellor - I'd be fervently praying all the current policies - fiscal policy, lower interest rates, lower exchange rate, increasing money supply would soon have an effect in bringing the economy out of recession.

Difference in Response to Great Recession

The UK and Eurozone have responded to the great repression in different ways.

1. Fiscal Policy. Firstly, the UK has been keen to borrow as much as the markets will stomach. The UK feel higher borrowing will enable the government to kickstart the economy and to take the place of falling private sector spending. EU countries have been more sceptical of fiscal expansion. Germany have displayed a greater fiscal conservatism. They have been more concerned about the negative effects of higher borrowing.

2. Monetary Policy. UK (and US) interest rates were cut much quicker and more sharply. The ECB have reduced interest rates more cautiously and have interest rates 1% higher than in UK. This reflects the ECB's greater concern about future inflationary pressure and a desire to keep the Euro strong.

3. Quantitative Easing. The UK adopted a policy to purchase bonds through the creation of money. The ECB are reluctant to consider this. 'Printing Money' is an anathema to the German influenced ECB. Also, it is more difficult for the ECB to decide which countries bonds to buy. In the UK it is more straight forward. The UK is pressing ahead with quantitative easing, the EU remains reluctant.

4. Exchange Rates. The ECB have seemed relatively unconcerned about relative strength of the Euro - often pointing to this as a strength - reflecting their ability to weather the economic shock. The UK, on the other hand, have seemed unconcerned about the Pound's corresponding decline - pointing to the boost to exports.

5. Bank Bailouts. The UK has been forced into one of the most extensive bank bailouts within the EU. This reflects the scale of the banking crisis within the UK and also the importance of the banking sector to UK. However, EU countries have not been immune from this.

The UK has been hit hardest by the current downturn, but has also embraced unorthodox policies to try and recover.

Related

• When Do Recessions End?

Difficulties Facing European Economies

The current economic crisis is often seen as an Anglo Saxon crisis. Originating in America and affecting the UK the most. Many European leaders (Germany and France) felt (hoped) they would be relatively insulated from the crisis because of their relatively lower exposure to the banking crisis and slumping housing markets. However, data suggests that the recession is hitting all economies - even those without the same exposure to volatile housing markets.

Problems Facing Europe

• Slump in Global Trade. The EU has become increasingly reliant on world trade. The global downturn has seen a sharp fall in exports; this has particularly affected Germany. In February Germany saw industrial production fall a record 2.9 percent. In Italy it was -3.5%
• Unemployment. Already high, EU unemployment is likely to keep rising. Spain, which has a forecast of GDP growth of -3%, could see unemployment touch 19% by 2010.
  
• The Euro has Proved Strong. The strength of the Euro is a mixed blessing. On the one hand it insulates countries from an Icelandic style meltdown. On the other hand many Eurozone countries are suffering from a strong Euro. This is especially the case for fringe Eurozone members like Greece and Spain - where rising wages have made their exports very uncompetitive.
• Housing Market Slumps. Whilst the US and UK have witnessed spectacular housing slumps, unfortunately it could be much worse for countries like Ireland and Spain. Both economies became reliant on a construction boom that has switched to a slump. Combined with excess supply, bubble prices, and a shortage of banking credit, house prices could fall significantly creating many problems for economy - see problems of falling house prices.
• Lack of Flexibility. The Euro provides currency stability. That is desirable in the present situation. But, unfortunately, it limits the response of European countries to the crisis.

1. Firstly, it removes option of depreciation to improve competitiveness (surely Greece and Spain would like to devalue, like the UK has benefitted)
2. Secondly, the ECB are more conservative in cutting interest rates and adopting unorthodox measures such as quantitative easing.
3. Thirdly, EU countries have proved more reluctant to pursue expansionary fiscal policy - either because of large public sector debt (e.g. Italy over 100% of GDP) or a fiscal conservatism and concern over borrowing too much.

• Eastern Europe. Many eastern European countries are facing even more serious problems. e.g. Ukraine's national debt has been labelled highly risky. There is pressure for the EU to bailout their eastern neighbours - or even admit them into the Euro. But, both policies would place a strain on the Eurozone which faces enough of its own problems.

Related

• Europe heading towards recession
• Greece Economy
• Irish economy in recession
  

Problems of Swiss Economy

It's a little surprising to find myself writing a post about the problems of the Swiss economy. Traditionally, the Swiss economy ran as calmly and soundly as - well a Swiss clock, well oiled by the billions of inflows to private Swiss banks.

However, not only is the international community trying to crackdown on tax havens like Switzerland, but the economy displays signs of real problems.

The main problem in the short term is the impact of deflation. Swiss CPI recorded an annual price falls of 0.4%. This rate of deflation is expected to fall to 1% by mid summer. Unlike the UK where 0% RPI reflects falling mortgage payments, this deflation reflects a fall in general prices. It is every Central Banks worst nightmare. Swiss GDP is forecast to contract by 2.2%, but, the danger is that this decline in output could be exacerbated by the deflation. As mentioned several times, deflation can be one of the most damaging effects on the economy as it discourages spending and investment. If not tackled quickly, the impact of deflation can be difficult to dislodge - as Japan found out.

The response of the Swiss has included attempts to devalue their currency, through intervention on the foreign markets. This involves basically selling Swiss Francs to reduce the value. The hope is that this devaluation reduces deflation because:

• Exports are cheaper, increasing demand
• Price of imports rise.

The problem of this approach is that many other countries are looking to devalue their currency too. If the Swiss France depreciates against the Euro. It makes Eurozone exports less competitive and reduces price of many goods in the Eurozone.
Japan has also suffered from the strong Yen and will be looking to weaken the Yen. China is likely to look to depreciate the Chinese Yuan to boost a lagging export sector.

Relying on a weaker Swiss Franc is problematic because:

• Other countries will also try devaluing their currenciess (this is sometimes known as beggar Thy Neighbour Economic policies)
• Switzerland has a current account surplus, which tends to increase value of currency.

Switzerland may be forced into more unconventional policy methods which will undermine the status of the Swiss France as a strong currency.

Even Swiss banks got burnt by the subprime crisis. UBS, the Swiss financial giant, has so far been forced to write down about $43 billion.

Good Time To Buy A House?

Very tentative signs have suggested a recovery in the housing market.

There have been monthly reports of price increases (by Nationwide, but not Halifax), mortgage approvals were up in February and March, and confidence has slightly improved. Admittedly, the rise in approvals is from a very low base. But, the outlook looks less grim than in 2008.

From a personal perspective, it is quite easy to see why the housing market crash has showed signs of easing. When I took my mortgage out in 2005 (btw it was a self certification mortgage several times income - the kind you would have no chance of getting now) I was paying £937 a month. Now I'm paying £435.

(This included extending the mortgage term from 32 years to 47 years. But, the fall in interest rates have made paying a mortgage a very attractive proposition.)

To rent a similar house in Oxford would cost in the region of £800 - £850 a month. You don't have to be an economist to see the attraction of buying rather than renting - If you can actually get a mortgage that is.

For me the great attraction of buying a house, was not the fact mortgage payments were cheaper than renting, it was the expectation moderate inflation would, over time reduce the real cost of the mortgage.

£900 a month was a lot, but I knew that if I kept renting, the price would keep rising by at least inflation. In retirement, the cost of renting would be almost prohibitive. But, if I got a mortgage, the payments would get easier to make as long as my real income rose. It also gave the chance of living rent free in retirement; this is as good as saving for a substantial pension.

Problems Ahead in Housing Market

• In the last housing market crash, house prices fell for 4 years; the fall wasn't consistent, periods of rising prices proved to be false dawns. The present recovery in prices may be a similar effect.
• In 2010 and 2011 as the economy recovers, and as quantitative easing takes its effect on inflation, interest rates could increase quickly. You would be a fool to budget on the expectation that interest rates would remain this low for any foreseeable time period.
• Rising unemployment is likely to cause a rise in reposessions and depress the housing market. I can only see the unemployment figures worsening significantly this year. This rise in unemployment is likely to counter balance the improved affordability reducing demand for housing.

American house prices have been falling for over a year longer and still show signs of falling. But, the difference with America is that UK doesn't have the same surplus of excess houses (This surplus of newly built houses will be a problem for Ireland and Spain)

Whatever anyone says, I can't see the UK building many new houses. Demographic trends, such as move towards smaller households will increase demand faster than the supply of new houses. Thus in the long term, I can't understand predictions of 50% falls in house prices. I still think house prices will fall this year. But, in the UK, buying a house remains a sound investment for the long term

Dealing With Unemployment

The scale of the recession means that unemployment is forecast to increase to 3 million. What, if anything, can be done to limit the rise in unemployment?

• Subsidise Declining industries. Car industries have been calling for government support to stay open. The justification for subsidising industries is that it protects jobs. However, this is an expensive way to protect jobs. It is also difficult for the government to decide which industries / firms to save - the government may end up saving inefficient firms in an overcrowded industry. There may be a case for helping with finance, but loans should be competitive. (more: should government subsidise declining industries)
  
• Creating Public Sector jobs e.g. construction, litter collection. There are many jobs that the government could create temporarily during the recession. Last year the government built 300 council houses. Building new homes by employing unemployed construction workers could deal with a public service issue as well as create employment. Expensive to create any significant number of jobs, but government would at least save unemployment benefits
• Increase Aggregate Demand. Arguably the most effective strategy for the government is to increase aggregate demand and allow market forces to create real jobs (as opposed to 'artificial' government sector jobs) The problem is after cutting interest rates, a large fiscal boost, depreciation in Pound and quantitative easing there isn't much else the government can do. There is an element of waiting hoping that the policies will work.
• Supply Side Policies. These are policies to deal with microeconomic imbalances. For example, education and training to help the long term unemployed find jobs in growing areas of the economy. Although one feature of this recession is that well education workers are losing their jobs just as much as the unskilled.

Flexible labour markets to encourage firms to take on workers. Although UK labour markets are already flexible

Better information.

There are long term policies and won't deal with the current crisis.

However, they may be important for the speed by which unemployment falls. After the 1981 recession, unemployment remained high for a long time. After the 1991 recession, unemployment fell much quicker.

In addition to the demand side policies, I would have liked to see the government create more public sector jobs. It is a great shame, public borrowing for this year is already hitting 11% of GDP. If we had kept reducing borrowing in the boom years, we would have had more room for this policy which would definitely have helped cushion the blow.

The unfortunate truth is that there is very little we can do to prevent unemployment rising. But, we can limit the extent of the recession, we can speed recovery and we can target spending to most effectively deal with the rise in unemployment

• Supply side policies for dealing with unemployment
• Unemployment in UK
• Costs of Unemployment
  

The Skeptical Economist

There are certainly no shortage of books on economics coming out these days. It seems everyone is taking more of an interest in economics.

The Skeptical economist by Jonathan Aldred looks into the assumptions behind many of the economic theory and beliefs. Some of the issues raised in the book include:

• The economics of ethics.
• Motives of workers and consumers - behavioural economics and
• Economics and Happiness
• The difficulty of putting economic value on environment and nature
  

In Chapter one J.Aldred chooses a quote from Freakonomics

"Morality, it could be argued, represents the way that people would like the world to work - whereas economics represents how it actually does work. Economics is above all a science of measurement." (Levit and Dubner, Freakonomics)

A significant theme of the book is challenging this assumption of ethic / morality free economics.

Rather than giving importance to utilitarian principles of efficiency Aldred makes a case for looking at a wider determination of what increases economic welfare and human happiness.

I think economics needs to give greater weighting to normative judgements of how society can improve real living standards. Something that is far more important than just considering economic data.

It is quite long, and sometimes lacks the shortness and snappiness of competitors such as Freakonomics. This length probably gives chance to delve into more depth on issues, but, it will make it less likely to be bought. However, that's just my opinion as someone with little patience to read long books. ( I blame the twitter culture... - very bad I know.)

• The Skeptical economist at Amazon.co.uk
• The Skeptical economist at Amazon.com

Related

• Does economic growth bring happiness