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.
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.
- The Economist – The Borrowers – 9th September 2017
- BERL: New Zealand among lowest government debts in OECD – 26th September 2017
Just been doing some revision with my CIE AS class and discovered this diagram on macro policies. Mind maps like this are very useful ways of revising topics.
Fiscal policy can be distinguished from monetary policy, in that fiscal policy deals with taxation and government spending and is often administered by an executive under laws of a legislature, whereas monetary policy deals with the money supply, lending rates and interest rates and is often administered by a central bank.
Supply-side policies are mainly micro-economic policies aimed at making markets and industries operate more efficiently and contribute to a faster underlying-rate of growth of real national output
New to the A2 syllabus last year was the Laffer Curve. PBS Economics correspondent Paul Solman explores the question of just how high U.S. tax rates should or shouldn’t be and examines the relationship between economic activity and tax rates. There is a good explanation of the Laffer Curve which is the relationship between economic activity and tax rates.
In between, a smooth curve representing Laffer’s pretty simple idea: Somewhere above zero percent and below 100 percent, there is a tax rate where government will collect the most revenue in any given year. Now, the Laffer Curve applies to everyone, but the top so-called marginal rate is only relevant to the rich. It’s now 35 percent on all taxable income in excess of about $380,000 a year. Does that 35 percent rate maximize total tax revenue for the government?
Sad news yesterday of the passing of John Clarke. As well as his Fred Dagg character he was part of ‘Clarke and Dawe’ which aired on ABC Australia in which prominent figures speak about matters of public importance. Below is the time they look into what Quantitative Easing actually is. Very amusing and his sense of humour will be missed.
The FT had an excellent article back in April last year that covered many concepts which are a part of Unit 4 of the CIE A2 Economics course. It covers the liquidity trap, deflation, MV=PT, circular flow, Monetary Policy, Quantitative Easing etc.
The article focuses on the liquidity trap with Monetary Policy being the favoured policy of central banks. However by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.
Normally lower interest rates lead to:
- savers spending more
- capital being moved into riskier investments
- cheaper borrowing costs for business and consumers
- a weaker currency which encourages exports
But when interest rates go negative the speed at which money goes around the circular flow (Velocity of Circulation) slows which adds to deflationary problems. Policymakers pump more money into the circular flow to try to stimulate growth but as price fall consumer delay purchases, reducing consumption and growth.
The article concludes by saying Monetary Policy addresses cyclical economic problems, not structural ones. Click below to read the article.
The global liquidity trap turns more treacherous.
Just been going through this part of the course with my A2 class and came across a table from some old A Level notes produced by Russell Tillson (ex Epsom College Economics and Politics Department) to help them understand the principal differences.
You may remember a previous post I did on ‘WetheEconomy’ now there is ‘WetheVoters’ The site has 20 short films designed to inform, inspire and ultimately activate voters nationwide with fresh perspectives on the subjects of democracy, elections and U.S. governance.
Below is a parody of the television programme “Real Housewives” with a political and economics twist. It shows a good example example of the current political climate and some possible avenues for change. On the one side you have Jessica who is concerned with the government balancing its budget and Lara who believes that the government needs to spend more on infrastructure etc to stimulate the economy and creates jobs. She also uses the austerity measures in the EU as an example to support her opinion. Jessica does make the point as to who is going to pay for all this spending – our kids. Then there is Vanessa who is neutral although does get into trouble by informing Lara that Jessica thinks the government should increase defence spending. From this point it gets quite heated but they do make up. Enjoy!
Here is a powerpoint on “Keynesian and Monetarist Theory” that I use for revision purposes. I have found that the graphs are particularly useful in explaining the theory. The powerpoint includes explanations of:
– Circular Flow and the Multiplier
– Diagrammatic Representation of Multiplier and Accelerator
– Quantity Theory of Money
– Demand for Money – Liquidity Preference
– Defaltionary and Inflationary Gap
– Extreme Monetarist and Extreme Keynesian
– Summary Table of “Keynesian and Monetarist”
– Essay Questions with suggested answers.
Hope it is of use – 45˚line shown. Click the link below to download the file.
Keynes v Monetarist Keynote
There is growing anxiety that policymakers in the developed world will need to consider some radical approaches to tackling the next downturn. Quantitative easing (the buying of government bonds using the money of the central bank) is limited and with interest rates already a record lows a further drop is unlikely to stimulate much more aggregate demand. Fiscal policy could be employed – tax cuts and increases in government spending. However the issue here is how much fiscal stimulus can government’s afford with the debt they already have? See table
Government policy in recent years has done little to improve the economic climate. Although there has been many rounds of quantitative easing the productivity of those in work has been poor leading to lethargic growth levels. This ultimately limits real wage growth and tax revenue to reduce government debt levels. Economies are now doomed to many years of weaker growth with lackluster demand which will mean more radical policies outside the square. Some policy options could be:
Fusing Monetary and Fiscal Policy
An option discussed in The Economist was to finance public spending and the tax cuts by printing more money. This could be more effective than Quantitive Easing (QE) as the money now bypasses the banking system and goes straight into the pockets of the consumers. This would hopefully encourage consumers to spend money straight away instead of going through the process of borrowing money from the bank as is the case with QE.
Incomes Policy – wage-price spiral
The aim of an incomes policy in the 1960’s and 70’s was to link the growth of incomes to the productivity so as to prevent the excessive rises in factor incomes which raise costs and hence prices. However the idea here is to generate higher incomes at all levels by using tax incentives and to encourage a wage-price spiral. This seems bizarre in the context of the 1970’s as this is what governments were trying to solve.
Capital spending on infrastructure is seen as a much more effective tool to stimulate growth than tax cuts. Unlike tax cuts, capital spending goes directly into the circular flow and it attracts complementary spending elsewhere in the economy more than any other intervention. It is estimated that a third of roads in the USA are in a poor state and over 10% of its bridges are not structurally sound. However although it might sound a good idea, infrastructure spending can be wasteful as even many years of capital spending in Japan hasn’t had the desired effect of boosting the economy.
Where to from here?
The problem, then, is not that the world has run out of policy options. Politicians have known all along that they can make a difference, but they are weak and too quarrelsome to act. America’s political establishment is riven; Japan’s politicians are too timid to confront lobbies; and the euro area seems institutionally incapable of uniting around new policies.
Source: The Economist – 20th February 2016
The December 2015 edition of the New Internationalist discussed 10 Economic Myths that need to be addressed especially after the GFC. Below is the list and the NI goes through each in detail – click here to go to the NI website.
Myth 1: Austerity will lead to ‘jobs and growth – ‘
It’s wrong to sell austerity as a cure for economic woes
Myth 2: Deficit reduction is the only way out of a slump
- Don’t rely on those who caused the crash to resolve it
Myth 3: Taxing the rich scares off investors and stalls economic performance
– Taxation creates prosperity just as much as private enterprise
Myth 4: Economic migrants are a drain on rich world economies
– Migration follows a demand for labour and benefits the receiving country
Myth 5: The private sector is more efficient than the public sector
– There is no evidence of greater efficiency
Myth 6: Fossil fuels are more economically viable than renewables
– Not if you look at the environmental costs
Myth 7: Financial regulation will destroy a profitable banking sector
– Why should financial markets be accountable only to themselves?
Myth 8: Organized labour is regressive –
It can be argued that the opposite is actually true.
Myth 9: Everyone has to pay their debts
– We need debt management not reduction
Myth 10: Growth is the only way
– why we need to find another way, fast.
Although it is repetitive in places especially when they talk of debt and austerity it does provide some valid arguments. I think that the last myth ‘Growth is the only way’ is of particular importance in that GDP growth at all costs has led to wasteful resource use, particularly by the wealthier countries, on an unparalleled scale and without a backward glance. It is often noted that the economy is a subset of the ecological system, but equally there seems to be a belief that nature can cope with anything we throw at it. However, an assessment by the Global Footprint Network indicates we are running a dangerous ecological debt. Currently the global use of resources and amounts of waste generated per year would require one and a half planet Earths to be sustainable (see graph below). The price to be paid for this overshoot is ecological crises (think forests, fisheries, freshwater and the climatic system), a price that is again paid disproportionately by the poor.