Petrol prices - is the duty holding back the economy?

Today a group of motoring lobby groups will appeal for a reduction in the duty on fuel. Britain has a relatively high duty on fuel and this has often caused motorists to complain.

The attached article, from The Daily Mail, tries to make the case as only the Mail can. Poor oppressed motorists and consumers are unfairly put upon by a cruel government.

The petitioners to the Minister will also suggest that lower fuel duty will allow the economy to recover as people are prepared to take to the roads again and goods will be transported more cheaply.

There are several points of economics.

1. While demand for fuel has fallen as prices have risen (by 19% in two years) the elasticity of demand is still inelastic. This is because there are few substitutes and its necessary for most people to get to work, the shops and pursue a normal life. Goods also have to be moved to customers.

2. While the tax on fuel is high it is there to help cover the external costs of travel. This includes carbon and other emissions and congestion. These negative externalities are significant and while difficult to measure most economists consider the fuel duty does not yet cover them.

3. The supposed macroeconomic boost of a cut in fuel duty is unlikely to make much difference to overall AD, but a cut in VAT would be more effective. Whether businesses will welcome the expense of changing VAT rates twice more is less clear.

Enjoy this rare link to one of the less credible newspapers, but beware their biased and rabble rousing views.

The Mail article is here

Who would believe Keynes still had something right?

Keynes was very concerned that households would not spend all they earned. This would lead to money leaving the circular flow and so national output falling.


This view is known as 'underconsumption'. While shown to be logically impossible by J.S. Mill in work published in 1841, if households continually earned money and did not spend it all then leakages from the circular flow could reduce national output and lead to recession.


Of course Keynes imagined a world where people put their savings 'under the bed' and the money literally left circulation. This does not generally happen in the modern world as people leave their money in the bank and the bank ensures that it is not idle.


There are reports of nearly £6 billion of cash being hoarded as people have lost faith in the banks. This fall in the active money supply is potentially deflationary and would justify the actions of the Bank of England in extending Quantitative Easing.


So how significant is £6 billion of cash hoarding? There are  £54 billion of notes and coin in circulation in the UK according to the February 2012 Bank of England Balance Sheet. 


While this seems a lot M4, the widest measure of the money supply, is well over £1500bn and most transactions take place electronically. Also the velocity of circulation, how often money changes hands, could adjust to a shortage of cash and further the Bank of England would simply supply more cash in a shortage. However we have a modern example of a leakage from the circular flow due to savings behaviour and that has not happened for a while.

The story is here 

Why we joined the European Union

When Britain joined the European Union (called the 'Common Market' in the UK at the time) it did so because it wanted to be a member of a free trading area.

It turned out not to be as free as we thought, but in 1993, thanks in large part to an initiative by the Blessed Margaret, a 'Single European Market' was created. Here labour, goods and services and capital had complete freedom of movement.

So anyone who is an EU citizen can work anywhere in the EU, a firm can sell their services anywhere in the EU and the people can put their money in any EU bank they like.

This encourages specialisation and trade, as a result everyone is better off. It is also encourages competition and will drive down prices because barriers to entry in the market have been reduced, benefiting consumers.

The Premier League at last lost a case where they had prosecuted a pub in Portsmouth for using a foreign decoder to watch football matches. It took the European Court to rule on this matter and today the High Court had to agree that the pub landlady should get her money back. The ruling - the exclusive deal with Sky contravenes Single Market legislation.

So the EU is not all bad!

The BBC covers the story here

Neet's to be helped

Click on image to enlarge

NEET's are  young people Not in Employment, Education or Training. There are a worryingly large number of them.

The problem is that a 16 or 17 year old, with no GCSE's above C grade, is really quite low down the list when it comes to picking amongst job applicants. The very poor job market means that many of the people in this category are not getting that first job they need to gain experience.

The problem is that if a 16/17 year old does not get a first job until then when will they? The possibility of a lifetime of short term, casual jobs is quite likely and this equates to a lifetime of poor living standards.

So giving these people a start is important and a new scheme has been announced. Essentially employers will be given a subsidy to employ 16 and 17 year olds who qualify. Hopefully the skills they gain will allow their continued employment.

This is a supply-side policy. It is targeted, it affects the costs of firms and it is expanding the productive potential of the economy. Like many supply side policies the effects will take some time to come through and are far from certain to work. Maybe the firms will take the money, employ the young workers for a short time and then release them having benefited from cheap labour. Of course those people do now have work experience, so some good comes of it.

The budget, £126 million, is small but as each employer will only get around £2000 per employee the measure could benefit a lot of NEET's. But is it enough? That remains to be seen.

The Guardian has some NEET's data here

The problem of externalities in motoring

One of the facts of transport  is that cars cause negative externalities. Specifically congestion and carbon (and other) emissions.

One solution is to reduce the negative externalities by subsidising alternatives that create fewer problems. This principle has now been applied to electric vans. The government are to subsidise up to £8000 of the cost of an electric hybrid vehicle. This will result in a reduction in carbon fuel use and so less pollution.

The subsidy, which can cover 20% of the price of the van, is badly needed. A Ford Transit van costs £18000 in the diesel version, but £32000 in the electric version. This is a major obstacle to sales despite the lower running costs of the electric vans.

So with such a hefty subsidy there is there bound to be a big take up? Sadly not. A similar scheme was announced for cars. Under  that scheme 1,052 cars were sold in 2011, using up just £5.26m of the original £250m budget.

The problem is that the  demand for these cars and vans is highly inelastic. A very large price reduction is required to promote a significant rise in demand. You should consider what the factors are that determine that inelastic response.

One of the things we have learnt in transport policy is that complementary measures are needed to provide support for policies that aim at changing the mode of transport. This policy is just one of the many such policies.

The BBC cover the story here

What next for fiscal policy?

Last week retail sales figures in January were reported to have risen by almost 1% on the year before. This was rare welcome good news, although there is more than a passing chance that its a statistical slip up (due to seasonal adjustment).

Despite this its not at all clear that the economy has turned the corner and the question that is now being discussed is what the stance of the budget should be. Budgets can be contractionary or expansionary. An expansionary budget adds more to aggregate demand than the previous one did, so if the deficit is planned to be bigger next year than this that makes the new budget expansionary.

Of course the plan is that the next budget period should have a lower deficit than the previous one. That would make it contractionary. Many feel this would be a mistake, because the economy is doing much worse than was expected when the plan was first formed.

Sadly politics makes sensible decisions on this question difficult. But at the very least there is a strong argument to say that the budget should not attempt to contract aggregate demand. This would involve not making some of the expenditure cuts planned or cutting taxes to compensate.

The linked BBC article gives attention to some options, largely proposed by Ed Balls. It is interesting to ponder what the most effective tax cuts would be and what would be the fairest. But the chances of a tax cut, beyond an over indexing of the tax free allowance, seem remote.

The BBC article is here

Unemployment hits 17 year high

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

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

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

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

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

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?

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

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