Regulating market failure

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

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

Chinese have been reading the Development textbooks

One of the pieces of advice given to Less Developed Countries (LDC's) by the 'First World' in the 1960's was to invest in 'leading sectors'. This was based on the view that certain sectors have high second round effects and so a high multiplier value.

While this advice was largely ineffective, and in many cases disastrous, the idea of government intervention and 'unbalanced growth' to kick start under developed economies has remained in the literature. Clearly the Chinese have read about it as they now wish to invest in British infrastructure in order to help boost economic growth.

The Chinese are, of course, acting in their own best interests. They need Europe to grow so they can buy more Chinese goods. They also need somewhere to invest their considerable wealth. They have established 'sovereign wealth funds' to do this, a very sensible move as China cannot possibly use all the profits currently earned by their exports.

There are several ideas to explore here. Will there really be a big multiplier effect as a result of the proposed new investment? Is this the golden goose the Public Private Partnership programme has been looking for (it has totally failed to attract significant private funds for nearly ten years)? Are sovereign wealth funds a good idea? And of course how long has China considered the UK an LDC?

Whatever the answers it is clear that old copies of Todaro have a ready market in China.

The BBC cover the story here

Welcome to a future built in BRIC

Please read the attached article by Jim O'Neill. It is a follow up to his original paper 10 years ago about his prediction of the potential growth of the BRIC Economies (Brazil, Russia, India and China). He makes us question the role of the G7, with China now the second biggest economy in the world and Brazil set to surpass France and Britain to become the 5th largest economy. Also Russia and India are bigger than Canada. The world order is changing as he states that by 2020 the GDP of the 8 Growth Nations will equal that of the G7. Whilst the European crisis is important for the future of the United Kingdom it is important not to neglect other parts of the world as O'Neill argues this may be where the future lies.

The Telegraph Article Here

One million reasons to study harder

The figures released last week of record unemployment of over 2.6 million (8.3%) indicates the economy is stuttering along. Unemployment figures record the economic performance of the past and illustrate the impact of sluggish economic growth. However, the youth unemployment figures (over 1 million for the first time) is even more disturbing as it gives a window into the the productive capacity of the future. The NEETs (Not employed, educated or trained) lend themselves to a bleak future. Opportunities need to be created for the youth otherwise the economy will need to deal with and try to overcome the difficult problem of hard-core or long term unemployment. For you as a student you may be entering the workforce during a very tough economic climate. Education will become a vital bargaining chip in gaining employment.
The Telegraph Article Here

Growth, inflation and government budgets

The Bank of England have slashed their growth forecast and predicted a rapid fall in inflation over the next two years. At the same time the governments aim at reducing the government budget deficit now appears optimistic due to the slowdown in the Eurozone economies.

This latest news illustrates the relationship between economic variables.

Economic growth leads to upward pressure on prices as demand rises, while slow growth exerts little inflationary pressure. The slowing of the Eurozone economies has affected Britain because Europe is the main market for British exports. Lower export growth has led to a stalling of British growth as net exports are a component of Aggregate Demand. The general uncertainty of the whole crisis is making UK households save and pay off debt rather than spend so reducing Consumption, another component of AD.

The result is that the Government is not gaining as much revenue as they thought (through lower income tax, VAT and corporation tax receipts) and are spending more than they hoped (on unemployment benefits for example). The result is the government budget deficit is larger than predicted.

Of course this is exactly what should happen and is caused by the operation of automatic stabilisers. For the Bank of England there are new problems. Inflation is well above target but threatening to drop below over the next two years. It means that interest rates will not rise anytime soon and more Quantitative Easing is possible.

The Guardian lead article is here

Watch the latest Inflation Report presentation here

Free trade makes a comeback

The leaders of the Asia-Pacific region are meeting in Hawaii. Might sound insignificant but together the member nations account for over 40% of the worlds trade and population.

Unlike the EU trade agreements in the area are fairly rudementary. They consist of a series of bilateral agreements and a few small Free Trade Areas - FTA's (although NAFTA is an obvious exception). Now nine members of APEC are talking about extending the TPP - a small free trade association set up in 2006 - to include the USA and Japan among others.

Economists like free trade. They don't see trade as a 'zero-sum' game, where losers and winners cancel each other out. Rather everyone gains from trade, the buyer and the seller both think they are better off as a result of an exchange, otherwise they wouldn't do it. And so it follows that the more trades that take place the more people that are better off.

At the most fundamental level trade allows specialisation and exchange. As everyone already knows that is the basis on which the economy of the world has been able to improve the standard of living of everyone since before the industrial revolution.

But free trade meets significant opposition. In the recession there were fears that 'economic nationalism' would lead to a new round of protectionism in the misguided belief that it would help keep jobs in countries experiencing difficulties. Despite the lessons of history some countries continue to have strong protectionist lobbies that value short-term protection over long-term prosperity and a political system that rewards such views (such as Australia).

The move to a nine-member Pacific FTA is therefore to be welcomed. In theory FTA's are the lowest rung on a ladder towards full economic integration. The next rung up is a customs union and then a common market and above that the EU style 'monetary union'. The aim is to increase the well being of all members by allowing more trade and so more specialistion. FTA's tend to be about trade in goods only, but represent a significant advance and the new TPP will include some non-goods trade provisions.

The NDTV article explains some of the advantages here.

 The Wikipedia page on Free Trade Areas is here

Another chapter in the Euro crisis?

I am not sure if this is a new chapter or just another plot twist, the Euro saga has continued for so long its critical importance is sometimes forgotten.

The crisis deepens as Italy is now on the brink. Italy isn't like Greece or Ireland, it is a big economy with their government owing 120% of GDP to creditors. Italy is the third biggest economy in the Euro zone and even the enhanced €1 trillion bailout fund is nowhere near enough to save it if default comes.

Italy has no credible plan to resolve the problem and the market knows it. The market is demanding higher and higher interest rates (6.69% is the latest) to fund their overspending and the likelihood is that that rate will rise as Italy must borrow over €300bn next year.

There is a solution. Let the European Central Bank (ECB) lend the money to Italy. The ECB could buy Italian Government bonds and can theoretically supply all of Italy's needs. The Germans, at least, completely oppose this move.

If the ECB buys Italian debt they will do so with money they simply create. As with Quantitative Easing this raises the supply of Euro's in circulation (its printing money). The Germans always have in their minds the hyperinflation of the 1920's caused by printing money and the post-war Deutchmark which was managed so well that inflation was only an issue after the costs of unification with East Germany. They don't want the ECB to start a potentially inflationary process.

Most people disagree with the Germans. They see the need to save the Euro as far greater than the risk of inflation. They also point out that the Germans can only be right when the rate of rise in the money supply is faster than the rate of rise in real output. So far in this period of instability monetary growth has been sluggish and over the period 2009 - 10 the money supply would have fallen but for central bank action. The graphic at the top is a little small but shows M1 and M3 growth in the EU.

It is clear that if the ECB does not act and the Italian government does not change then the danger of a collapse in the Euro is imminent.

The Guardian has details here

The really difficult aspect of unemployment

People become unemployed for a number of reasons. Their industry declines, their firm is competed out of the market, or labour saving technology reducing the need for workers are all possible causes. A general fall in demand, such as in a recession, means all firms require fewer workers. The result is cyclical or structural unemployment.

Cyclical unemployment is short lived, structural unemployment is less easy to deal with and older workers in particular may find themselves out of work for prolonged periods. But there is one group who don't have to lose their jobs to become unemployed; the new entrants to the work force.

Youth unemployment is very difficult to solve and, because each year of high unemployment adds another cohort of new job seekers to the stock of those who have never worked, gets worse and worse. As one commentator notes in the linked article:

"For a young person, being out of education, employment or training can have major ramifications, including long-term reductions in wages and increased chances of unemployment later in life, as well as social or psychological problems arising as a result of sustained unemployment." 

Once a recession is over employers have the choice of new jobseekers or those who have been unemployed for some time. Fearing that those who have had long periods of enforced idleness may have been 'unemployed for a reason', or will have lost the work ethic,  firms will usually opt to employ more recent school leavers and graduates. This leaves the economy with a large group of long term unemployed who are 'detached from the workforce'.

Only supply-side policies, such as increased training provision, can deal with this problem but it does so very slowly. To make matters worse the problem is concentrated in some areas, because a higher proportion of new jobseekers failed to find work in those places in successive years.

The BBC report highlights this problem and identifies the worst affected areas. For you the lesson is that you must achieve the highest possible qualifications from the best universities in order prove to employers you are the person to hire.

The BBC report is here

On the bright side for Africa

So much bad news makes many recall Carlyle's view of economics as 'the dismal science'. But there is some good news out there.

Africa has really had the worst deal in the second half of the last century. Real incomes actually fell in some parts of Africa from the 1980's to the early 2000's. But now Africa is growing and there are several reasons for hope.

China's demand for raw materials has pushed up the price of commodities, improving Africa's terms of trade considerably. This has already raised the real incomes of countries which export these minerals, rising living standards. Africa has large reserves of these commodities and is benefiting from international investment to expand capacity, especially from China, which sees the chance of both influence and cheaper supplies.

Now there is news of an ambitious plan to expand the production of renewable energy from North Africa. The energy produced will be used locally and exported to Europe. Northern Europe isn't a great place to produce solar power efficiently, but North Africa is.

One problem that particularly holds Africa back is the lack of domestic saving due to the very low real incomes of the population. Saving is needed to provide the investment funds required for growth. With the funds coming from Europe, a process known as Foreign Direct Investment (FDI), Africa can grow more quickly.

The benefit to Africa comes in two ways. 

1. They get a better energy infrastructure which will allow them to build other industries and provide power to their own population raising the standard of living. 

2. There will also be the multiplier effects on local economies as the investment in the infrastructure takes place. Local incomes will rise improving employment and so reducing poverty. 

For Europe this also helps to reduce the use of damaging fossil fuels in energy production and so aids the efforts to mitigate climate change.

The Guardian covers the project here.

Growth improves, but one swallow does not make a summer

The UK economy grew 0.5% in the third quarter (July to September) which was a welcome relief after the second quarter growth of just 0.1%.

While 0.5% may not seem like a lot it is actually a huge improvement and a welcome sign in an economy that needs growth badly. Unfortunately part of the improvement is a 'rebound' from the poor second quarter - a 'catch - up' rather than a clear upward trend.

The figures hide differences between sectors. Services and finances showed their strongest growth since 2007, but manufacturing continues to struggle.

There is talk of recession. Let's be clear on what that means - falling GDP, not slower growth. A rule of thumb is that a recession is two consecutive quarters of falling GDP. This remains a possibility, especially if the Euro collapses.

It may be useful to talk about the stages of a recession and policy responses. This can be illustrated in the excellent BBC graphic on the linked article showing the path of previous recessions.

Stage 1 - Falling GDP. Here there is falling output and the immediate policy response to slow the fall in GDP. At this stage fiscal and monetary policy are set to expansionary settings and the challenge is to stop the recession being as deep as it otherwise would be.

Stage 2 - Levelling out. Here the crisis is not over but the economy has stopped shrinking. Fiscal and monetary policy continue to try to boost Aggregate Demand to help use up spare capacity. Unemployment will continue to rise, probably faster than in Stage 1 as firms let worker go and adjust to the new level of demand. Workers entering the workforce find it difficult to find jobs as firms are not hiring.

Stage 3 - Recovery. In this stage the economy begins to grow. Unemployment remains a problem, continuing to rise, especially among young workers. They have no experience and are expensive to employ. Firms are cautious and confidence is low among consumers as well.

This is the most challenging phase in terms of policy. The challenge in this phase is coping with unemployment and preventing a large group of long-term unemployed. Expanding AD may not work and supply side measures, that will target the structural and youth unemployment, take a long time to work. Productivity increases alone may mean few extra workers are needed for the modest rises in GDP.

Stage 4 - Return to growth. This stage is elusive. Productive capacity begins to increase as well as demand. It is not clear when normality will return and as the BBC graphic shows it is taking longer to get there than in previous recessions. This is mainly due to the greater extent of the recession and the fact it originated in the financial and not the goods market which makes fiscal stimulus largely ineffective in stages 2 and 3.

None of these stages has a fixed time-frame of course, adding to uncertainty.

Apologies for a long post, this has been on my mind for a while!

The BBC article is here

The bailout explained

The European bailout plan is complicated. This movie was created by Tom Meltzer of The Guardian to explain the situation.

A video is here

Saving the Euro or just delaying the inevitable?

I can't do justice to this subject in a post. The Euro crisis has so many issues and aspects. But the agreement reached yesterday is certainly important and adds to the story in a way that does sum it up to an extent.

The Euro area countries have agreed to

* Cut by half the amount Greece owes the banks (reducing their total debt and so not only the amount they will repay but also the annual interest).
* Recapitalise the banks so they are better able to withstand further shocks (say a default by Italy or Spain)
* Increase to €1 trillion the bailout fund available in case of potential default.

The markets love it and have soared, but should we be so sure?

The French President stated that 'Greece should have never been allowed to join the Euro' because they were not ready and falsified the figures. Well he is probably right and the fact that the Euro area is not an 'optimal currency area' has not gone away. Maybe this isn't the time to say France 'managed' the figures too to meet the joining criteria, but it is certainly true that Belgium and Portugal should not have the same currency.

The 'partial default' that the 50% cut in Greek debt represents is a managed way to prevent a full default. That would cause panic and probably the break up of the Euro area. That would be disastrous for trade - what does anyone do between the Euro and the 'new' currencies that would replace it? Months of lost trade, shutdowns and unemployment would be inevitable and that would affect the UK too, with 60% of visible trade done with the EU.

As one commentator said. 'What the Eurozone needs is growth'. This will solve many problems. The debt to GDP ratio will fall, and governments will have more revenue and lower expenditures, allowing them to service their debts. Growth will also allow confidence to return and the growth will become self-sustaining.

But the recapitalisation of the banks will slow growth. For banks to have more capital they have to keep more of their assets, and that means lower lending. Lower lending leads to a credit squeeze and firms can't get the capital they want. Interest rates will probably rise as firms demand more loans and the price rationing process kicks in.

Perhaps the most worrying aspect is that €1 trillion is nowhere near enough to bail out Italy let alone Spain and Italy together. The Euros inherent weaknesses remain and in all probability this is just a temporary lull in the crisis.

The BBC covers the issue here

Discrimination is not always conscious

The difference between the pay and job opportunities for different groups in society is not easy to explain. Despite legislation dating back to 1970 and numerous Act's since men are still payed more than women, whites more than black and those from the middle class get more than those from working class. The difference in unemployment rates are similar.

One way to overcome this is to allow free access to higher education and select those who can access this opportunity on the basis of academic ability and not the ability to pay. Then at least everyone has the chance to present qualifications to potential employers that makes their worth clear, regardless of race, gender or background.

The first indications of university applications this year, with the new higher fees, show a substantial drop. This is probably inevitable (straightforward law of demand), but has wider issues.

The drop in applications from women is roughly double that of men. This may reflect the, very old fashioned view, that education benefits women less than men as women will become 'homemakers' and so it is not worth spending as much on them. While this seems strange to us it was the received view up to the 1960's.

But the damage that will be done to Britain's long term productive capacity and competitive position, by a less well educated workforce, is the most worrying aspect of this data. In a knowledge based economy, as Britain's future economy must be, this move is akin to cutting off an arm in an attempt to lose weight. Effective in reducing short-term expenditure, but plain stupid as a strategy.

The problem of education is that it is an imperfect information good, people don't understand how good education is for them and how much their education benefits society as a whole. Education is a merit good therefore, the market will never provide the socially optimal amount and it needs to be encouraged by the government.

Notice in The Independent report below that overseas applications are up. Britain is a relatively cheap place to study in international terms and this has been enhanced by the fall in the value of the pound over the last two or three years.

The Independent story is here

Accuracy of inflation measures

Firstly I should declare an interest. This story affects my well-being in retirement and I'm not very happy about the pension changes currently proposed by the Government.

But the economics of this story, whether CPI or RPI should be used to annually adjust public sector pensions, is a relevant economic issue.

All price index's are compromises. They are based on the cost of a 'typical' basket of goods, discovered by a survey of consumer spending. However there are no 'typical consumers' the basket of goods is just an average. For some households the cost of living rises faster, for others slower.

The CPI was introduced when there were thoughts Britain might join the Euro (although it was never a serious option) and became the UK's 'official' measure of inflation. The CPI is more comparable with other EU countries measurement of inflation, but the British spend their money on slightly different things. So to construct the CPI the basket of goods had to be adjusted, reducing the impact of housing costs and including other items that did not actually affect UK residents.

The CPI is statistically more elegant. It reduces the effects of rouge price changes and deals with complex goods, such as the price of 'white bread' with its many varieties and easy substitution in a way that makes the RPI look clumsy, if not crude. But CPI will usually give a lower inflation rate than RPI (initially estimated at 0.5% it has actually been 0.75% since 2003).

The result of indexing pensions by CPI and not RPI will then lead to a 0.75% smaller rise in pensions each year and will save the Treasury £40bn in this parliament alone.

Actually neither CPI or RPI are the right measure to adjust pensions. A Pensioner Price Index should be used based on the typical basket of goods a pensioner household buys. For example fewer pensioners have mortgages and so both CPI and RPI overstate the effects of the housing market and mortgage rates on them. A Pensioner Index (PePI) is child's play to construct and indeed one already exists!

Of course the PePI may actually give smaller rises to pensioners!

The Guardian cover the story here

Tax boob?

VAT is to be applied to cosmetic surgery. The odd thing is that it wasn't before.

VAT is an indirect tax that, by its nature, is regressive (it takes a higher proportion of the income of poor households compared to the rich). The UK has always sought to mitigate the regressive nature of VAT by excluding things such as food, children's clothing, books and newspapers and taxing energy at a lower rate.

So not taxing cosmetic surgery undertaken for reasons of vanity only, that must be the preserve of the rich, seems odd. To my mind this is simply a fair application of the tax.

The problem of indirect taxes, such as VAT,  is that they change relative prices. The price mechanism is the means by which resources are allocated in the market. So when the relative price rises less resources are allocated to that product. Not taxing cosmetic surgery makes it relatively less expensive than goods that do attract VAT, so more resources are devoted to cosmetic surgery than would be in a free market.

Governments can get these things wrong by applying indirect taxes poorly and causing an inefficient allocation of resources. But using indirect taxes to reduce tobacco, alcohol and carbon consumption correct market failures. The important thing is to treat all goods appropriately and try to avoid making the distribution of real income worse. So I think this move should be applauded, although somebody should be asked why it has taken forty years to remove this anomaly.

The Guardian cover the story here

The protection of agriculture in the EU at what cost?

As an Australian who has seen our farmers locked out of the European markets through the Common Agricultural Policy it is difficult to understand why Europe continues with protection of this industry. The latest reform includes handing out €435bn of taxpayers' money over the next 10 years. This is during a time when many other Europeans can not find work. The CAP is the EU's single largest expense, making up nearly half of the EU budget (38.5% now, but down from 72% in 1985).

Whilst the protection for farmers is what the EU desires, it neglects the impact this will have on every other industry.


The Guardian Report

Who is unemployed?

The rise in unemployment to a 17 year high is very bad news for the UK economy. The cause of the unemployment is a combination of factors:

1. Cuts in public sector jobs
2. Slow private sector growth
3. Rising productivity

I am not going to get into the argument about how to solve this situation again. I am interested in two points that arise from The Guardian article linked below.

The economy is growing at 'about half the rate needed' to keep the unemployment rate stable according to one commentator. So the economy is growing, but unemployment is rising. How is that possible? The answer is that each year labour productivity improves, and so to produce the same amount of goods and services each year less workers are needed. A rule of thumb is that 1% Real GDP growth offsets productivity gains to maintain the level of employment.

Therefore the UK is not growing nearly fast enough to keep unemployment stable.

The other point is how we measure unemployment. The economic definition for being unemployed is that the worker is " Willing and able to work at the current wage rate, but cannot find a job". To meet this criteria someone who is unemployed must be able to start full time work in a suitable job at the wages offered in the market.

When someone wants to work but thinks the wage on offer is too low they are voluntarily unemployed (i.e. they fail the 'willing' part of the test). The way the Labour Force Survey measures unemployment means that it can count some people as unemployed when they actually are not willing to work. At this point I should point out that the LFS is more accurate than the Claimant Count which clearly understates unemployment.

The issue raised in the article is that over a quarter of a million of the youth unemployed are in full time education. The Minister thinks they are not properly unemployed as they fail the 'able to work' criteria. This is an issue that arises in every period of high unemployment. Education is often referred to as the 'employer of last resort', if you can't find a job keep busy on a course.

Here the difference between the official statistics and what economists mean by unemployment is highlighted and is useful material for examples when asked about the limitations and advantages of the measures of unemployment. This question comes up in about 50% of F582 papers.

The Guardian article is here

Don't forget the BBC website that provides interactive data in the useful links box on the bottom right

Barriers to entry and excess profits

A key difference between different market structures in the existence or not of barriers to entry. If a market has high barriers to entry then we expect to see only a few firms, each able to protect its market share and so charge higher prices. These higher prices mean lower sales but higher (excess) profits for the firms.

Where few, or no, barriers to entry exist new firms can enter a market and compete for a share of the profits earned by others. This leads to an increase in supply and a falling price. Consumers gain but excess profits are competed away.

The telecom companies used to be able to earn a lot of money from text messages (SMS), but this market is changing. There are no barriers to entry for free apps that allow free text or even calls. So the days when O2 or Orange can charge high fees for texts is going and so are their profits.

This, slightly odd, piece from The Age in Australia explains how this market is changing. Not news at all to you I'm sure, but an excellent example of how things you took for granted have an economic explanation.

The Age article is here

An expected Nobel Prize

Professors Tom Sargent and Chris Sims are the 2011 winners of the Nobel Prize for Economics. I was expecting it for years.

The important work for which they have received the prize is their contribution to modelling expectations. Prior to their work economists used a method known as 'adaptive expectations' to predict how households and firms would react to policy changes. This meant the computer models of the time used an equation that implied expectations moved slowly after a change in policy or events. Without being too technical this meant that policy changes could have big effects on behavior even though the policy was very predictable and mechanistic.

Sargent and Sims showed that expectations changed faster than previously thought and that by manipulating the expectations of firms and households policy, say to reduce inflation, would be much more effective. Many of you will have already looked at the importance of inflation expectations in the inflation process.

Today their work is very important in deciding macroeconomic policy, particularly in designing monetary policy. Take for example the debate on the pace of deficit reduction. Confidence is crucial in consumption and investment and based on their work it could be argued that more public spending and higher budget deficits will actually cause a worsening of confidence due to the effect it has on the expectations of households and firms.

The Nobel website has a Popular Information section, look at the 'Information for the Public' link and that allows you to download an excellent, non-technical,  summary of their work. (Pretty important for anyone considering Oxbridge/LSE/Warwick/Southampton/UCL economics.)

Nobel site link here

The Guardian coverage here

Meddling in markets

For some reason governments can't help interfering in agricultural markets. And most of the time they make things worse, an example of government failure.

Thailand are the latest government to distort a food market. They are offering a premium of about 50% to rice farmers to buy up rice in unlimited amounts. The claimed motive for this policy is to raise the income of farmers who are amongst the lowest paid in the country.

But such policies, however well intentioned, distort the market. This effectively raises the price in the local market, (see the diagram above) but will inevitably lead a situation of excess supply in Thailand and a distortion of the international market.

As a major rice exporter changes to the local market will inevitably lead to changes in the international price. Why would a Thai farmer sell on the open market when the government will pay more? So the supply of Thai rice to the international market will fall, forcing up the world price and causing problems for the poor of other nations.

There is also the question of what to do with the rice the government buys. Some schemes stockpile food in years of surplus to release in lean years. Doing so helps moderate price fluctuations and smooth out farm incomes. However the Thai floods mean production is actually down this year so its not the time to start buying up stocks.

The EU pursued a disastrous agricultural policy from the 1950's to the mid 2000's where they paid farmers far to high a price for food. This caused an inefficient over production in Europe and reduced the incomes of farmers in LDC's where the market would produce the food most cheaply and efficiently. The solution for the EU was to move to direct income payments, simply giving money to the farmers and so avoiding the incentive to them to produce ever more unwanted food.

Businessweek report the Thai policy here

Costs and benefits of a Heathrow-Gatwick rail link

There is a proposal to link Heathrow and Gatwick airports by a high-speed rail link. This suggestion will require a thorough cost-benefit analysis (CBA).

The idea is to help improve airport capacity and avoid building new runways or new airports to achieve that. While I am not really clear how much capacity it could add the costs and benefits are worth investigating.

A CBA identifies all the costs and benefits of a project, both private and external, gives them a monetary value and then decides if the investment is worth the cost. Perhaps the strongest advantage of CBA is that it allows comparison of projects. So in this case the Heathrow-Gatwick rail link can be compared to expanding Gatwick, or Heathrow or building a new airport somewhere.

For those doing transport economics this year it represents an excellent opportunity to apply CBA. Also it is not too late for this to be included in the June Transport paper, and is a certainty for 2013 otherwise.

The Telegraph reports the scheme here

Petrol consumption falls 15%

The AA has reported that petroll consumption was 15% lower in the period January to June this year. The AA say this is due to rising fuel prices.

AA President Edmund King said: "There is no downplaying the impact of record fuel prices on family's and other people's lives. A 1.7bn litre drop in petrol sales says just one thing - too many car owners cannot afford these record prices."

On an annual basis prices have risen about 20% for the period in question. So does this mean that the rise in price by 20% has led to a 15% fall in quantity? That would imply a price elasticity of demand (PED) of -1.3.

In this case simple PED cannot be applied. While quantity demanded has fallen 15% this is not just due to the rising fuel prices. Ceteris paribus does not apply because at least two vital factors have also changed:

1. Real  disposable income has fallen in the period due to high inflation, rising taxes and falling actual incomes due to higher unemployment.

2. Consumer confidence has fallen leading to a change in tastes and preferences.

Both of these changes mean the demand curve for fuel has shifted to the left meaning that less is demanded at all prices.

So the change in the amount of fuel consumed is a good example of how in the real world more than one factor can change at once. However we can understand the change as a combination of a move 'up' the demand curve as price rises and a movement of the demand curve to the left as some conditions of demand change.

The BBC report the AA findings here

Monetary boost to avoid inflation being too low

The Bank of England Monetary Policy Committee kept interest rates on hold today. No surprise there, nor in the announcement that that there would be more quantitative easing (QE).

The aim of the MPC is to keep inflation at 2% on the CPI measure. But they can't work in the short term, inflation is a complicated process and monetary policy takes up to two years to take effect, so the MPC must aim to keep inflation on target in two years time.

At the moment inflation is well above target and will go up rather than down in the next few months. So why not try to contain inflation? Well the horse is several fields away on that one and so the MPC look past he current inflation figures as they cannot affect them. They see the VAT rise dropping out of the index in January, weak economic growth around the world reducing export growth and domestic inflationary pressures being contained. They believe that without action inflation will drop below 2% in the final quarter of 2013.

So the MPC will boost the liquidity of the financial sector by pumping £75bn of new money into the economy. This will stimulate lending and demand and hopefully assist growth in aggregate demand.

The BBC have helpfully restored their Q&A on Quantitative Easing, explaining how it works, why it is used and why its not going to cause runaway inflation such as the German and Zimbabwe hyper-inflations. The BBC Q&A will answer the questions of Deps on what this measure means, but everyone should read the reports of this move carefully.

The BBC Q&A on QE is here

UK economic growth cut to 0.1% for April to June

These figures released yesterday have led to the usual argument over potential policies. These are the usual demand management options. The calls are coming for the government to increase spending and for the Bank of England to adopt QE. It is important to remember the source for the financial downturn which is greatly influenced by the poor economic performance in Europe.

Guardian Article Here

Is 15p enough (a tough balancing act)?

The National Minimum Wage (NMW) has risen by 15 pence per hour to give a pay rise for Britain's lowest paid workers.

With RPI inflation running at 5.2 per cent (CPI at 4.5%) the real income of these workers will fall. Inflation is high due to this year's VAT increase, increasing fuel prices and any number of other significant price pressures.  This years increase in the NMW won't allow Britain's lowest paid workers to maintain their standard of living.

However, before rushing to any judgement on this apparently about the small increase, consider that the Low Pay Commission (LPC) (which oversees increases in the minimum wage) had a truly tricky job on its hands. Given the poor GDP growth forecasts and rising unemployment, they couldn't risk making a tough labour market worse.

Therefore the key conflicting issues the LPC need to consider are:
What increase do we require to maintain the lowest income earners' standard of living?
and
What level would an increase in pay cost jobs in this economic climate?

Retailers take the view the NMW will cost jobs here

When is a single market not a single market?

Barriers to entry in a market allow firms some monopoly power and that gives them the chance to raise prices. produce at lower quality and earn excess profits. This is not good for the consumer and most countries attempt to prevent it through Competition Law. As the European Union is a 'single market' that means Competition Law is a European and not a national matter unless a firm operates only in one country.

The '1993' rules of the EU make it clear there can be no barriers to firms, workers or capital between member nations. All firms are free to operate in any other member state and all citizens of the EU can work where they like within the EU.

To illustrate this before 1993 a computer manufacturer had to produce 11 different models of the same computer to meet local regulations and a British lawyer could not appear in a court in Germany or Italy. The 1993 regulations said that such barriers were illegal.

However in many countries not all of these regulations were adopted. The Spanish banks continue to charge non-Spanish customers a higher interest rate, insurance companies are denied access to the Irish market and domestic broadcasters deny the right of foreign broadcasters to sell their services in the UK.

Yesterday the European Court ruled that the Premier League had no right to deny broadcasters other than Sky and ESPN to sell access to their broadcasts of football matches. To do so breached the 1993 EU regulations and EU competition law.

This is an example of the law removing a barrier to entry in the market. The result will be that more firms will enter the British market, competition will increase and everyone will have cheaper access to broadcasts. (Although the ruling is complicated and will take some time to work through.)

The actual case involves showing Premier League football in a Portsmouth pub. Of course Sky and the Premier League will protest, it will affect their profits, but the winner is the consumer. Just 38 years after Britain joined the European Union it is about to get one of the benefits it was promised!

 The BBC covers the story here

Dealing with a different sort of recession

Political debate usually generates more heat than light. That is one of the basic rules of life and the political debate over policy to deal with the recession illustrates this well. So we have to try and look through the politics of the latest announcement.

The last recession was caused by a collapse in financial markets which, by various means, led to a collapse in Aggregate Demand. A prudent response by most governments was to pursue an expansionary fiscal and monetary policy. This was to deal with the immediate effects of the crisis.

The debate now rages on how to continue to cope with the crisis, especially now that a 'double-dip' recession seems a possibility. Sadly at least one group in this debate have missed the point.

The Keynesians have, as usual, crawled out from under their stones and claimed they have the answer. 'Boost Aggregate Demand by the government spending more money', which they borrow. But Keynes was talking about a recession caused by a failure in the goods market in the General Theory, not one caused in the financial markets. (Read the General Theory if you like, it's pretty obvious. There is a copy at the back of Mr Lewis's room and online).

The time for old fashioned demand management has passed. It is necessary to deal with the financial market problems, such as the European Debt Crisis and Bank re-capitalisation. But this has led to a drying up of funds available for lending to businesses and this is preventing a timely recovery in the private sector.

Despite encouragement banks find they cannot both re-capitalise their balance sheets (so they can survive a second GFC or major default by Euro area countries) and lend to small and medium size businesses. This prevents those businesses expanding and reducing the unemployment problem.

Small and medium size businesses basically have two sources of capital, loans and retained profit. Unlike in the USA (where such bonds are a major source of funding) they cannot easily issue 'corporate bonds' as there is no established market for them.

So now the Chancellor is proposing to help develop this additional source of funding by offering to buy bonds issued by smaller firms. It is an unusual, and potentially far sighted, move to help recovery. It is, however, fraught with difficulties.

As the market for small firm bonds is currently tiny it is likely the costs of operating in this market will be high. It will also take time to establish and the firms that can benefit will find it is some time before they are ready to issue bonds. However they now have a guaranteed buyer in the government and so they can raise money with certainty and, presumably, at a lower cost than any alternative. The government hopes it will allow the development of a small/medium firm bond market that will persist in the future.

The measure is being called a credit easing plan. It directly addresses an issue caused by a financial market induced recession and so should be applauded. I would call it a 'supply side' measure as it is trying to help a market work, is specifically targeted at an issue, will allow the expansion of productive capacity and will take a long time to work.

Time will tell how effective it is.

The Guardian reports the measure here

Fat tax for Denmark - where next?

Denmark has just introduced a 'Fat Tax'. The aim is to raise the price of foods with a high saturated fat content.

The problem for markets is that they don't work properly when one side of the market does not have, or ignores, full information. A classic case is tobacco. Despite the known dangers of smoking people continue to smoke, imposing costs on themselves and others (negative externalities).

As with somoking a high fat diet imposes long term health problems on those who eat the food and costs on the rest of society as the cost of treating those health problems falls on the rest of the population through the NHS.

Traditional policies to tackle these 'lack of information' or 'demerit goods' include education, labeling of the products and, usually, tax. By raising the price of tobacco fewer people buy it. That's the law of demand. (Education and labeling shift the demand curve to the left, so the policies are complementary.)

Denmark has now taken the first step in introducing a tax on high fat goods. Any product with more than 2.5% saturated fat attracts the tax. How effective it will be remains to be seen. When tobacco was taxed at first demand was very inelastic (did not respond to the change in price very much) as people were addicted to smoking. Maybe there are more substitutes for high fat foods than there are to tobacco and so this will see a bigger response?

The Guardian reports the Danish tax here

Retirement age abolished

Supply side policies are far more important than managing aggregate demand when it comes to sustaining economic growth and achieving long term prosperity. Hence the focus of policy in the early 1980's (under the benign leadership of the Blessed Margaret) moved to improve the capacity of the UK economy. Despite the recent emphasis on maintaining aggregate demand that is just a short-term 'make-do and mend'.

The aging population means that there are two pressing factors to be dealt with. One is to ensure that the workforce is big enough to support a growing dependent (old) population. The second is how to pay the benefits and pensions the old will require without running an ever larger budget deficit.

One solution is to let everyone work longer. They get benefits later and pay more tax while they continue to work. The effect is that the Aggregate Supply curve (technically the Long-run AS curve) shifts to the right. It has positive effects on growth, employment and inflation.

The BBC explains that some firms may offer 'golden goodbyes' to get rid of staff they can't make retire. Personally I am open to offers now.

You may not have noticed but the National Minimum Wage also rose today. This is also a supply side policy, although unusually one that restricts markets rather than freeing them up. The NMW rose to £6.08 an hour for those over 21, that's 15p an hour more than before. For 16 and 17 year olds the rate is now £3.68 an hour.

The effect of a minimum wage depends on if the market would have set a lower or higher wage than the government minimum.  It can reduce employment if set too high, but can reduce poverty when firms would have set a lower wage, but can afford a higher one.

The BBC cover the retirement age abolition here

Keeping up with the Euro crisis

Keeping up with the saga of the Euro area crisis is becoming as confusing as watching every third episode of a spy series with a revolving cast.

Today the Germans voted to put extra funds into the 'bail out' fund for defaulting Euro members. Most people think this is nowhere near enough.

The Commission have proposed a tax on all financial transactions to create a 50 billion Euro fund to help pay for the bailout. But the British will never agree to this as it means the UK will be paying to prop up a currency they never joined.

The Euro was never an 'optimal currency area' and as the late Professor Pearce said 'It will never work'. Despite the best, if reluctant, efforts the Euro will probably not survive.

The BBC understand your angst at this long and drawn out affair and have produced a Q&A on the latest IMF/G20/EU proposal. This includes proposals to let Greece partially default which is seen as inevitable now.

The BBC Q&A is here

Operation Twist - Probably misinterpreted

I know this post is challenging and is aimed at A2 students only. However it is a very important recent development in monetary policy.

The Federal Reserve has undertaken a restructuring of the debt it holds in an attempt to lower long term interest rates. This has become known as 'Operation Twist', but this is mainly because people want more.

The Fed has tried to lower long term interest rates by causing an excess of demand in the market for long term government debt. This is done by withdrawing from the market long term debt by buying it themselves. Such government debt is an important part of many investment funds portfolios, for example pension funds.

As a result there is less long dated government debt on the market and so the price of the remaining debt is bid up. A government bond pays the holder a fixed amount each year, say $2 for each $100 of the face value of the bond.

As the price of the government debt rises then the annual payment made by the government to the holder of a bond is a lower percentage of the market price. This means long term interest rates are lower. For example a $100 bond pays $2 a year. The market price of the bond is forced up t0 $200 and so the $2 paid now represents a rate of interest of just 1%.

So the Fed have tried to buy up long term bonds, taking them off the market, and replacing them with short term bonds. This will hopefully reduce the rates on all long term loans and so stimulate, for example, mortgage borrowing. This would encourage a recovery in the housing market which remains crucial in the USA.

The markets have taken this as a sign of panic. This has not helped confidence, hence the plunge in the stock markets. The markets also wanted more Quantitative Easing as they feel the economy needs a bigger boost.

I am far less clear on the Fed's motives. There was a time when central banks structured the debt in a way that was consistent with the interest rate set. Having more short term bonds on the market certainly increases the liquidity of the market and most commentators seemed to have missed this.

This is an unusual move by the Fed. It has been, at best, badly received and at worst seen as a sign that the policy options have run out. Most economists also doubt that the move will actually be effective.

The Guardian explains 'Operation Twist' here

Dr Death suggests Greece default on its' debts

Dr Roubini (Dr Death) is renowned as one of the world's most pessimist Economists and has been credited with predicting the Global Financial Crisis in 2008. He has suggested that Greece default on their debt and leave the Euro.

His justification for this is because of advantage of floating exchange rates. He states that if Greece leaves the Euro and returns to the Drachma then they would be in a stronger position to recover. This is because a return to the Drachma would lead to a dramatic depreciation of the currency. This depreciation would improve competitiveness and growth.

A depreciation of a currency will make exports cheaper and imports more expensive therefore improving conditions for local producers. He also examines the success of Argentina and Iceland after they defaulted in 2001 and 2008 respectively to successfully recover.

His article is here

Markets need information to work properly

We know that free markets allocate scarce resources efficiently. But the key point here is that they are 'free' with full information on both sides of the exchange.

Lots of things can make markets fail to work properly. Two are monopoly power and a lack of information on one side (asymmetric information). Governments work to try to avoid such issues and the Competition Commission and the Office of Fair Trading (OFT) exist to protect consumers.

The OFT is going to investigate the charges made to holidaymakers to convert pounds into foreign currency. The problems of lack of information and monopoly power exist here. People don't really understand the service they are paying or the costs involved. Also financial institutions are able to lock in their own customers to their services and also exploit the lack of information because of a lack of competition between banks.

The BBC explain the issue and a 'Super complaint' by 'Consumer Focus' to the OFT in the article below.

For Deps consider the information a market needs to work well and reduce the issue of scarcity through specialization and exchange. Grecians should consider this from the point of view of market failure that is involved in F581 and the issue of market failure that will arise in Transport Economics.

The BBC article is here

The problem of argricultural markets

I have never met a poor farmer, but I have never met one that didn't complain either. But they do have their cross to bear.

The problem of agricultural markets is that natural events cause good and bad years with no predictability and so farmers incomes are literally all over the place. Ironically the 'good years' for crop yields are the bad years for income.

Deps won't know the term 'inelastic' yet, but it means that demand does not vary much with price. In rich economies everyone has enough income to eat and when food prices fall they don't each much more. Equally when food prices rise people have to buy food and so demand does not go down much either. So demand for food is 'inelastic'.

The result is that when there is a bumper crop farmers have to accept very much lower prices as supply expands. The quantity consumed goes up by less than the price falls and as a result consumers expenditure (farmers incomes) is less. In the diagram above the expenditure at price P2 and quantity Q2 is more than P1 Q1.

This is the situation Australian orange growers find themselves in. The rain and the sun arrived at exactly the right times, and so everyone has a good crop. There is no point letting the oranges rot on the tree and so all the farmers sell, raising supply in the market and lowering the price. The result, in this case, is a price lower than the costs of production.

This is one reason why so many countries intervene in agricultural markets. (Note this comes up in IB all the time.)

I suspect that the fools in IT continue to block the pictures, but I can't find a link to a picture that will show what I need you to see. So use your phone or ask Mr. Camburn to use his computer.

The Age explains the plight of the orange farmers here

EuroZone

The inability of Greece to meet the required targets and the rising expectation that Greece will default has brought about a huge amount of speculation of what will happen next. The Daily Mail expects the "EU to be torn apart", the Telegraph views it as an opportunity to start again and design an EU that Britain would like to join and the Guardian warns Great Britain that this is going to hurt.

The last prediction is why these developments are so important. This is because over half of Great Britain's trade is with to Europe. Economically the relationship between the EuroZone and the United Kingdom is extremely close. The attached graph further justifies the close relationship between the two economies.

Watch the following connections to get a full understanding of the issues revolving around a Greek default.

http://www.youtube.com/watch?v=rrsGSvuBAi4&feature=player_embedded

http://www.youtube.com/watch?v=m-fWgT26rzs&feature=player_embedded#!

Inflation rises to 4.5%

Worse than expected inflation figures have surfaced this week putting increasing pressure on the Bank of England to increase interest rates. These are very tough times with many predicting unemployment figures to rise further. The only good news coming from the article is the hope of inflation figures dropping by the end of 2012. Read the article below.

http://www.bbc.co.uk/news/business-14895510

Unemployment rises strongly

There is a problem with all policy choices. There is an inevitable trade off, one goal has to be sacrificed in order to achieve another.

While there have been periods when that really didn't seem too bad (such as the NICE decade), now the costs are transparent. In particular the aim of long run growth and securing a sound budget position is causing a rise in unemployment and the sacrifice of short-run growth.

The recent unemployment figures show this clearly and have inevitably led to a call for a reversal of policy. In this case the costs of the policy are unevenly distributed, those who loose their jobs pay the highest price and for some, the young, there is little prospect of a job anytime soon.

The BBC covers the story and have an excellent interactive map if you follow the links at the bottom of the page!

The BBC coverage is here

Another GDP growth downgrade

It looks all gloom!

Dr Archer added: "The current softness of the economy and anticipated GDP growth of one per cent in 2011 and 1.5 per cent in 2012 is particularly bad news for Chancellor George Osborne as it is substantially below the OBR's projections of 1.7 per cent growth in 2011 and 2.5 per cent in 2012 on which the Chancellor based his target of reducing the Public Sector Net Borrowing Requirement to £122 billion in fiscal 2011/12."

Read the full article below.

http://www.myfinances.co.uk/news/2011/09/13/oecd-expects-faster-uk-economic-slowdown

Times are getting tougher?

A recent IFS (Institute for Fiscal Studies) suggests that living standards will be at the lowest level in 30 years.

They stress that the next ten years the UK household budgets will be squeezed. It is suggested this will occur because of the impact of increasing taxes and government spending cuts. In other words it is the governments fault. What do you believe? Read the attached article and decide whether these severe consequences could be avoided. What is the government's motivation behind tightening fiscal policy? Why does the BBC article neglect to raise this issue?

The BBC cover the story here

London Riots highlight the failure of Capitalism

Before following the English press with calls for anarchy or a return to socialism it is important to examine the economic causes behind the riots. It has undoubtably been stimulated by some simply wanting to create havoc, however, could it also be a classic case of economic market failure illustrated through poor housing and lack of economic mobility? Is capitalist system failing minorities in London?

A fairly 'left field' view can be found here

The impact of policy

Everyone knows that times are tough. One of the issues that can't be avoided is that the recession led to a fall in output and that means someone has to be worse off.

The policy response of the government meant the recession was not as bad as it could have been, but the government debt that built up as a result is now an issue.

How to reduce the balance of the debt the government built up is a contentious subject. The Institute of Fiscal Studies has looked at the impact of the governments plan to reduce the debt. It is important to consider the distribution of the pain of the solution.

However some may say that the argument is pointless. If the government had not acted then the pain would have been much worse and unfairly distributed (the unemployed would take all the costs) and that there is little anyone can do except spread the pain acrosss more generations.

The Guardian report the IFS study here

Economists argue against 50% Tax on the Rich

Twenty Leading Economists have written to the government questioning the 50% tax for those earning over £150 000 per year.

They state the following:

We are concerned that Britain's 50p income tax rate is doing lasting damage to the UK economy. It gives the UK one of the highest personal tax regimes in the industrialised world, making it less competitive internationally and making us less attractive as a destination for both foreign investment and talented workers.

"It punishes wealth creation by imposing on entrepreneurs and business people a marginal tax rate in excess of 50 per cent once national insurance contributions are added in. This is particularly damaging when the UK needs to create new businesses in new industries."

"We call on the Government to drop the 50p tax at the earliest opportunity as part of a package of measures to stimulate growth. Only by returning to an internationally competitive tax regime will Britain enjoy long-term sustainable economic growth."

The Channel 4 news piece is here

Do you believe this is an appropriate strategy to reduce the budget deficit?

Reduced child-care support hurts the poor

Cuts to the working tax credit have hit poorer families. Four in 10 of those affected have considered giving up work because they will no longer earn enough to cover their childcare bills. The cut has added £500 extra on average to the childcare bill of low-income families.

Around 80 per cent of parents in low-income families who are in employment agreed with the statement: "Once I have paid for childcare, I am in a similar position to as if I was not working."

Parents spend almost a third of their incomes on childcare - more than anywhere else in the world, according to research by charities Save the Children and Daycare Trust.

The situation is even worse for families already living in poverty, where nearly half have had to cut back on food to afford childcare.

Please watch the Channel 4 video here

What impact is this having on society and how does it impact on social mobility?

A temporary solution?

Yesterday I looked at the arguments on the way UK fiscal policy should be deployed. The alternative short-term policy is to use monetary policy.

Usually monetary policy is about adjusting interest rates. This affects saving, borrowing and so consumption and investment behaviour. In short it pushes Aggregate Demand (the total amount of demand in the economy) up or down and so influences the level of economic activity.

The economic data suggests that the UK could slip into another recession. A more expansionary fiscal policy is ruled out (see yesterdays post) and so monetary policy might be an option. The problem is interest rates are already just 0.5% and so can't be lowered. The alternative is to simply print money.

Printing money in this context is called Quantitative Easing. The money supply rises, people have more money to spend and so consumption rises and firms have an incentive to invest. Easy really.

The problem is that printing money could be inflationary. That is unlikely, the money supply has not grown in the recession and the effect will likely go into demand. But another problem is that confidence among households and firms is so low that the extra money will simply be saved and have no impact on output.

The Monetary Policy Committee of the Bank of England meets today and will leave interest rates where they are. Some want them to do more Quantitative Easing (QE2). It probably wouldn't do any harm, but would confirm that the Bank fears the worst.

The Guardian covers the call for QE2 here

Stick or twist?

The debate on how to manage demand-side macroeconomic policy has been going on since Alistair Darling came up with Labour's deficit reduction plan. The Coalition government have decided to reduce the deficit faster and further than Labour wanted to.

The issue debated is how much support Britain's fragile economy needs to return to growth and how much damage increased levels of public debt would do.

Labour, on the whole, take the view that the government should be doing more to ease the short term pain of low growth, high unemployment and the danger of a new recession. So they urge a slower reduction in the deficit with the government doing more to boost Aggregate Demand.

The Coalition take the view that long term growth is more important and the burden of debt could reduce that significantly. They also point to the debt crisis in the PIIGS and say that creating such a debt crisis would be much worse. So they are happy with a lower stimulus to AD (it is still significant given the government deficit deficit) but the prospect of more secure long term growth.

You will find that differnet newspapers will take different views on this and many other issues. The Daily Telegraph is a supporter of the Coalition Policy and so run stories largely sympathetic to the government strategy. However the Guardian and Independent will be more critical and sympatetic to Labour's view. It is important you recognise bias when reading stories and stick to the economic, not the political, arguments.

The two stories below illustrate the sublte (sometimes not so subtle) differences when reporting the Chancellors speech here. Compare and contrast.

The Daily Telegraph article is here

The Guardian article is here