CHEconomics

Unemployment hits 17 year high

2012-02-16T01:58:00.000-08:00

Unemployment continues to rise and there isn't going to be a let up soon. The poor growth in the EU and USA means that the world economy is not growing fast enough to maintain employment.

I have written at length on youth unemployment before, but that has reached a new high, and again this has a way to go.

A factor that is making things worse is the fall in public sector workers. 65,000 fewer public sector workers were offset by only 5000 more private sector workers. Remember the plan was that the private sector would grow enough to allow for the public sector expenditure cuts.

While the situation gives scope for cheap jibes of 'too much too fast' there does have to be serious questions about how best to deal with the situation. Policy trade-offs are a harsh reality for everyone.

Details from the Independent here

Inflation falls as expected

2012-02-14T10:16:00.000-08:00

CPI inflation fell to 3.6% from 4.2% last month. RPI fell to 3.9% from 4.8%.

This was not at all a surprise because inflation is measured by a month twelve moving average. This means that the price rises that occurred in January 2011 dropped out of the index and were replaced by price rises in January 2012.

In January 2012 VAT rose by 2.5% (from 17.5% to 20%). As VAT remained at 20% last month the whole effect of that rise was removed. Given that the small fall in CPI, by 0.8%, might seem rather modest.

The fall in inflation is welcome news for households who have found wages rising less quickly than the general level of prices.This erosion of real living standards has inevitably affected consumption and so aggregate demand.

Inflation is forecast to fall to around 2% by the end of the year. This will help, but only if incomes rise by at least 2%. Britain continues to grow slowly and today Moody's cast doubt on the UK's ability to keep its AAA credit rating because of the poor growth rate.

THE FT covers the inflation rate change here

An insight into the Credit Crunch

2012-02-13T01:36:00.000-08:00

The clear lesson of the credit crunch was that nobody actually understood derivatives, but had convinced themselves they did.

One reason why banks and other financial institutions committed so much to trading derivatives was because they had models that told them that their investments were sound. This all turned out to be false.

The attached article is a challenge, but illustrates the problem of assumptions and abstracting. The Black-Scholes equation was the first equation which valued investment options in a seemingly reliable way. It worked for a long time and encouraged the use of similar mathematical models that valued more complex assets in what were essentially gambles.

Regardless of what we may think of banks gambling with their clients money, the way these valuation models worked is fascinating. The bankers made assumptions on volatility and various other variables and the models became more ambitious. It turned out that the models did not survive reality with disastrous results. Yet it was quite clear that the models could never survive reality to anyone outside the financial sector.

The article is excellent reading for all those interested in financial economics and doing economics at university.

The Guardian article is here

New round of stimulus by Bank

2012-02-09T14:06:00.000-08:00

The Bank of England is injecting another £50bn into the economy. They say that while many indicators are looking up there are too many uncertainties and the Euro area, Britain's main export market is at best flat.

The aim is to put extra liquidity into the financial markets, push yields (interest rates) down and this will lead to increased demand through higher consumption and investment in the economy and the recovery will be given a boost.

This new round of quantitative easing, which is being called QE3, is drawing both good and bad comments. Some feel that the good January figures for the UK economy are merely a blip and won't be sustained and the others that the 'headwinds' faced with the economy are still strong and so this is a welcome move.

Others say that this is an inflation risk and that the effect on yields is going to seriously affect savers and especially people retiring this year and in the next few years.

All policy is a trade-off and so there are always costs. A more important question is will it work? Monetary policy is a notoriously blunt instrument and has long and variable lags. There are good reasons to think that QE3 is like 'pushing a piece of string', there is no effect at the other end of the process.

The Independent covers QE3 here

Carbon emissions and national income

2012-02-08T03:25:00.000-08:00

Many variables move with national income (some in the opposite direction of course). One of them is carbon emissions.

During the recession industrial production fell and households took fewer holidays. Carbon emissions fell and our progress towards the carbon reduction targets looked good. Now it appears that the recovery is reversing the trend and carbon emissions are rising.

In a week where 100 idiot Conservative backbenchers called for the cutting of subsidies for renewable energy it is important to remember why these industries need help.

Carbon emissions are a market failure. The market does not price emissions as there is no charge for putting them into the atmosphere and so firms don't consider the cost of those emissions. The result is that more carbon is dumped in the atmosphere than is optimal.

There is a way to stop this. We tax firms on their carbon emissions or issue tradeable permits. This isn't always popular and does not do enough in a highly inelastic market to reduce demand. So directly subsidising renewable energy, which cannot compete on price with coal, oil or gas will allow low carbon energy production.

It is a case of attacking the problem from two directions. Another way, as an article linked to the one below points out, is to insulate homes properly. A staggering 10 million homes have no or inadequate loft insulation and almost as many don't have cavity wall insulation. Subsidising insulation (and it is already) can shift the demand for energy to the left and will help in a third way.

The Guardian article is here

Change of plan - Supported prep

2012-02-06T04:27:00.001-08:00

Mr Russell's supported prep will be on Tuesdday.
Mr Cmburn's supported prep will be on Wednesday

All due to conflicting forces etc!

What to do with Monetary Policy?

2012-02-06T00:44:00.000-08:00

This week the Monetary Policy Committee will hold their monthly meeting. Interest rates will stay at 0.5%, that's a given, but further Quantitative Easing is a possibility.

Today there is an opinion piece in The Guardian on what they could do. The piece looks at the cost of the recession, the size of the stimulus package so far and the consequences of the end and reverse of Quantitative Easing.

This article shows just how difficult the decision process is, with various competing factors to consider. Among other points raised is the effect of reversing Quantitative Easing. The government debt that the Bank of England have bought up in the market to boost the money supply will need to be sold. Doing this will push bond prices down and so interest rates up, possibly affecting the pace of the recovery post 2015.

This is an article that should be read to the end, but remember it is an opinion piece, not news and you should remember the writers bias.

The Guardian article is here

Opportunity cost at work

2012-02-02T00:13:00.000-08:00

NICE, the National Institute for Health and Clinical Excellence, have the job of deciding if treatments are value for money for the NHS. It's a pretty thankless job. The NHS has a fixed budget and that has to be allocated to the most effective use.

The problem is that new treatments are very expensive and so take a lot of money. The case of a new prostate cancer drug illustrates the dilemma.

Prostate cancer is the most common cancer in men and kills 10,000 a year. A new drug that costs £3,000 a month will extend the life, but not cure, those with advanced prostate cancer. This very effective drug will cost a great deal of money, reduce suffering, but save no lives.

NICE have decided that, at the preliminary stage, the drug should not be available on the NHS. The decision is based on opportunity cost. How many more treatments can be provided to other patients instead of giving this drug to prostate cancer patients?

NICE are applying a cost-benefit approach and living with the problem of scarce resources. But that is little comfort to those with prostate cancer.

The BBC cover the story here

University applications down, but is that a sensible response?

2012-01-30T09:44:00.000-08:00

You will not need reminding that university tuition fees rise to at least £6000 next academic year. The predictable response is a fall in demand.

Applications are down by 8.7% overall. This is what we would expect from the law of demand, price up, quantity down. And in terms of price elasticity demand that's pretty inelastic as the price change, at least on the surface, is at least 100% and in the 'better' universities 200%.

But should students turn away from a university education? The problem with education is that it is an imperfect information good. Consumers of education will not consider two aspects of university education:
1. The benefit to society generally of having a better educated workforce.
2. The full benefits to themselves of attending university.

Potential university students only consider the benefit they believe they will get and weigh them against the cost of attending university. However students rarely realise at the time how much extra income a degree brings them. Nor do they consider their increased productivity and the benefit to the countries productive capacity.

Overall this means that consumers by less education than is allocatively efficient. This is an argument for subsidising education not raising the costs. Indeed some of us got paid to go to university, but maybe I will stop at that!

The Independent covers the application figures here

Fall in Real GDP can't be good news

2012-01-26T06:08:00.000-08:00

The UK economy shrunk last quarter by 0.2%. This should be a period of recovery and growth after the recession and so not at all what was hoped.

However, if you can see the BBC graphic in the story below, you will notice that the economy shrunk by 0.5% in the equivalent quarter in 2010. After that growth returned, 'caught up' in fact, so this may not be a return to recession. Remember one observation is not a trend.

What is clear is that growth is pretty flat and nowhere near the levels the economy needs. The Deputy Prime Minister, Nick Clegg, has called for a stimulus measure, raising the tax free threshold to £10,000. This will raise the disposable incomes of all tax payers, but the biggest effect will be on the low paid. They tend to spend a higher percentage of their earnings and so this will raise consumption and boost Aggregate Demand.

Would such a stimulus work? Well it depends on whether the tax cut is spent or saved. Also would a boost of £7 a week really help that much?

The BBC cover the growth figures here

At last proof McDonalds is an inferior good

2012-01-24T11:21:00.000-08:00

McDonald's have reported a 11% rise in revenue. What could have caused this?

We know that when real incomes fall then the demand for normal goods shifts to the left and less is bought at all prices. For inferior goods of course more is bought.

Is this the explanation for McDonald's? Well real incomes have been strained and some people have moved away from more expensive food to more 'affordable treats'. So this may be the reason.

However there are other factors in play. McDonald's have invested in their restaurants and staff and have promoted new products. So ceteris paribus does not apply.

Another reason could be that demand for McDonald's meals is elastic. They have many substitutes and they are not an essential item. So a price cut will have led to a rise in revenue.

The BBC report the story here

Where to draw the line between compassionate support and incentives?

2012-01-23T00:26:00.000-08:00

Today the House of Lords will vote on the Government proposal to limit cash benefits to families at £500 per week. The measure, which commands overwhelming public support according to polls, is not sure of passing through the 'revising chamber'.

The economic arguments for the change are based on the disincentive effects of high benefits. £500 a week or £26,000 a year represents an income that is equal to average earnings (£35,000 before tax and equal to average family income). If benefits are higher than in work income there is less reason to leave unemployment. So this is a supply side measure to increase the participation rate and increase the use of resources.

There is a further argument based on deficit reduction. Social Security is the largest spending department by far.

But jobs are few and far between. Is it really as simple as this to get people to leave benefit for work?

The arguments against this move are based largely on compassion. Some families could not afford their current homes on the new maximum benefit and would have to move. Others point out that needs vary between families and a single maximum benefit is unfair and some ask for Child Benefit to be excluded.

This is a supply side measure that seeks to improve the way the labour market works. The benefits should be an improvement in long run capacity by incentivising the voluntary unemployed. However the cost will fall on some who are powerless to change their circumstances.

For those interested in constitutional matters this may hasten the reform of the Lords as the unelected Church of England Bishops abuse their undeserved position yet again.

The BBC cover the story here

Plan C urged by IMF, World Bank, WTO and others

2012-01-20T06:16:00.000-08:00

Forecasting economic conditions is a critical part of setting policy.

Consider mid 2010. The economy appeared to be returning to normal growth, albeit slowly. The fiscal and monetary stimulus given to the economy appeared to have been successful, but debt levels were rising rapidly. Forecasts told governments that they could expect modest growth that would allow them to restore the public finances.

But the forecasts were incorrect. Growth faltered and then fell and is now virtually non-existent. Further monetary stimulus has kept heads above water, but now there is a danger that withdrawing more of the fiscal stimulus could do harm.

At present the fiscal stimulus provided by the government is over £160bn in the financial year. That is a huge boost to demand. But the plan is to reduce this through expenditure cuts. The IMF and others have now warned that this could be too much.

Policy must react to the current situation. Stimulate the demand side of the economy in recession, and work on the supply side during growth periods. Monetary conditions require stability at all times and right now that means boosting the money supply (Plan B) to prevent a 30's style contraction (so high marks to Mervyn King on that one).

So now may be the time to call a halt to cuts. Further stimulus is likely to have little effect and would scare the markets. However cutting expenditure will have a negative multiplier effect on Aggregate Demand and that could tip the economies of Europe into recession. That seems to be the concern of the IMF and others and you can probably see their point.

The Guardian covers the story here

2012-01-18T02:53:00.000-08:00

UK Unemployment

UK CPI inflation

There is a well known relationship in Economics, called the Philips Curve. It states that there is a trade off between inflation and unemployment. As unemployment rises inflation subsides.

This relationship was solid until the mid 1970's but broke down in spectacular manner with rising unemployment and inflation appearing simultaneously. However many continue to look for this relationship in the data and the figures announced in the last two days will be seen as a return of the relationship.

Inflation has fallen sharply, so sharply that the Bank of England are worried about undershooting their 2% target. Unemployment edged up, less than feared, but it remains on an upward trend.

The causes of the rise in unemployment and fall in inflation are well known. But this is a perfect example to use when looking at the trade offs between the two variables. It makes it very difficult for governments to achieve their objectives in both.

Can you see the trade off in the data above?

BBC on inflation figures here

BBC on the unemployment figures here

Climate change action needs growth

2012-01-17T00:42:00.000-08:00

Climate change is, in my view, a far more important problem than economic recovery. While a second financial crisis might see us moving back to the Stone Age it remains unlikely, but climate change is a certainty and threatens the very survival of the species.

The inaction on climate change globally is therefore quite staggering (although the EU is far ahead of the rest of the world on this). In other countries, such as the US and Australia 'climate change deniers' hold sway and even get some support in the UK as the picture above shows.

In the Guardian Max Boykoff reviews the current situation and explains that before we can get serious and effective action on climate change we need economic growth. The irony of course is that it is economic growth that caused the climate change in the first place. However for politicians to be prepared to commit resources to tackling climate change they need the population to feel well enough off to afford it, otherwise they vote for the guy who promises tax cuts.

Boykoff's article is here

The unemployment and crime link

2012-01-16T01:25:00.000-08:00

One of the costs of unemployment that students often like to talk about is a rise in the crime rate. This is a long established relationship that suggests the more unemployed there are the greater the poverty and so the greater the incentive to resort to crime.

In fact in the recession itself crime figures actually fell, but now comes news of rising retail crime. The value has retail crime has risen to £1.4 billion a year. This is a mixture of shop lifting and fraud.

So when discussing the costs of unemployment can we still claim the link to the crime rate? Well possibly not. Petty crimes by individuals appear not to have risen, but crimes by gangs of shoplifters and other fraudsters (which requires far greater organisation and planning) has risen.

The story is covered by Sky here

Increasing competition or normal oligopolist behaviour?

2012-01-15T01:16:00.000-08:00

In October it was reported that the big six energy companies had increased profits from £15 to £125 per customer per year. This drew the attention of the regulator Ofgem.

When the nationalised industries were privatised the idea was to move from state monopoly to a competitive market where the consumer got a better deal. What we got in a lot of cases was either private monopolies or strong oligopolies with high barriers to entry.

Ofgem are trying to improve the situation by forcing the 'big six' energy companies to auction off some of the electricity they generate to allow new entrants into the market.

However this week a number of the big six announced price cuts. Does this mean the fear of new entrants is forcing them to act (a contestable market)? Ofgem would be delighted if this were true. But this behaviour is consistent with oligopolist's profit maximising behaviour.

The warmish winter means spot market prices for energy are lower this year than the last two years. With lower than expected costs one firm moves price down to gain market share. The others lower prices to match them to protect their market share. The kinked demand curve model and game theory would both predict this move.

The Telegraph report the story here

Means test benefits or not?

2012-01-13T06:05:00.000-08:00

The government proposes that child benefit will be means tested. This means any family that earns more than a certain amount (£45,000) will not be paid the benefit at all.

This is an unusual form of means testing as normally benefits fall as income rises. The proposal is for an 'on-off' switch at 45k. However the aim is to reduce public expenditure by removing this flat rate benefit from the better off.

So that seems fair? After all the rich don't need it do they? Some will, however, argue that the Child Benefit is an 'indicator targeted' benefit, it is given to a group that are known to have a high proportion of need - those with children have to spend more and the aim is to ensure children are well provided for. Another example is old age pensioners, they receive a flat rate benefit regardless of income, because many old people have low incomes. By offering this unconditional benefit nobody needs to ask for it, nor do they need to disclose any personal details.

One aim of government is a more equal distribution of income. Does this move improve it? Could it be that for some it will increase poverty?

The BBC provide the details of the latest discussion here

Fatties surcharge proposed for airlines

2012-01-11T23:31:00.000-08:00

A former QANTAS economist has proposed that overweight people should pay more to fly.

When you fly you are given a weight limit for you luggage. A base amount might be 20Kg or 23Kg, which is not that much for a long trip. Ryanair charge €12 per Kg for overweight bags (and more for each extra bag).

And yet as you queue up you see people of all shapes and sizes and their weight differences make the luggage weights look insignificant. So why not charge passengers by their combined body and luggage weight rather than per seat?

This may seem rather odd, even discriminatory. But the heavier an aeroplane is the more fuel it uses. So the airlines costs are affected and in a market prices should be (partly) determined by costs.

The economics of this idea is known as price discrimination. Customers are charged different prices for the same product. Usually this is according to when they buy, or where they buy the product, but this is a quite reasonable extension of the idea.

Of course for overweight people this will be a new way of improving on the market failure caused by the 'lack of information' goods - high fat foods!

The ABC report the story here - please tell me if you can't see the video

2012-01-11T11:23:00.000-08:00

The UK experienced an unwelcome fall in exports in the latest figures reported by the ONS. The trade gap widened as a result.

Perhaps the more surprising thing is that exports had been rising at all. Europe, the UK's biggest trading partner, has been experiencing such problems it would not have been a shock if they had bought less.

The concern for Britain is that, in a time when the UK desperately needs growth, a rise in net exports is an important factor in increasing Aggregate Demand. These figures mean that net exports is effectively reducing AD and so will reduce growth not boost it.

On the bright side imports have risen slightly. While bad for net exports now this can indicate returning consumer confidence and possibly improving disposable income.

The Guardian reports the trade situation here

Immigration - good or bad?

2012-01-10T05:35:00.000-08:00

Some people are fond of telling us that the problems of Britain are down to the many immigrants that arrive here, for example The Daily Fascist (aka The Daily Mail and The Daily Express).

Recently 'Migration Watch' blamed youth unemployment on migrants. And the Migration Advisory Committee, the governments own advisers, have today claimed that for every 100 non-EU immigrants 23 jobs are lost to UK residents. But can such views be justified?

Increasing the labour force by migration raises the capacity of the economy (the PPF/Long Run AS curve shifts right). Skilled migration will also improve productivity. Of course if the migrants are not of working age these advantages are not gained.

The National Institute of Economic and Social Research (NIESR) have simultaneously declared that there is no harm to jobs from immigration. Personally I am with them on this issue. The need to expand the supply side of the economy is most important and good immigrants provide a skilled workforce far faster than the education and training system.

Politically this one will not go away while unemployment remains high.

The BBC report the Migration Advisory Committee here

The Independent reports the conflicting NIESR report here

Good news for Britain in US recovery

2012-01-09T13:44:00.000-08:00

The Republicans are sick 'as sick as parrots'. It's not due to the awful quality of their Presidential candidates but the recovery of the US economy.

Unemployment is at last coming down and the likely cause is Obama's last stimulus package - something that the Republicans opposed at every turn.

The good thing for Britain and the EU is that the falling US unemployment means that demand and output are picking up in the large US market. The recovery has been long delayed by the poor performance of both the US and EU economies and the strong growth in America will certainly boost British exports and so growth.

There are two points to consider here are:
* The world is far more interdependent than ever before. So the performance on one large trading area impacts on all the others to a greater extent than previously.
* The change in the US has been brought about by fiscal and monetary boosts. What are the lessons for Europe in this? Will the growth spurt last? What are the long term consequences for the US of more debt?

The Independent report the US figures here

Is it really worth it?

2012-01-07T06:22:00.000-08:00

There is a proposal to build a faster passenger link between London and Birmingham. It's called HS2 (HS1 was a more ambitious plan for the building of a high speed link to the North of England).

The link will cost £17bn and will take 49 minutes ofF the journey. This is exactly the type of capital project that Cost Benefit Analysis was designed to evaluate.

The problem is that the last major review of UK transport needs, the Eddington Report, said this was the dumbest idea ever and that a vastly more beneficial use of the money would be in removing the many bottlenecks in the transport system. Cost Benefit Analysis gives you a Benefit:Cost ratio (BCR), and Eddington said that such a high speed link would give a BCR of about 1.3, whereas smaller schemes, costing £100 to £1bn could provide BCR of 100+!

It would seem that there is a political will to build this new railway. Perhaps because it gives hope to many that such Keynesian work creation schemes solve unemployment (they don't by the way).

You might consider what the costs and benefits of the HS2 scheme are and how they can be evaluated. This is part of the A2 Transport module.

The BBC covers the story here

Regulating market failure

2011-12-21T17:19:00.000-08:00

Market failure occurs in many ways. One of the less well covered is the 'Tragedy of the commons'.

Nobody used to own the fish in the sea and so fishermen could catch them without paying for them. This led to chronic overfishing and so declining fish stocks. This is really a case of 'lack of information' and failing to take account of externalities. The fishermen maximise profits according to their private costs which do not include any cost of fish themselves.

The way to regulate this is not easy. With the Commons on land the answer was to enclose them and confer property rights on individuals. The farmers then consider the full costs of the land (well nearly, most ignore the effects of intensive farming on the environment) and farm it sensibly.

It was not possible to confer private property rights on the sea, but in the last forty years EU governments have established government control of the sea for 200 nautical miles offshore.

The solution taken by the EU to the problem of fish stocks is quotas. Each fishing boat is allowed to catch so much a year and can only fish for so many days each month. In this way fewer fish are taken and stocks should recover. Of course the fishermen earn less and some leave the industry. Others are compensated by the higher fish price as supply in the markets fall.

So that's easy then! Problem solved? Except fish stocks have not recovered. Every year they seem to decline, or at least not improve. Every year the fishermen complain they will never survive and need higher quotas (obviously stupid as fish will then run out and they all lose their livelihood). And each year each EU government tries to negotiate their fisherman's quota higher.

Overall this is an example of an attempt to correct market failure that has turned into a classic example of government failure. It does have some sense. Hayek would applaud it for using the rule of law to enforce a solution that attempts to be fair. Others would point out that the lower quotas raise fish prices and so use the market to reallocate resources more fairly.

However the obvious point is that after 40 years of fishing quotas the policy has not worked. This is because the quotas chosen were wrong (due to imperfect information, 'accidental' fishing AND cheating). The other obvious solution is to offer tradeable fishing permits to operators of vessels. Price the fish accordingly and the fishermen won't try to overfish. A tax is another possible solution, but much more expensive to administer (as each catch must be weighted and taxed, permits could apply to boat capacity per day).

The annual quota negotiation has just finished. The BBC cover the story below.

The BBC covers the story here

Crucial questions on policy

2011-11-28T14:42:00.000-08:00

Despite appearances to the contrary most economists do not spend their time on designing policy. They actually spend their time on the 'basic science' of economics. The answers they come up with allow others to design policy accurately.

In a recent FT article by Lord Skidelsky and Felix Martin suggest a 'Plan C' is needed for the UK economy.

Plan A was cut the deficit and by this remove prssure on the hard pressed 'wealth creating' sector.
Plan B was print money to reduce interest rates and encourage investment (Quantitative Easing).

The authors argue that Plan B would not work due to theoretical issues raised by Keynes. They then back this up with evidence from the experience of QE, principally pointing out that confidence is the main determinant of capital investment, not interest rates.

They present Friedman's argument that liquidity is a key element of preventing depression, but don't give it the credit it deserves. Perhaps because it is a short piece, or perhaps because they are both Keynesians and have been waiting thirty years for a chance to get their own back.

Whatever their motives their piece is an excellent survey and shows the requirement to understand how the relationships in the economy actually work before policy is designed. Sadly the theory often lags reality.

The FT article is here