Black Monday – 30 years on

Black Monday refers to Monday, October 19, 1987, when stock markets  around the world crashed, shedding a huge value in a very short time. In New Zealand and Australia it is sometimes referred to Black Tuesday because of the different time zone. By the end of October stock markets around the world fell significantly:

  • Canada – 22.5%
  • USA – 22.68%
  • UK – 26.45%
  • Spain – 31%
  • Australia – 41.8%
  • Hong Kong – 45.5%
  • New Zealand – 60%

Unlike other countries the effect of the crisis was compounded by the Reserve Bank of New Zealand’s inaction to lower interest rates and therefore reduce the value of the NZ dollar. This is in contrast to the USA, Germany and Japan whose banks loosened monetary policy to prevent a recession. Below is a video from the FT looking back at the events 30 years ago. Also a useful graph to put the crash in perspective – the two circled ares are the dot.com crash and the GFC.

Black Monday in context

Transition Economies – Challenges

A new part of the AS Level syllabus in 2016 is Transition Economies. What have been the formidable challenges facing eastern European countries (command) embracing capitalism? Here are some thoughts as well as an informative video from the IMF:

  • In planned some goods are provided free but not in a market economy
  • Corruption – widespread in communist countries in eastern Europe – Oligarchs
  • Inflation ↑ – privatised firms began to charge prices that reflected high costs
  • Lack of entrepreneurial experience
  • Rising unemployment as owners of businesses try to them more efficiently.
  • Labour relations – Poor as workers are in a new environment – Job security?
  • Consumer sovereignty – some industries decline/expand
  • Resources – surplus and shortage
  • Self-Interest – fewer merit goods and more demerit goods
  • Time Gap before framework of government controls can be developed
  • Expansion of industry – potentially for greater externalities
  • Old/disabled – vulnerable with the change of government role
  • Welfare system – limited support for unemployed etc. will take time to develop
  • Provision of public services – disruption to police and other public services
  • Moral Hazard – the state insure workers against risks of losing their job

AS Revision – Economic Systems

With the AS Data Response and Essay Paper next week here is some revision material on economic systems. It goes through the features of the market, command and mixed economies. Below is a screenshot of the information but you can download the word document by clicking on the link – ECONOMIC SYSTEMS.

Eco Systems

IMF’s global growth forecast

Below the FT’s Chris Giles talks to Maury Obstfeld, chief economist of IMF, on how the global economy is growing at its fastest rate in almost seven years. One chart (below) shows a falling unemployment rate with stagnant wage growth – Obstfeld talks of lower labour productivity as the reason for this. Well worth a look and very useful for the prospects of global growth – including developed and developing countries.

Unemp v Wages

Behavioural Economist Richard Thaler wins Nobel Prize in Economics.

Great news for Behavioural Economists with Richard Thaler winning the Nobel Prize for Economics in 2017. Below is an interview with Richard Thaler on the PBS NewsHour – Making Sense by Paul Solman to launch his then new book “Misbehaving”. Notice that the book is 30% off in the Chicago Booth Bookstore. As Thaler says people love deals and can be driven to purchase things that they don’t really want if the deal is good enough. He explains the concept of sunk costs, time and money already spent with some Cameroonian students. Also the way most people value their time.

Richard Thaler, also the co-author of the book  “Nudge” , has suggested that economics has always been about behaviour. Adam Smith’s first book “The Theory of Moral Sentiments” is in fact a Behavioural Economics treatise and within it Smith talks about its contribution to both psychology and ethics. Its purpose is to find a rationale for ethical judgement in human psychology. The latter is found in human nature: a human being put in a certain situation has a tendency to react in a certain way eg. includes sympathy, feelings and approval by others. It was Smith’s belief that human behaviour was impacted by emotions such as fear and anger and drives such as hunger. However according to Smith these emotions and drives were checked by an “impartial spectator”.

The impartial spectator allows one to see one’s own feelings and the pulls of immediate gratification from the perspective of an external observer.

In the domain of self-control and self-governance, the impartial spectator takes the structure of a long-term interest – “I won’t have that rich cream cake at morning tea because I can see that I will feel guilty about it later”. In the area of social interaction, the impartial spectator allows us to see things from another’s perspective rather than to be blinded by our own needs. The dissention is especially significant when you consider savings decisions – savings is a precision choice to delay immediate indulgence for a long-term interest. So we have the conflict between the voice of a short-term pull versus the voice of the impartial spectator.

Only recently has the field of economics advanced enough to have the tools to reincorporate the factors that Smith had always felt were important in human interaction: our caring about each other and about fairness, our difficulties with aligning our long-term interests with short-term pulls, etc. One of the most unexplored areas, which we are only now beginning to be able to measure, is the degree to which people are motivated by reputation and social status, something Smith thought was a crucial motivation for economic activity.

Nudge

The essence of behavioural economics stems from a concern that rational behaviour driven by self-interest will not guide many of us to health, wealth and happiness. People tend to make bad decisions whether it is not saving or eating the wrong type of food. This disturbing state of affairs arises because homo economicus tends to be in a continuous condition of information overload, and consumer makes errors because of their unfamiliarity about options and their effect. Richard Thaler and Cass Sunstein argue in ‘Nudge’ that subtle changes can influence peoples decision so that they can make choices that will improve their well-being. However, consumers use various methods in deciding their optimal consumption as the cost (time and effort) of acquiring all the information about the benefits of product/service might outweigh the benefits of consuming it.

Homo Economicus – the basis for a majority of economic models is the assumption that all human beings are rational and will always attempt to maximize their utility – whether it be from monetary or non-monetary gains

Observatory of Economic Complexity (OEC) – great graphics on global trade

I picked up the OEC site from Michael Cameron’s blog ‘Sex, Drugs and Economics’. The Observatory of Economic Complexity is a tool that allows users to quickly compose a visual narrative about countries and the products they exchange. It was Alexander Simoes’ Master Thesis in Media Arts and Sciences at the MIT Media Lab. The project was conducted at The MIT Media Lab Macro Connections group. Alex’s Advisor was César A. Hidalgo, principal investigator of Macro Connections. Since its creation in 2010, the development of The Observatory of Economic Complexity has been supported by The MIT Media Lab consortia for undirected research.

The graphics on each country and products are superb and include:

  • Exports
  • Imports
  • Trade Balance
  • Destinations

It also includes Economic Complexity Index which measures the knowledge intensity of an economy by considering the knowledge intensity of the products it exports. Below are some images on New Zealand trade.

New Zealand Exports – 2015

NZ Exports 2015.png

New Zealand Imports – 2015

NZ Imports 2015

Government debt as % of GDP – New Zealand amongst the lowest in the OECD.

In 2015 New Zealand’s government debt as a % of GDP was amongst the lowest amongst the OECD countries coming in at 35.6% – NZ$86.1bn. This gives the government the ability to borrow billions of dollars to stimulate growth in the economy and fund necessary infrastructure projects. This is important when a recession phase is threatening the economy. In 2015 the median level of debt to GDP was the Netherlands with 77.5% and Australia was 67.7%. The UK and the USA had debt to GDP of 112.6% and 125.9%. The standout countries are Japan with debt of 234% of GDP and Greece at 182%. High amounts of debts are only become a concern when the debt is mainly funded from overseas and issues in non-local currency and the country is unable to alter its exchange rates. For Japan a lot of the debt has been issued internally and been bought by the Bank of Japan (central bank) but this is not the case for Greece as they have had significant help from other countries.

Govt debt as % GDP

Does aggressive or cautious fiscal stimulus lead to higher debt-to-GDP ratio?

With low interest rates globally and liquidity trap conditions a more expansionary fiscal policy has become more prevalent for most governments. However the level of severity of fiscal policy – aggressive fiscal stimulus v cautious fiscal stimulus – is important with regard to a country’s debt-to-GDP ratio as recent experience shows. A paper by Alan Auerbach and Purity Gorodnichenko of University of California Berkeley found that short bursts of expansionary fiscal stimulus doesn’t necessarily lead to higher debt-to-GDP ratios or to higher interest rates. They noted that in some instances markets revised down their worries about creditworthiness in response to large scale stimulus.

Other research by Brad De-Long University of California Berkeley and Larry Summers Harvard University seems to support this view. Their research suggests that long periods of cautious growth eat away at an economy’s productive potential as investments don’t get finished and healthy workers drop out of the labor force.

In future the level of stimulus and its time periods should be automatic and proportionate to the severity of the downturn. Examples could include:

  • Labour tax rates could be linked to unemployment figures so that pay packets jump the moment conditions deteriorate.
  • Funding to local governments could be similarly conditioned, to limit painful cutbacks by municipalities.
  • To prevent a scramble for worthwhile, shovel-ready infrastructure projects, governments could make sure to have a ready queue, so spending could easily scale up in a downturn.

Sources:

  • The Economist – The Borrowers – 9th September 2017
  • BERL: New Zealand among lowest government debts in OECD – 26th September 2017

Growth from cutting capacity – Chinese way

Economic growth is normally we associate growth with capital investment and a shifting out of the production possibility curve. The Chinese have implemented an alternative policy that entails cutting capacity of its steel and coal production by at least 10% over 5 years which will reduce global supply by 5%. The rationale behind this is that:

less supply = greater scarcity = higher prices = greater profits.

Supply curve leftAlthough there have been doubters over this policy it seems to have worked. Coal and steel prices increased as have the profits in those industries and this has led global markets to be more positive about China’s economy. The higher prices has also reduced the threat of deflation coming out of China. Furthermore the Yuan has appreciated and nominal growth has close to a five year high.

Problems with this policy:

  • The higher price caused by reduced supply raised concerns that supply would lead to surplus capacity.
  • The underlying problem was that cheap loans were forthcoming from Chinese banks for certain projects run by state-owned firms. This can lead to an uncomfortable scenario with the firms being reckless as if their investment runs into trouble they will be bailed out by the government.
  • The reducing of output of steel and coal means a loss of 1.8m jobs which will concern Chinese authorities as a top priority has been to keep unemployment as low as possible and thereby limiting possible unrest that may follow.

Lower income extroverts spend more on status enhancing goods

People who are ‘extraverted’ and on low incomes buy more luxury goods than their introverted peers to compensate for the experience of low financial status, finds new UCL research. In Psychological Science, Dr Landis and Dr Gladstone analyse a year of data from more than 700 British bank accounts in 2014. They sort purchases into categories, ranging from high-status (foreign air travel, electronic goods and so on) to low-status (money spent at salvage yards and discount stores). They then correlate the results with those from personality tests taken by the account-holders.

People living on a low income often feel low status in society and spend a higher percentage of their money on goods and services that are perceived to have a high status. Previous research has found that people who are sociable and outgoing care more about their social status than others. The new research shows that when extraverted people have a lower income, they spend proportionately more on status goods than introverts on the same income. At higher incomes, the difference in spending lessens as introverted people buy more luxury goods.

The study analysed thousands of transactions from 718 customers over 12 months. The results took into account other factors that could influence spending habits, such as age, sex, employment status and whether the customers had children. Cash spending was also taken into account.

low income conspicuous cons.pngEach person’s spending data were sorted into a number of spending categories from one (very low status) to five (very high status). High-status categories (i.e., those with average scores of four or five) included foreign air travel, golf, electronics and art institutions, whereas low-status categories (i.e., those with average scores of two or one) included pawnbrokers, salvage yards and discount stores.

The team found the interaction between income and extraversion in predicting spending on luxury goods is significant and emphasize that while this useful in understanding the relationship, further research is needed to see whether the relationship is causal and whether the results are representative of the UK population as a whole.

The study found, though, that the gap widened with poverty.

  • Extroverts with an annual income of £10,850 the 25th percentile of British individual incomes in 2014, spent approximately 65% more on high-status goods than similarly remunerated introverts did.
  • Extroverts with an annual income of £28,470 the 75th percentile, they spent only 14% more. This suggests how keenly extroverts feel about keeping up appearances.

Sources:

  • The Economist “Poor extroverts spend proportionately more on buying status” 26th August 2017
  • UCL – Personality drives purchasing of luxury goods – 23rd August 2017

Where is inflation?

Since the GFC in 2007/8 the developed economies have been awash with stimulatory forces including quantitative easing, record low interest rates and increased government spending. This has led to accelerating growth levels driven by an increase in Aggregate Demand – C+I+G+(X-M). Business and consumer confidence has also increased and this has come about by the decline in financial and economic risk.

Supply ShockSo you would assume with stronger aggregate demand that the capacity constraints in the supply of goods and services accompanied by shortages in the labour market would lead to inflationary pressure. Yet in some countries core inflation has actually fallen and this creates a dilemma for central banks as although there is growth in their economy the inflation rate is below their target band. A reason for this could the supply side shocks (Aggregate Supply to the right – see graph). The following maybe the cause:

  • Globalization keeps cheap goods and services flowing from China and other emerging markets.
  • Weaker trade unions and workers’ reduced bargaining power have flattened out the Phillips curve (see below), with low structural unemployment producing little wage inflation.
  • Oil and commodity prices are low or declining.
  • And technological innovations, starting with a new Internet revolution, are reducing the costs of goods and services.

NZ Phillips Curve

Sources: Project Syndicate, Economicsonline.co.uk