For the A2s, following on from the lessons on interest rates & inflation:

Had a thought - what if your question is on negative interest rates? This blog commentary (by an LSE alumni, so it must be true...) takes us into that territory, but it mainly questions the policy actions versus what we are told is going on through economic data (i.e. high growth but no movement on rates UK or US). We need to think about putting all this into a package for an exam question. Some of the blogger's commentary may be a little complex to follow, but do read it - it is not long. I am not so much interested in his wry commentary as I am in understanding why Sweden & Denmark persist in ultra-loose monetary policy; this is so far an unanswered question:

https://notayesmanseconomics.wordpress.com/2015/04/29/sweden-and-denmark-are-offering-an-alice-in-wonderland-future-for-monetary-policy/#comment-14162

Sweden and Denmark are offering an Alice In Wonderland future for monetary policy

Posted on April 29, 2015

Often we are told in Britain of the Scandanavian nations and Sweden in particular setting a good example and they are regularly held up as a model to follow. This particularly happens in the areas of social policy and education. However the last year or so has seen developments in monetary policy which has had me musing if they are setting a template for the future for all of us. This is in the area of negative interest-rates and expansionary monetary policy when you have an economy which is expanding and indeed booming. This is an inversion and some would say perversion of monetary policy theory where a central bank is supposed to lean against trends rather than give them a further push!

Denmark provides an example of this if we examine the situation described in the latest monetary review of its central bank the DNB. A Martian economist might think that things were going well at this point.

GDP growth in Denmark is expected to be 2.0 per cent this year and to remain at that level in 2016 and 2017. The projection thus reflects continuation and strengthening of the upswing that has already been underway for some time.

However our Martian economist will be scratching his or her head a little at this bit.

(The DNB) reduced the rate of interest on certificates of deposit on four occasions in January and early February, to -0.75 per cent. This is an all-time low for a Danish monetary policy interest rate.

The combination of solid growth with little or no consumer inflation might seem like not far off economic nirvana so why mess with it? We are seeing domestic policy in Denmark being made subservient to the exchange rate which is pegged to the Euro. A type of competitive devaluation our Martian might think should he or she be aware of the 1920s and 30s. Also our Martian would exclaim “you don’t say!” at this bit.

there is a risk that a prolonged period of very low interest rates will trigger an unhealthy development with self-reinforcing price rises for owner-occupied dwellings.

Ah a house price boom, what could go wrong? For now Denmark has a monetary environment where many mortgage bonds trade at negative yields and where households are unsurprisingly keen to remortgage.

indicating that the volume of remortgaging is exceptionally high, as was also the case last quarter.

So Denmark has potentially sacrificed balance in its internal economy on the altar of keeping its Krone pegged to the Euro. Unless of course you think that issuing Treasury Bills at -0.98% as it has done this morning – yes the investor and not the government is paying interest – is (the new) normal.

Sweden

This is an even more extraordinary development as it has not been forced down this particular path by a type of fixed exchange-rate policy. Indeed as it is supposed to have a central bank accused of being “sado-monetarists” by Paul Krugman you might wonder  even more about its current path. Back on February 11th they made a move which would confuse our Martian economist even more which I described the next day as this.

This is very significant as imagine if growth happens as they anticipate and inflation does pick-up at the policy horizon of circa two years then they have just made completely the wrong move!

They moved into negative territory with interest-rates cut to -0.1% but in a Krugmanlike state of mind they decided that not only this but some QE was required as government bond purchases were announced. Only a fortnight or so later we discovered that economic growth was running at an annual rate of 2.7%. So very strongly pro-cyclical monetary policy as they add a supercharger to an engine that was already turbocharged!

What happened next?

There was another cut to -0.25% on UK Budget Day  as our Martian looked for some headache pills to stop his or her brain hurting. Now let me bring you fully up to date with some news from Sweden Statistics from this morning.

In March the annual growth rate for lending to households increased by 0.2 percentage points, from 6.2 percent in February to 6.4 percent in March.

As you can see the fear I expressed for Denmark seems to be bubbling along in Sweden and our Martian’s alarm would rise if we narrow our focus.

Housing loans account for 81 percent of total lending to households, and increased by SEK 160 billion to SEK 2 526 billion. The annual growth rate was thus 6.8 percent in March.

This boom has been at least partly caused by the fact that mortgage-rates are very low and have been falling. The numbers below compare to 2.43% a year ago.

Households’ average interest rates for housing loans for new agreements from MFIs fell from 1.81 in February to 1.74 percent in March.

Rather then being middle of the road that seems “chirpy,chirpy,cheap,cheap” to me and it would appear that Swedish companies think so too.

Most of the loans to non-financial corporations comprised loans with multidwelling buildings as collateral.

So there you have it a housing market which is being pumped up and a money supply which is either growing at an annual rate of 13.8% (M1) or 7% (M3). If we take a rule of thumb for wider monetary growth of 7% we subtract expected economic growth of 3% and get inflation of 4%. Thus a central bank of “sado-monetarists” would be singing along with Dawn Penn.

No,No,No….

The Riksbank this morning

Firstly it confirmed its view that the outlook is bright from its eyrie by upgrading its economic growth forecasts.

The expansionary monetary policy is having a positive impact on the Swedish economy…….GDP growth in Sweden is good and the labour market is continuing to improve.

Thus our Martian looking at surging money supply growth and in particular lending for mortgages and housing would be expecting a tightening of policy. But instead rather than an economics text-book it would appear that the Riksbank has been reading Alice In Wonderland recently.

My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.

So rather than a tightening we got an expansion.

the Executive Board of the Riksbank has decided to purchases government bonds for a further SEK 40-50 billion.

Also a hint of more interest-rate cuts combined with a Forward Guidance style promise of lower interest-rates for longer.

In addition, the repo-rate path has been lowered significantly compared with the decision in February. The repo rate has been left unchanged at −0.25 per cent but may be cut further.

And in a Mad Hatter style panic they appeared willing to throw the kitchen sink at things.

The Riksbank is also prepared to launch a programme for loans to companies via the banks and to intervene on the foreign exchange market………..Purchases of other assets than government bonds are also a possibility.

I think that in terms of possible monetary expansion that is about it, for now at least! Although for some who had in my opinion really got carried away with their rhetoric that fact that there was not an interest-rate cut today was a surprise. Of course Lewis Carroll got there first.

Why, sometimes I’ve believed as many as six impossible things before breakfast.

Comment

There is much to consider at the moment from monetary policy in the Nordic regions but I am afraid that not much of it is good. Sweden in particular but Denmark too seem set on a helter-skelter type monetary policy where the economy is sacrificed to the growth now gods with this sort of perspective about time.

Alice:How long is forever? White Rabbit:Sometimes, just one second.

You have to ask what is the Riksbank of Sweden afraid of? If we are being told the truth about the Swedish economy,it is time for it to be reminded of the words on the front of the HitchHikers Guide to the Galaxy which in big friendly letters says.

DON’T PANIC

Meanwhile the Bank of England may be observing a far slower quarterly GDP growth rate of 0.3% and think it is missing out on this fashion for negative interest-rates! Especially if the current rally in the UK Pound continues (US $1.53+,1.40 versus the Euro,182 Yen). at which point in my opinion the Nutty Boys should be on repeat.

Madness, madness, they call it madness
Madness, madness, they call it madness
I’m about to explain
A-That someone is losing their brain

Video infographic - is there an "Eastern Europe" anymore?

If you get a question on unemployment:

First, it tends to have detrimental effects on the individuals involved. Workers’ human capital (whether actual or perceived by employers) may deteriorate during a spell of unemployment, and the time devoted to job search typically declines. Both factors imply that the chances of leaving unemployment fall the longer it goes on. More generally, long-term unemployment adversely affects people’s mental and physical wellbeing and it is one of the most significant causes of poverty for their households."

This is from an article looking at the situation in Greece:

http://www.telegraph.co.uk/finance/economics/11554873/Why-theres-little-hope-for-Greeces-unemployed.html

The Economics of Politics - A2s please note

I hope you all now realise the importance of having "current context"; without it your essays are like an unseasoned sauce - yes, it is food, but it doesn't add much to the eating experience.

With that thought, you should be reading this blog religiously. These articles, for instance, put the current fiscal position, and the promises of our esteemed candidates, in perspective. It would be a shame if you got a question where you could use this material, but you assumed that if you understood the principles of tax and spend that would be enough:

We can take out without paying in — that’s the Miliband illusion

Camilla Cavendish Published: 26 April 2015

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ELECTIONS are great for nosy writers like me. Everyone is a potential voter. What surprises me is how much intimate information I can elicit just by uttering the word “election”. Total strangers launch into detailed descriptions of their personal finances. How much they earn, what they pay in rent or mortgage, what they are getting in benefits. Many people have seen their benefits fall (not pensioners, whose entitlements have been cherished and embellished by the coalition). Even with inflation down, they remember that they felt better off under Labour. 

People are not immune to the argument that there is no money left. Most understand that we can’t spend beyond our means for ever. And they are quick to accuse other people of taking too much from the state: the lazy neighbour; the divorcée on legal aid; the family who inherited their council house. Yet decent, hard-working people feel strongly about any threat to their own entitlements. No one is particularly grateful that the coalition has allowed them to keep more of their own money before they start paying tax — the policy that Tories and Lib Dems boast about. Nor do they thank the government for a recovery they have either not yet felt or have already banked. 

This is human. Social psychologists such as Robert Cialdini have extensively documented the ways in which we feel losses more deeply than gains. Heartfelt proofs of Cialdini’s thesis flooded my inbox in 2013, when the government decided to remove child benefit from households where one parent was earning more than £50,000 a year. Many high earners were furious. A Church of England vicar wrote to me complaining that his daughter, who had five children, could not possibly manage without it. It didn’t seem to occur to him that she could have chosen to have fewer babies. Or that it was not fair for a household earning at least twice the national average income to expect other taxpayers to chip in. 

We all want someone else to take the pain. The rich dread the mansion tax. The poor dislike the benefit cap. Frontline public sector workers loathe wage freezes. The salariat who have worked long hours to get promoted into good jobs resent the landed gentry and the super-rich who, as The Sunday Times Rich List shows today, are continuing blithely on an upward trajectory while others struggle. 

No democracy finds it easy to tolerate cuts in public spending. Our politicians have been brought up to spend, not cut. Since the financial crisis, indebted western governments in hock to international lenders have struggled with electorates that do not want to face the harsh new reality, especially when average wages have been falling. Low interest rates have inflicted terrible damage on savers, especially the elderly, in Europe and America. But the “easy money” of zero interest rates has inspired less protest against governments than spending cuts. 

As the world becomes ever less secure, and so do our livelihoods, we seek comfort in illusions. One is the mantra that “I’ve paid in, so I’m entitled to take out”. We pay seemingly endless taxes — income tax, council tax, national insurance, VAT — but more of us than we imagine may actually be net recipients of state largesse. 

Three years ago the Centre for Policy Studies think tank tried to work out how many people were receiving more in state aid, health and education than they were paying in taxes. It calculated that 53% of households received more in benefits than they paid in tax in 2010. Even the middle fifth of earners were getting more on average than they put in, according to this thesis. Only the top two-fifths of households were paying their way. 

You can quibble with the exact figures, for various reasons. What is more important is how they have changed over time. Even if you exclude pensioners, who have been increasing in number and so inflating the recent figures for net recipients, the proportion of working-age households that seem to have “taken out” more than they “paid in” has jumped from 29% in 2000 to 40% in 2010.

This is a dramatic change however you cut the numbers (which the Office for National Statistics provides on its website). It was partly a consequence of Labour’s higher spending on public services, funded by borrowing. It was also a result of Gordon Brown’s determination to expand the scope of the welfare state. As chancellor, he increased the number of households in receipt of tax credit from about 700,000 in 1997 to something approaching 4.7m by 2010. By creating a whole new class of benefit recipient, he gave more middle earners a stake in the status quo. This made it even harder to tell voters the truth when the money ran out.

For all the huffing and puffing about austerity, the coalition has only begun to slow public spending. This has inflicted real pain, particularly on social care budgets, because the government has had to spend so much on debt interest. But with an ageing population, if so many working people are net recipients rather than contributors to the state, public spending levels are unsustainable. 

There are only two alternatives to cutting spending: borrow more or raise taxes. There is a limit to both, though. Borrowing sounds nice and distant — unless you’re Greek, or Spanish, even French. And the limits to how much the government can soak the rich were demonstrated by Friday’s announcement that HSBC, fed up with paying the bank levy that George Osborne has just hiked again, is thinking of quitting London. 

Osborne has managed to extract unprecedented wads of money from the wallets of the rich. What Ed Miliband likes to call “Cameron’s tax cut for millionaires” — the reduction of tax rate on those earning over £150,000 a year from 50% to 45% — has resulted in the top 1% of earners paying 28% of all income tax. The richest 0.5% now pay almost three times the total tax paid by the bottom half of all taxpayers. Infuriating though some of the super-rich may be, living in their bubbles of bling, this makes it rather important that they do not leave the country. 

What, then, is the real choice at the election? On Thursday the Institute for Fiscal Studies (IFS) predicted that a Conservative-led government would cut spending by about 18% in unprotected departments, if it sticks to its deficit goal; and that a Labour-led government would increase national debt by about £90bn, despite its claim to be “relentlessly focused on the deficit”. 

The IFS accused Labour of being “considerably more vague” about its plans. That’s saying something, given the Tories’ reluctance to detail their spending cuts. 

Secretly, we voters want it both ways. Despite it being impossible, we’d like fiscal responsibility without pain. That is what Ed Miliband is selling. The fact that so many people would like to believe this illusion is, I guess, a victory for Gordon Brown. 

camilla.cavendish@sunday-times.co.uk

We’ll need much more than an umbrella to shield us from the approaching storm

Philip Aldrick

 

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Published at 12:01AM, April 25 2015

Elections have a remarkably telescopic effect on political thinking. Hardly long term to begin with, the debate all too often ends up compressing the nation’s future into only five years. For economics, given its pretensions to shaping history, the whole experience becomes rather petty.

Take the disputes over where the Tories will find £3 billion to lift the 40p income tax threshold to £50,000, or whether Labour can raise £1.2 billion from a mansion tax. Set against the dismal long-term prospects for the UK’s public finances, it’s all noisily irrelevant — a bit like watching two people squabbling over an umbrella while a tornado tears up the street behind.

Make no mistake, a storm is brewing. The true state of Britain’s public finances is dire — far worse than suggested by the official figures, which are simply bad. According to the Office for National Statistics, borrowing in the past financial year was a mighty £87.3 billion, or 4.8 per cent of GDP. As awful as that sounds, it was better than hoped. Unfortunately, it wasn’t the whole story.

Britain’s public finances are calculated in a rather generous way, in line with European Union rules. The real cost of public sector pensions, as well as future commitments on private finance initiatives and nuclear decommissioning, is ignored. If we lived in UK plc and the nation’s finances were subject to the same scrutiny as a company, the reported level of borrowing would almost double.

In the year to 2014, this “accounting deficit” was £77 billion larger than the official deficit. Using the same rules, there was also £450 billion more debt, largely because of unfunded public sector pension promises. The figures come from the “whole of government accounts”, a formal measure of the country’s long-term financial challenges. Those are real costs that one day will have to be borne. So the deficit today is arguably closer to £160 billion — about a quarter of government revenues. Britain’s debt is also larger than the national income, rather than four fifths its size. And that’s the good news.

Unless more savings are made, the deficit will rise by another £70 billion in today’s money by 2060 purely as a result of the country’s changing demographics. As intergenerational dependency rises, with more old people reliant on fewer workers to pay their pensions and cover the cost of their healthcare, the hard yards made in the past five years will be undone.

The OBR reckons that borrowing will automatically increase by 4.7 per cent of GDP, putting the UK’s public finances back on to an “unsustainable” trajectory. If net immigration falls below 100,000 a year or productivity growth, which has stagnated since the crisis, fails to recover to 2.2 per cent a year, the public finances will look even worse.

Which brings us back to the general election. The longer these problems are ignored, the more expensive they become.

In its 2014 Fiscal Sustainability Report, the OBR presented two ways of dealing with the debt by 2060. The first was a one-off £15 billion additional dose of austerity in 2020, amounting to 0.9 per cent of GDP. The alternative was to do 0.3 per cent a decade, amounting to a cumulative tightening of 1.7 per cent of GDP — almost £30 billion in today’s money. Both are workable solutions, but the OBR’s projections clearly demonstrate that delaying has a price.

Looking over a narrow five-year horizon, none of this shows up. As a result, unsurprisingly, the problems always end up being the next government’s problem.

For once, though, this election is different. The Tories plan to start paying off Britain’s debt by 2018. Assuming that they held power until 2030, the Institute for Fiscal Studies reckons that UK debt would be down from 80 per cent to 52 per cent of GDP. That would be £270 billion less than under Labour, according to the IFS, although Ed Balls disputes its assumptions. The Tory plans don’t go far enough to address the long-term state of the public finances, but they are a big step in the right direction.

For the first time since 1992, there is a chasm between the parties on the economy. Paul Johnson, director of the IFS, has been banging this particular drum for months. Russell Brand and his acolytes say that politicians are all the same, but this time they are — emphatically — not.

Put simply, the Tories want a small state to afford low taxes and prudent public finances. Labour balks at what that would mean for public services. Labour offers compassion today, the Tories a plan on the public finances for tomorrow. Ultimately, however, there can be no escaping the demographic juggernaut. Seen through our grandchildren’s eyes in 2060, the Tories would look compassionate against a Labour party in denial.

One assumption that the OBR makes in its fiscal sustainability analysis is that tax thresholds and benefits will be uprated in line with earnings growth rather than inflation beyond 2020. It’s hard to see how that could hold once the debt started to spiral, which would mean more people being dragged into higher rates of tax at the same time as inequality between those in work and on benefits widened — the worst of both worlds.

There are legitimate questions about whether the Tories can honour their promises. If the recently dissolved parliament is any guide, they will break their rules and deliver a slower deficit reduction than pledged in their manifesto. But, for once, at least they are fronting up to the long-term threat and aspire to give the country economic shelter. An umbrella, after all, really isn’t going to help, given the size of the storm clouds approaching.

Philip Aldrick is Economics Editor of The Times

Industrial development:

All over Radio 4 this morning, MIRA Technology Park:

http://www.miratechnologypark.com/

MIRA tests all sorts of vehicular applications, and in order to keep itself a global leader has invested £300m in developing a technology park where it hopes related businesses will "cluster". However, it suffers from skills shortages, and the CEO is very concerned about immigration restrictions, and very worried about an exit from Europe - he says he already has to persuade potential clients in places like China that we are not in the process of leaving; he says the perception is that it is already happening. Demonstrates how distance distorts news.

Superb article which you all MUST read (AS & A2):

This hits all the buttons on its topic, which means you have really good context, and bang up to date material to use across a range of questions. You should probably all email Allister Heath and say thank you...

Britain’s productivity crisis: beware all the usual simplistic solutions

Too few economists seem prepared to accept that at least some of the UK’s productivity shortfall was a good thing

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Improving and enhancing the UK's infrastructure ought to be good for productivity, but only if done in the right way Photo: Bloomberg

By Allister Heath

9:37PM BST 21 Apr 2015

81 Comments

We keep being told, with some justification, that Britain’s greatest economic weakness is its poor productivity. The average worker doesn’t produce enough output for every hour that they work; given that our pay is directly connected to the marketable value of the output we generate, this helps to explain why wage growth has been sluggish over the past few years.

The numbers certainly make grim reading. The latest release from the Office for National Statistics reveals that output per hour fell by 0.2pc in the fourth quarter of 2014 compared with the previous quarter. For last year taken as a whole, labour productivity remained at roughly the same level as it was in 2013; depressingly, this was slightly below the level seen in 2007, prior to the recession and financial crisis.

Research by the Conference Board for the Financial Times showed a similar pattern. Total factor productivity – which includes not just the contribution of workers but also of capital and management – fell by 0.1pc in 2014, by 0.4pc in 2013 and by 1.5pc in 2012. This was the first time since 1992 that the UK has suffered three consecutive annual falls on this measure. The situation is almost as bad in France and Germany, which registered a much bigger drop of 0.6pc and 0.3pc last year but which have done better than the UK since 2010. 

I agree, as a general point, with the view that the UK’s productivity growth has been far too weak. But there is one big caveat that is too rarely made. Too few economists seem prepared to accept that at least some of the UK’s productivity shortfall was a good thing. It happened because a large number of low productivity workers found work in the UK, dragging down the average. Similar workers have not been able to get jobs in other countries.

To see why this matters, consider the following thought experiment: imagine two countries with identical economic characteristics and where the bottom 10pc of workers contribute 5pc of output. In the first country, a new law is passed banning them from working. They all lose their jobs, GDP drops by 5pc – but productivity shoots up by 5.5pc. Now imagine that all these workers move to the second country and immediately find work. That economy’s GDP goes up by 5pc, but because the number of workers rises even faster, average productivity falls by 4.5pc.

What country would you prefer to live in? The one being cheered by economists for its buoyant productivity and high-wage model, or the one with booming employment, where migrants, the young and labour market outsiders all find work? I would plump for the second without a second’s hesitation. I’m exaggerating, of course, but the UK has behaved a lot like the second kind of country in recent years, and countries like France or Italy like the first kind.

I’m not for a second claiming that we don’t have also have a genuine and extremely large productivity problem, merely that it has been exaggerated by the astonishing private sector jobs miracle of the past few years.

It is vital, as the election campaign enters its final weeks, that the politicians’ proposed solutions tackle the real issues. For a start, anything that reduces the labour market flexibility that has created so many jobs should be resisted. It is also time for a proper investigation into the role of in-work benefits: do they push down wages in a meaningful way, and are therefore a subsidy to firms, or do they subsidise people who otherwise wouldn’t work (because what they could earn is too low to sustain them)? If the second, as I suspect, what supply-side solutions could be used to make sure that they are able to earn more and require fewer subsidies? Clearly, these will need to involve dramatically improved vocational training and, for the long-term good of the economy, much better education.

Improving and enhancing the UK’s infrastructure ought to be good for productivity, but only if done in the right way. Building useless government-financed projects with costs greater than their benefits isn’t the answer, which is why I’m sceptical of those who blame cuts to the Government’s capital expenditure budget since the crisis for the slowdown in output per worker. The UK government has been short-termist for decades now, privileging current expenditure over capital spending, which is a good reason why as many important decisions as possible need to be depoliticised; but some of the figures that are often cited as proof of this exaggerate the trend by failing to control for the impact of the privatisation of industry, utilities and housing.

Some government capital projects that have been cancelled since the crisis would have boosted productivity; many merely represent a form of disguised consumption. The HS2 high-speed rail project would be a waste of money. By contrast, allowing the private sector to expand London’s airport capacity would add a vast amount of value.

The UK has a problem with mobility: it takes too long to travel. Pricing road use properly, rather than hitting motorists randomly through fuel duties and other taxes, makes sense – but it would be a terrible error merely to seek to suppress demand, rather than trying to bolster capacity. The UK must tap into the private sector’s appetite for financing long-term infrastructure projects.

^{HS2 high-speed rail project}

Infrastructure spending should not be seen to be synonymous with government spending, and especially not with the variety focused on buying votes in marginal constituencies. Like in the 19th and early 20th century, we need to unleash the forces of entrepreneurship and competition on all kinds of capital projects, from transport to energy.

Insurers need to match long-term liabilities with predictable, long-term cash flows; contrary to the received wisdom, this allows them to think in a longer-term way than politicians and to finance multi-decade capital projects.

Excessive regulations are also a major barrier to productivity. Vast amounts of time and resources are diverted to economically useless activities. Perhaps the single most pernicious regulations in the UK today are those surrounding land use: they have pushed up property prices by at least a quarter, imposing huge costs on families and companies.

Last but not least, the public sector itself needs to embrace technology to improve its own efficiency. Britain faces a massive productivity challenge, for all of the caveats I mentioned at the start of this article. But governments of all stripes must ensure they make the problem better, rather than worse.

allister.heath@telegraph.co.uk