"Quantitative Easing" - A way forward?

About roughly a month ago, I asked Mr Walton that perhaps, with the threat of deflation looming, the best thing for the Bank of England to do would be to print more money. My thinking was that by printing more money, the government would be literally shoving more money into the economy, which would in turn stem off deflation and potentially help to self-right the economy.

Sadly, as it was the end of period 3, Mr Walton gave me one of those looks which said "I really want to go and have a cup of tea", quickly mumbled "Yes" and made a sharpish exit from the room.

Now, without wishing to sound like I am the new prophet of the credit crunch or anything, looking at the papers now, my prediction seems to have come true.

Only 4 days ago the Open Market Committee of the US Federal Reserve (the American equivalent to the Monetary Policy Committee) announced its intention to start buying mortgage-backed securities (the supposed 'dodgy debt' that caused the credit crunch in the first place). Where would the money for this come from? The short answer: nowhere. The Federal Reserve will simply create money, electronically or through printing, to use to buy this 'toxic debt'.

Now, the upside for this is obvious: by putting money straight into the economy through such purchases, there are strong cash injections into the economy. Best of all, the government gets to do this for free. This will improve liquidity, allowing banks to start lending and business thus to start investing. It will reduce the cost of borrowing, allowing consumers and business alike more breathing space, reducing any potential falls in GDP and increases in unemployment.

You might start to wonder, however - since this is all so good, why don't we do it all the time? Well, as the saying goes, there's no such thing as a free lunch. The main danger with printing more money is that it has a strong inflationary pressure upon the economy. Milton Friedman won the Nobel Prize for Economics in 1976 for, amongst other things, the simple equation:

MV=PQ

Where M is the Money Supply, V is the speed at which money circulates through the economy, P is the price level (ie the level of inflation) and Q is the real economic output. Increasing the supply of money, by printing more of it, will increase inflation and/or GDP growth.

This effect can be so extraordinary that in Zimbabwe, where the government has been printing money for years, the economy suffers Hyperinflation. This is the rather comical situation where inflation reaches levels that devalue the currency so much that the economy cannot function properly. The official inflation level in Zimbabwe is 231,000,000%, meaning that when the $100 billion dollar note was introduced last October, it was only worth 8p.

However, inflation is not our main concern. We are currently experiencing a demand side slump in the world economy. Demand side slumps, or falls in the Aggregate Demand of the economy lead to higher unemployment, lower inflation (or possibly deflation) and falling economic output. The threat is actually from the pessimistic and demoralised economic situation that deflation can cause, and the economic depression that may result from the declines in consumer spending and reductions in employment levels of recent times.

Overall then, printing more money is potentially the only way forward. We are nearing the end of the usefulness of interest rates as a means of controlling the economy. In fact, low interest rates, as seen in Japan in the 1990s, may prove counter-productive (though something called "The Liquidity Trap" - where returns are so low that investment in anything is severely discouraged and people simply hoard money). In the short run, printing money may prove to be the most useful tool available to the government. But even in the medium term, it must avoid using it as a "magic bullet", a fix-all cure, and must know when to stop.

Otherwise we could leave the recession to find ourselves waking up to a inflationary crisis in 5 years time.

Further Info:

Forget Hard Choices. We need pampering - Anatole Kaletsky, The Times.
Press Release of 16th December - The Board of Governors of the Federal Reserve
Federal Reserve slashes Interest Rates to zero - Larry Elliot and Ashley Seager, The Guardian
Deflation: Making sure it doesn't happen here - Ben Bernanke, Governor, US Federal Reserve

What is deflation?

Completely out of the blue, someone in my Year 12 economics set asked me what deflation is. Apparently, there had been some discussion of this in a politics lesson and it was throught a good idea to refer the question to the economists! How wise. Best not to trust the politicians when it comes to anything to do with prices.

All the talk for the last 10 years has been about bearing down on INFLATION - the sustained increase in the general level of prices. So, why should DEFLATION matter?

Deflation is a sustained decrease in the general level of prices. 'Great', you may say. If things are getting cheaper then surely that must be good news? Well, no. If prices are continuously falling, what's the point of buying now when you can wait for prices to drop even further? If we all think like this, then spending will drop. If spending drops, overall demand drops. As demand drops that affects output. If output falls, that means jobs are lost. Defaltion matters because it causes us to hang on to our money rather than spend it and that means prolonged recession.

My challenge

A reward for the best account of the problems of deflation with an illustration from the recent economic performance of Japan.

Useful weblinks

Article in the Independent

Reuters guide to deflation

New GCSE - details for students and parents

From September 2009 the economics and business department will offer a new business studies and economics GCSE.

The GCSE, taught over 2 years, will allow students to engage actively in the study of both subjects and will develop skills such as building arguments and making informed judgements. Students will be encouraged to adopt a critical approach to the subjects, and appreciate different perspectives on business and economics issues.

The course is modular. Students will be assessed at various points throughout the two years and will be able to ‘bank’ their results or re-sit depending on their performance.

The course provides an excellent introduction to both business studies and economics and provides a rigorous preparation for the study of either or both subjects at A Level.

The first unit of the course provides an introduction to small business and focuses on the issues involved in setting up a business. It involves the study of entrepreneurs, how business ideas are put into practice, how business start-ups can be made effective and the economic environment in which businesses operate. It is examined by multiple-choice and objective test questions and can be sat online. Students will sit this exam at the end of Year 10 (the fourth form). This exam makes up 25% of their GCSE.

The second unit allows students to investigate a small business of their own choosing under controlled conditions in the classroom. Students are allowed six hours of research time and three hours of writing time. They are given a choice of five tasks:

Task 1: What are the most important qualities that an entrepreneur needs to possess, in order to start up and run a business successfully?

Task 2: What is the most important way in which a business you have chosen competes with its rivals?

Task 3: What is the most important way in which a business you have chosen motivates its workers?

Task 4: What is the most important element of the marketing mix to a business you have chosen?

Task 5: To what extent have recent changes in interest rates affected the business you have chosen to investigate?

This unit is marked internally and moderated by the exam board and makes up 25% of the total GCSE mark. It can be done in Year 10 (fourth form) but is more likely to be done in Year 11 (fifth form).

The final unit of the GCSE focuses entirely on economics and involves the study of a wide range of economic issues, including how markets work, international trade and exchange rates, monopoly power, how the economy is managed by governments and central banks, and debates related to economic growth, the environment and global inequality. The exam makes up 50% of the total GCSE mark and is a mixture of multiple-choice, short- and extended- answers and data response questions. Students will sit the exam at the end of Year 11 (fifth form).

Students and parents wanting to find out more about the new GCSE in business studies and economics may find these online documents useful:

The specification
Sample question papers
Student guide – page 1 and page 2
e-spec and guide

The economics and business department will be producing its own short guide to the new GCSE course shortly along with an outline scheme of work for each of the two years of the course.

When down is up

My Year 11 groups are looking at the management of the economy this week and have been asked to assess the effectiveness of fiscal and monetary policy in stimulating demand in the economy. Quite a big question, since that is exactly the one which is exercising the likes of Gordon Brown, Alistair Darling and Mervyn King.

Today we got to the point where we had traced through the impact of lower interest rates on the economy - the monetary transmission mechanism. OK, so that makes it all very simple we thought. That should mean that the Fed's latest interest rate cut (which brings US interest rates down to 1%) and the much anticipated cut in the Bank of England's Base Rate (some think as much as 1% will be lopped off the Base Rate) should give a welcome boost to demand.

But these cuts in interest rates just aren't getting through to households and firms who. in some cases, are paying higher interest rates than they have done in the past. So why when the Base Rate of interest is coming down are market rates of interest going up?

The answer lies in our attitude to risk. Lending money to anyone is now much riskier than it has been. So the rate at which banks lend to each other has risen (so-called interbank rates) and the rates they offer to savers has gone up to try to plug the hole in the bank's balance sheets. Look at the chart at the top of this post to see what is going on. Down really does mean up.

Watch this space as the Bank of England decides what should happen to UK interest rates this Thursday. In the meantime you might like to read some of the recent articles listed below.

Useful weblinks

Robert Peston's recent blog post on interest rates

US interest rate cuts

Bank of England may cut Base Rate by 1% point

It's all a beauty contest ... and the winner is ...?

John Maynard Keynes introduced the concept in his book, The General Theory of Employment, Interest and Money, in 1936. It goes something like this. The stock market behaves like a beauty contest in which people are asked to select the six faces they like most from a selection of around 100. Those picking the most popular face are entered into a prize draw to win a fantastic prize. How do you go about maximising your chances of being in the prize draw. According to Keynes, you don't choose what to you is the prettiest face:

"It is not a case of choosing those [faces] which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest.We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there aresome, I believe, who practisethefourth, fifth and higher degrees."

And so it is with the stock market. Or housing markets. Investors would be prepared to pay more for something that it is worth if they believe that others will pay even more for it in the future. And so you get bubbles in these markets which grow and grow, even if the fundamentals don't justify the high prices being paid. But bubbles burst and when they do, the rational thing to do is to keep selling whilst you believe that everyone else believes that prices will continue to fall. In short, what we have experienced over the last month or so is a classic failure of markets to value assets at their correct value.

Inevitably at this time, there is a more traditional beauty contest playing itself out. The contestants are flaunting their ideas for how best to rescue the economy from the downturn which we now know officially is under way. Alistair Darling thinks the solution, in part, is to bring forward public expenditure plans. A group of 16 economists writing in yesterday's Sunday Telegraph think not - best to rely on interest rate cuts, they say.

So, my question is 'who wins the economists' beauty contest (who is right) and why'? Usual rewards on offer ...

Useful weblinks

Stephen King's' article on the Keynesian beauty contest in today's Independent.

BBC report on the 16 economists disagreeing with Darling.

The letter itself

Roger Bootle's seven point summary of Keynesian economics in today's Telegraph

Beauty Expectations - online beauty contest game

It's official - GDP on the decline

Official figures released by the Office of National Statistics show that GDP declined by 0.5% in the third quarter of 2008 (July to September). This is a bigger fall in output than had been expected and the biggest fall in economic growth since 1990.

The BBC is running a day long coverage of the downturn which you can access here (or you could turn on your TV and tune in to the BBC News Channel). A running commentary is also available here.

Enjoy!

New international debt crisis looming?

A new and worrying twist to the global financial crisis emerges today.

If we didn't know it already, the lesson of the past few months is that we can't go on living beyond our means. What applies to individuals also applies to countries who import more than they export. The difference between what a country earns (its export revenue) and what it spends abroad (its import bill) has to be paid for. This difference is known as a current account deficit on the balance of payments. Countries bridge this gap by attracting flows of money, measured on the capital account of the balance of payments. These flows take many different forms - foreign direct investment and private and public sector borrowing. All very well if those providing the capital carry on doing so or don't want it back in a hurry. Not so good if this source of long-term capital dries up or the investors want their money back.

Just as a loss of confidence in the banking system causes individuals to withdraw their cash (a run on the banking system), a loss of confidence in a country's ability to repay its 'debts' causes a run on the currency. Capital flight, as it is called, can send a currency into free fall and countries going cap in hand to the International Monetary Fund (IMF).

So much for the theory. It's happening. According to the BBC's business reporter, Robert Peston:
Queuing up for the intensive care ward are Iceland, Hungary, Pakistan, Ukraine and Belarus, all of which are in discussions about accessing special loans from the International Monetary Fund, the emergency medical service for the global economy.
But there has also been a substantial withdrawal of capital from South Africa, Argentina and - most worrying of all - South Korea.

South Korea's balance between its exports and imports (its balance of trade) is much healthier than the UK's and they are not nearly so dependent on financial services as a source of export revenue. Sterling is falling on the foreign exchange markets. Is this the start of a new international debt crisis? Will the UK be next in the queue at the door of the IMF?

Read Robert Peston's excellent blog here.

The 'R' word

The National Institute of Economic and Social Research says its likely. The Governor of the Bank of England agrees. Gordon Brown acknowleges it at Prime Minister's questions today.

The UK economy is on the brink of recession.

GDP data for the third quarter of 2008 is published on Friday. It is widely believed that this will show UK output fell in the last three months. Also widely expected are revisions to the data for the second quarter which will show that the economy's output fell from April to June. That will be two successive quarters of negative economic growth and an end to the matter - recession will be official.

Brace yourself for a BBC day long special on Friday. Apparently, the decks have been cleared and the journalists dispatched.

Who's the discount Daddy?

The focus of our Year 11 economics and business lessons this week has been on business survival startegies in a recession. Discussion inevitably turned to price cutting and to the 'war' amongst supermarkets to attract the value conscious consumer. With annual food price inflation running at over 14% the big four supermarkets are keen to prevent their customers rushing to the big discounters like Aldi and Lidl. In one month alone (July), Aldi's sales increased by 44% as households strapped for cash sought to reduce their weekly shopping biils. Sales at Aldi are 25% up over the year and their market share is growing at the expense of the bif four - Tesco, Asda, Sainsbury and Morrisons.

So, it is no wonder the big four have fought back. Whilst my Year 11 groups raised the importance of cost-cutting, they recognised the even greater importance of cost-effective and targetted promotion during a recession. Students identified Tesco's latest claim to be 'Britain's biggest discounter' as evidence of this trend.

The extent of this promotion can be found in a fascinating article in the Independent from 22 September:

Last week, Tesco launched a major national press campaign to position itself as "Britain's biggest discounter". It booked every full-colour ad slot in the first 20 pages of all the popular and mid-market papers on Wednesday, a real advertising extravaganza and a great example of the power of print advertising.

Except that Tesco's campaign was hijacked by arch-rival, Asda. Having got wind of the Tesco blitz, which media buyers estimated would have cost the supermarket chain around £450,000, Asda booked its own full-page colour ads to run in the same papers on the same day, claiming that Asda sells 3,457 products cheaper than Tesco. Ouch.

This article is well worth reading in full - click here.

Year 11 'thinking skills' were at the fore when one student questioned how retailers such as Waitrose coped in a recession. Would they be forced to follow suit and abandon their business model based on selling quality food at high prices? How could they hope to regain this position in the future if they responded to changing market conditions by discounting?

These were exactly the questions Declan Curry posed to the MD of Waitrose last Friday when he appeared as the special guest on Working Lunch. If you are quick you can still catch the interview on BBC iPlayer by clicking here - the first six minutes and then the main interview 20 minutes in.

I just want to say to my Year 11 group how well I thought they ended a long and tiring first half of term. The demands of coursework investigations and the routine of past paper questions hasn't dulled your brains and your assessment of the strategies we raised was first rate.

No questions in this post (it's half term after all!) - just an encouragement to extend your learning by following up the three links I have given.
Commendations for the best comments to the issues raised as an incentive!

It isn't official ... yet

This week is the week that attention ought to be focused on the wider economy. Data on economic growth in the third quarter of 2008 is widely expected to indicate that the UK economy is entering recession. Last month the British Chamber of Commerce nailed its colours to the mast and announced that a survey of its members showed output falling. This morning the Ernst and Young Item Club, who use the same forecasting model as the Treasury, have declared that the economy is already in recession. So, watch this space - after you have watched this video clip from the BBC. There will be no prizes if official data confirms what most economists, businesses and the increasing number of unemployed already know.

Fresh from devising bank rescue plans, Alistair Darling (Chancellor of the Exchequer) has announced that key government expenditure plans will be brought forward in an attempt to inject extra spending into the economy. The implications for government borrowing will be significant, not least because they come at a time of record borrowing by the government - see this article on the BBC website.

Quick questions for Year 10 economics and business students (post your answers as a comment to this blog) - commendations for all those with a correct set of answers!

1. What is the official definition of a recession?

2. What is the name for the use of government expenditure and taxation to regulate the econmic cycle?

3. What are the four stages of the economic cycle?

Longer question for sixth form economists (post your asnwer as a comment to this blog)

1. What are the drawbacks of using government expenditure and taxation to regulate the economic cycle?

All hands on the interest rate lever

When this blog was running on the department's VLE, a week didn't go by without some reference to the dilemmas facing the Bank Of Engalnd's Monetary Policy Committee (MPC). At that time the tension was between keeping interest rates unchanged to keep inflationary pressures under control and bringing them down to anticipate a feared slowdown in economic growth.

All that seems a long time ago now! The crises in the financial markets have dominated thinking - Paulson plans, rescue packages, nationalisations and falling stock markets to name but a few debates raging. Last week's 0.5% co-ordinated cut in interest rates by the Bank of England the Federal Reserve and others didn't get the attention it might otherwise have got in more 'normal' times.

However, the global slowdown now gives central banks greater freedom to act to loosen monetary policy. Oil prices have fallen and so too have commodity prices. The inflationary pressures that concerned central bankers at the beginning of the year are receeding.

And so, some economists are now predicting historically low interest rates by the end of 2008. Roger Bootle, interviewed on Radio 4's Money Box programme, has predicted that interest rates might fall as much as 1% by Christmas and be down as low as 2% by next spring. If they did fall this low it would be the lowest interest rates have been since the creation of the Bank of England in 1694.

Forecasts are just that, forecasts. What is more important than whether interest will fall is what impact falling interest rates will have on the economy. Will lower interest rates stimulate spending and growth and can governments rely oon monetary policy alone to fend off a recession?

Two quick questions (give your answers via a comment to this blog)

1. Under what circumstances might reductions in the Bank of Engalnd's interest rate have little impact on the overall level of spending in the economy?

2. What is the 'liquidity trap' and with which British economist is this concept most closely associated?

Welcome

Welcome to the new-look King's EcBSt blog. I hope that the switch from it's Learning to Google blogger goes down well with everyone. The advantages are that I can include links to other blogs (see the BBC News and Tutor2u blogs on the right) and that it is much easier for you to comment on the postings on the blog.

Let me know if you would like to become a blog author or if you are interested in joining an EcBSt blog club. Call into the department office or email me at stephenwalton@kingschester.co.uk .

Nobel prize goes to Paul Krugman

The nobel prize for economics has this week been awarded to Paul Krugman for his work on 'new trade theory'. Krugman, professor of economiccs at Princeton University, has done much to popularise economics writing a regular column in the New York Times and publishing accessible books such as The Accidental Theorist - a collection of short essays in which he exposes bad economic ideas with a sharp pen. Krugman's columns in the New York Times have recently taken a dim view of the US response to the financial crisis and included savage attacks on the outgoing Bush administration.

You can find out more about Krugman by reading this short article from the FT.

Blocked pipes

My four year old son has a nasty habit of blocking the toilet with large wads of toilet roll. Unblocking what he has clogged up is not a pleasnt job, and it tends to fall to me.

As many of you will be aware, the present financial problems stem from the fact that banks are reluctant to lend to each other because of a breakdown in trust. As a result the pipes of the financial system are blocked.This is a classic failure of the market to function efficiently. Unblocking these pipes is proving difficult for governments around the world. These issues are the focus of one of the many useful article in this week's Economist magazine.

If you don't know your LIBOR from your EURIBOR, or are simply curious to find out more about the 'money markets' then you can't do better than to read this article.