What's it all costing?

Today a group of influential Labour MPs call for another £20 billion of government injections into the economy to reduce the impact of the recession. They claim that, if implemented, their package of measures would ensure that 2009 became known as the year the recession bottomed out. The measures include a freeze on stamp duty on house purchases, a tax credit for those buying houses, an increase in the Job Seeker's Allowance and a reduction in capital gains tax on new investments.

But what is all this really costing? There are several ways of answering this question. According to the Office for National Satistics ONS), the effect of the bank bailouts has been to add between 70 and 100% of the nation's GDP to national debt. The recession itself has reduced the amount of tax collected from individuals and businesses by around £7 billion. Then there is the cost to the economy of the lost output due to falling demand.

Economists have a simple but useful concept to measure 'cost'. This concept measures not the financial costs but the cost of what is foregone - the opportunity cost. The graphic at the top of this blog shows what the money so far spent on bank bailouts could have bought had it been spent on alternatives. This helps us to make sense of the very big numbers which have appeared of late.

My Year 10 economics and business students will be looking at opportunity cost after they return from half term.

Useful weblinks

ONS announcement on the national debt

January's public finances release from the ONS

Stephanie Flanders on the cost of the bank bailouts

BBC video on the reduction in tax revenue

BBC article on the reduction in tax revenue

Tutor2u presentation of the impact of the recession on tax revenues

BBC graphics: the global downturn

Latte lessons

My Year 12 economics classes are now well into their weekly 'latte lesson'. The concept is simple - each Friday morning is a break from the monotony of the specification and a chance to explore something economic that takes the students' fancy. Oh, and the drinks, biscuits, homemade brownies and chocolate tea cakes the presenter must supply!

The result? Some fantastic research, presentations and discussions so far on the Japanese economy and Zimbabwe. And a couple of inches on my waist line too!

Rex Harrison was spurred on to research Japanese economic performance in the 1990s in order to draw lessons about the current economic downturn and the appropriate policy responses. Rex's explanation of quantitative easing was masterly - who will forget his matchstick bankers? I will make his presentation available on the VLE for everyone to download.

In the meantime, as interest rates in the UK fall to 1%, the likelihood of 'quantitative easing' grows stronger. Year 12 students might be interested in this interactive guide to quantitative easing from the FT as a follow up to Rex's presentation. I think the FT may have borrowed the idea from Rex!

Who and what next?

'Cheers' to Charles Barry (U6) for his blog entry (see below). Anyone else want to join us?

1,200 job losses announced by M&S. Another 1,200 jobs lost at Nissan, Sunderland, the UK's most productive car plant. My Year 10 group may be quizzing me tomorrow, after today's discussion of the importance of productivity - guess which car manufacturing plant we were looking at?

Britain's oldest name in the clothing industry, Viyella, goes into administration (or at least part of the business does). The Sofa Workshop is on the brink of administration. Who is next? The impact of the recession deepens by the week - by the day would not be an exaggeration.

And UK interest rates come down to their lowest level since the Bank of England was founded in 1694. As Charles has explained there is a limit to how far interest rates can fall. With 0.5 percentage points knocked off the base rate today, the UK is now reaching this limit. What next? Will we see 'quantitative easing' and deliberate 'printing' of money to prevent the UK entering a period of deflation? Maybe. When the very politicians that gave the Bank of England its operational independence just over 10 years ago start talking about having a say in monetary policy you know that you are living in historic times. I first started to study economics at the height of 'monetarism' - a theory (actually more than that, as it provided the bedrock to a whole new political philosophy - Thatcherism) which urged governments to restrict the growth of the money supply. For an independent central bank to be contemplating deliberate expansion of the money supply is an even bigger shock than the return to fashion of Keynesian demand management.

What intrigues me about this is the battle for control over monetary policy which I suspect will grow over the coming months. Alistair Darling is effectively saying that responsibility for monetary policy decisions will now revert back to politicians. As an economist this scares me, but it doesn't surprise me. Monetary policy decisions made for political reasons are apt to destablise rather than stabilise the economy. And there is now talk of a further boost to government spending too. Economists don't always agree about appropriate policy responses, but at least the debate can be rational and objective. I know who I would want with their hands on the tiller.

Useful weblinks

Darling wants say on 'quantitative easing'

Economy may need a second cash boost

Bank cuts interest rate to 1.5%

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 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?