The debate of EU membership is really coming back

In 1975 the UK held its first ever referendum on whether it should stay in the EU (then the EEC) which it had only joined in 1973. 67.5% of people voted to stay and the Home Secretary of the day, Roy Jenkins, said that it had 'put the uncertainty behind us'.

While there have been people who have called for withdraw, such as UKIP, no mainstream politician has given it serious consideration. Today it appears that the inept and intellectually challenged Education Secretary Michael Gove believes the UK should leave (with support from, among others,  the giant brain of Iain Duncan-Smith).

I have a balanced and tolerant view of Mr Gove, but there is an economic argument for leaving the EU and that debate must now be had. The result will determine nothing less than the economic future of the UK.

The argument for joining the EEC in 1973 was that of trade creation. Barriers to trade would be eliminated between the UK and the other members and the amount of trade and specialisation would increase making everyone better off. This is classic stuff and exactly the sort of thing economists advise countries to do if they want to grow up to be big and strong.

Along with the lowering of trade barriers came political co-operation. This has included a European Parliament and a European Court. EU law supersedes UK law. This is what people like Michael Gove and UKIP object to, it restricts the ability of the UK government to act.

So is there a case for leaving the EU? Well actually yes. The result will depend on the terms of leaving. The ideal solution for the UK would be to get the same deal as Greenland when it left. That put Greenland in the same position as Norway - a part of the single EU market, but not a member.

Norway gets all the benefits of specialisation and trade, but pays nothing towards the running of the EU, has no say in the rules and gets none of the political benefits of a single European voice.

The Greenland option is going to be very hard to stop politically. The question to be decided is 'Do you want Britain to be a simple economic partner of Europe, or a political partner in Europe?'

Under starters orders.  This is going to run longer than the debt crisis!

The Mail (who else?) report Gove's views here

Incomplete analysis can lead to errors

In a time when the Department for Transport have admitted their analysis of Rail Franchise bids is flawed we are reminded that a faulty method can lead to poor decisions.

One of the most difficult decisions to be made is what transport infrastructure to invest in. There are very many factors to consider, such as forecasts of future demand and external costs and benefits. All of these are difficult to value.

The solution is a full Cost-Benefit Analysis that considers all the private and external costs and values them properly. Only then can a judgement be made and even so substantial margins of error must be considered.

So should we give much credibility to a study by MIT that a third runway at Heathrow is a bad idea?

The MIT study says that, compared to a new Thames Estuary airport (Boris Island), a third runway at Heathrow would cause more early deaths due to pollution. So that's it then, decision made.

However when questioned the authors admitted they had not included any of the following issues in their study:

* The cost of construction at either site
* The impact on local transport at either site
* The impact of extra road traffic too and from any new airport
* The external costs and benefits of either airport

Of course their defence was that they were only looking at health impacts of the two options and that is actually quite reasonable. It represents a contribution to the full cost-benefit analysis and a valuable one at that.

The Guardian reports the study here

From market prices to inflation

Markets set the prices for individual goods. Inflation is the continuous rise in the general price level. Of course we are taught that we must not confuse the two. When the price of a particular good rises this is due to either a rise in demand or a supply constraint, not inflation. But surely there is a connection?

The issue of food prices is a good example of where we can link market prices and inflation. Food prices generally are about to rise due to several factors:

1. The wet summer in the UK has led to a lower harvest and it is proving difficult to plant next years crop.
2. There have been droughts in the USA, Russia and southern Europe during the growing season.

This means that cereal prices overall are rising. It's due to a supply shock, relative scarcity has increased.

But this is going to feed through into inflation as it will cause a wider impact on prices.

Clearly the goods which use soya, wheat etc will have to pass on the extra costs. The price of bread for example. But cereal crops are also used to make biofuel and to feed animals. So we can, at the very least, expect the price of meat to rise too.

While these are changes in relative prices of individual goods this will feed through into inflation. Food is a significant item in average household budgets and so has a significant weight in the CPI. The rise in food prices, and goods which use inputs from the agricultural sector, will feed into CPI and cause a rise in the index.

This is, of course, quite reasonable. Average households will find the cost of living is rising

The Guardian covers the story here

The case for Plan A

Yesterday the Conservatives put the argument for continuing their plan to reduce the government budget deficit in the strongest terms for over a year.

Fundamentally there is on two types of news on the economy, bad and absolutely awful. Given that the government might as well take it on the chin and express their beliefs.

George Osbourne, The Chancellor, said he would find more money through benefit cuts. This plays surprisingly well outside of the Conservative Party with the general public. It remains to be seen if it can be done and whether people will accept the reality.

The Prime Minister asserted the cuts will continue, despite the growth forecast for the UK by the IMF being cut. (Well we all knew that!). He pointed out that one million new private sector jobs have been created and this is compensating for public sector cuts.

The government argues that the deficit needs to be reduced to avoid problems in the future. The Opposition says a boost is needed to get the economy growing again.

The IMF says that a short term stimulus might be appropriate, but that the markets will take fright on any large scale and longer term rise in spending that will raise the deficit. So some support for both sides there.

One issue that is clear is that the government has not reduced the deficit as far as they wanted to. This shows just how difficult it is to cut spending. Good luck with the plan George.

The Independent cover the current issues here

"Most people don't understand inflation"

The Office for National Statistics (ONS) are considering changing the way the Retail Price Index (RPI) is calculated.

The RPI and CPI don't provided the same figures for inflation as they have different baskets of good and are calculated in a different way.

This may not seem that important but government benefits, pensions and some investments are linked to one index or the other. When one is constantly higher than the other this means the gap between the various benefits and pensions widen.

Also some may say that the government wants the RPI to be lower so they can save money on those payments based on RPI.

So if the RPI is adjusted it may do some groups harm. Pensioners and pension funds among them.

The ONS are consulting on the need for change, but not many people are likely to respond. According to research very few people understand inflation let alone the complexities of how it is calculated. It may be that people with a lot to lose stay silent.

Rest assured I will be adding my voice to the consultation, but I'd like the use of geometric means in RPI which will cause the reported figure to fall a little.

The article on this raises important points and helps you to better understand how inflation is measured.

The BBC report the issue here

Consumer confidence returning?

Consumption is by far the largest component of Aggregate Demand. Around two-thirds of the total. Therefore rising consumer confidence will be good news for the economy as it struggles out of the double dip of this recession.

Consumers have been shell shocked since 2009. Real income is down due to low wage rises and inflation which is higher than the wage rises (in the public sector and some industries wages have been frozen or even fallen in money terms). Also the uncertainty associated with the recession, the Eurozone crisis and government cuts has led to a higher savings rate.

Currently the economy needs short-run growth desperately. Just using up more of the idle resources of the economy will help a lot. Output and employment will rise and there is then a good chance that a sustainable rate of growth will emerge. Households spending more will allow this to happen.

So the news from Visa that shoppers have spent more in September (around 3%) is great news. One swallow does not make a summer, but it really is a good sign.

The BBC report the figures and speculate on whether the economy has really turned the corner here.

Fuel sales decline 15%

The AA is reporting fuel sales are down 15% in the UK, that's 1.7bn billion litres less compared with three years ago.

The AA blame rising fuel prices. The price of petrol was around £1.05 a litre three years ago and is now £1.37.

Can we infer the Price Elasticity of Demand from this data? Well actually no, ceteris paribus does not apply.

You could calculate the PED but it won't be very accurate. Incomes have changed markedly in the recession, moves to reduce carbon emissions have been ongoing and of course households have had time to adjust to higher prices since the 2008 peak.

Interestingly the same phenomenon has been reported all over the world. All over Europe, in India and North America fuel consumption is down.

The BBC report the drop here

Just because it has not changed does not mean its not significant

Today both the European Central Bank (ECB) and Bank of England decided to leave interest rates unchanged. For the UK it means interest rates have been at an all time low of 0.5% since March 2009.

This lack of change is deceptive. The low interest rates reflect concerns over the very low levels of demand in the economy and the expansionary monetary policy which is trying to stimulate Aggregate Demand. So what is happening is an ongoing active monetary policy.

But rates are pretty much as low as they can go (although there are rumours of a fall to 0.25% next month) and additional help through more Quantitative Easing (printing money) may still be required to help the economy recover.

The decisions to be made about monetary policy are not straightforward. The Bank of England must predict what inflation will be in two years time. As the linked article below shows it is not even clear what the July to September GDP figures will be, so predicting influences on inflation up to two years ahead is far from straightforward.

Monetary policy is a key policy weapon. Balancing the needs of growth (which needs low interest rates) and inflation, which is still above target, is a continuing headache.

The BBC explain some of the difficulties here

Another rail fiasco

The decision to award the West Coast Main Line franchise to First Group in August has already caused a commotion. Virgin had launched a legal challenge claiming 'somebody does not like us at the DfT' (Department for Transport).

Well its not only people in the DfT who find Richard Branson a pain in the arse, but that was not the reason Virgin lost. Officials miscalculated the time value of money and passenger numbers in the 13 year franchise bid. It does make a difference when money flows are received as inflation and interest rates are key elements.

The whole process is now up in the air and will have to be examined again.

For us the process is the issue. How do we assess long term transport projects? Stephen Glaister a former LSE and Imperial professor is a specialist Transport Economist. He looks at the issues in this excellent Guardian article here. (Essential for A2!)

Glaister's article is here

Can government spending really help the recovery

It is the turn of the Labour Party to have their conference this week and opposition parties generally have a free hit at the government.

The Shadow Chancellor, Ed Balls, used his speech to suggest that the government should spend more money (£4 billion) on building new houses and giving a tax break to first time house buyers to try and boost economic activity.

This is standard Keynesian stuff. The government spends more money to boost Aggregate Demand. The multiplier effect then raises national income and employment by even more than that. Balls claims it will 'kick start' the economy.

It's good politics, but not really believable as economic policy. The government is already spending far more than it raises (around £170 billion) to boost Aggregate Demand. Although using government spending on construction keeps a lot of the spending local at first the multiplier is very low (maybe 1.25?) and so it might raise GDP by £5billion if its new money.

The biggest hole in the Balls argument is how it would be funded. According to him Labour would use the money raised from the auction of 4G licences by the mobile phone companies. That money has already been earmarked for use so actually it would be financed by more borrowing.

The argument about how much to stimulate the economy will go on for ever. See what you think of the Balls plan.

The Independent report the policy proposal here