Category Archives: Fiscal Policy

How do we stimulate the global economy in tackling the next downturn?

There is growing anxiety that policymakers in the develoPublic Debtped 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.

Infrastructure development

InfrastructureCapital 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


10 Economic Myths from the New Internationalist

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.

ecological footprint

House price inflation: Ireland v New Zealand

Brian Gaynor wrote a piece in the NZ Herald comparing features of the Irish and New Zealand economies. One area that he focused on was the increase in residential property prices from 1995 – 2015.

Ireland – 199%
New Zealand – 232%

Although New Zealand house prices have been increased by a larger percentage it is interesting to note that they have been relatively steady whereas Irish prices peaked in mid-2007 and then plunged 50% by early 2013. Since then they have recovered 31% but are still 35% below their highs in 2007.

Dublin house prices (average) – 2007 = $730,000 2015 = $485,000
Auckland house prices (average) – 2015 = $771,000

LTV – Loan to Value

Like the RBNZ the Irish central bank has introduced new regulations regarding mortgage lending by regulated financial services providers. These included mortgages of no more than 80 per cent of LTV (loan to value) on the principal private dwelling and no more than 70 per cent LTV on investment properties. Additionally mortgage loans on the principal private dwelling are restricted to 3.5 times gross income in Ireland but this ratio in New Zealand is 6 times although 9 times gross income in Auckland.

Ire v NZTax Policy
The two countries tax policy are interesting when you compare how they impact companies and individuals. The message for the New Zealand economy is that the experience of the Irish economy shows that countries take a long time to recover from the impact of housing collapse.

AS and A2 Macroeconomics: Internal and External Balances

In explaining the differences between internal and external balances I came across an old textbook that I used at University – Economics by David Begg. It was described as ‘The Student’s Bible” by BBC Radio 4 and I certainly do refer back to it quite regularly. Part 4 on macroeconomics has an informative diagram that shows the impact of booms and recessions on the internal and external balances.

Internal Balance – when Aggregate Demand equals Aggregate Supply (potential output). And there is full employment in the labour market. With sluggish wage and price adjustment, lower AD causes a recession. Only when AD returns to potential output is internal balance restored.

External Balance – this refers to the Current Account balance. The country is neither underspending nor overspending its foreign income. For a floating exchange rate, the total balance of payments is always zero. Since the balance of payments is the sum of the current, capital, and financial accounts, saying the current account is in balance then also implies that the sum of the capital and financial accounts are in balance.

In the diagram right the point of internal and external balance is the intersection of the two axes, with neither boom nor slump, and with neither a current account surplus nor a deficit.

The top left-hand quadrant shows a combination of a domestic slump and a current account surplus. This can be caused by a rise in desired savings or by an adoption of a tight fiscal policy and monetary policy. These reduce AD which cause both a domestic slump and a reduction in imports.

The bottom left-hand corner shows a higher real exchange rate, which makes exports less competitive, reduces export demand and raises import demand. The fall in net exports induces both a current account deficit and lower AD, leading to a domestic slump.

In a downturn a more expansionary fiscal and monetary policy can hasten the return to full employment eg. Quantitative easing, tax cuts, lower interest rates. However one could say that today it doesn’t seem to be that effective.

New Zealand: #1 in Open Budget Index

From The Economist. New Zealand rates as having the highest level of budget transparency. The Open Budget Index measures the amount, level of detail, and timeliness of budget information that is publicly available in 102 countries. Only 24 countries have acceptable levels of budget transparency whilst the remaining 78 provide “insufficient” information; 17 of these provided scant or no budget information. Although transparency has improved since the last survey in 2012, thanks largely to improvements made by countries at the bottom of the index, the average score is still only 45 out of a maximum of 100. New Zealand = 88, South Africa = 87, USA = 81, China = 14

open budget index

AS Revision – Indirect Taxes

Currently at AGS doing a 3 day AS revision course. Used this graphic to explain indirect taxes. An indirect tax will have the following effects on the market:
Indirect Tax
• The supply curve shifts vertically upwards(effectively a shift to the left) by the amount of the tax(gf) per unit. The price increases but not by the full amount of the tax. This is because of the slopes of the demand and supply curves.
• The consumer surplus is reduced from acp to agb. The portion gbhp of the old consumer surplus is transferred to government in the form of tax.
• The producer surplus is reduced from pce to fde. The portion phdf of the old producer surplus is transferred to the government in the form of tax.
• The market is no longer able to reach equilibrium, and there is a loss of allocative efficiency resulting in the deadweight lost shown by the area bcd. This represents a loss of both consumer surplus bhc and the producer surplus hcd that is removed from the market. The deadweight loss also represents a loss of welfare to an individual or group where that loss is not offset by a welfare gain to some other individual or group.

10 reasons why not to be so concerned about China’s stockmarket plunge.

Last month the drop in the Chinese stockmarket – Shanghai Composite – sent alarm bells ringing around the world economy that the world’s second largest economy was in trouble. A recent Economist article (‘Taking a Tumble’ – August 29th 2015) suggest that all is not lost for the Chinese economy and the developed world should not be agitated. Several arguments were made to ease the concern of the West:

1. The Shanghai Composite in relation to the over all size of the Chinese economy is very small – 33% of GDP compared with over 100% in developed economies.
2. Stocks and the economic fundamentals are not strongly correlated – share prices increased 30% last year but this data didn’t reflect improved Chinese growth forecasts.
3. Less than 20% of Chinese household wealth is invested in shares.
4. The money borrowed by consumers to invest in the sharemarket amounts to just 1% of total banking assets – not significant.
5. For the Chinese economy the property market matters more than stocks and shares do. Housing and land account for the vast majority of collateral.
6. The service sector now accounts for a bigger share of national output than industry.
7. With regard to the fiscal position of the Chinese government things are looking quite positive. It aimed for a budget deficit of 2.3% of GDP this year, but as of July it was still in surplus, having raised more in taxes than it had spent. Therefore it has the ammunition if required to stimulate more growth.
China I and C8. The economy is rebalancing, albeit slowly, away from investment and towards consumption (see chart 3). China still has many more homes, highways and airports to build, but the trend away from them is unmistakable.
9. Economic growth is almost certainly lower than the rate reported by the government but it appears to be in the range of a soft landing.
10. The People’s Bank of China (central bank) still have room to cut rates – benchmark one-year lending rates are at 4.6%. Furthermore the required reserve ratios are at 18% for trading banks. The central bank has room to cut both rates whilst most developed countries don’t have that luxury.

Bad news for China’s trading partners

As a result, China’s appetite for commodities has probably peaked. That is bad news for companies and countries that prospered over the past decade by selling it mountains of iron ore, copper and coal – e.g. our cousins across the ditch in Australia. A decline in Chinese consumption would be of huge consequence: it absorbs about half the world’s aluminium, nickel and steel, and nearly a third of its cotton and rice.

The countries most exposed to shifts in China’s economy, meanwhile, are the commodity exporters who supply the raw materials for the steel girders and copper piping that have underpinned the construction boom.

Final thought
The plunge in the Chinese stockmarket was not evidence that the economy is on the edge. However, there are those that now doubt China as having such a safe economy.

How much wriggle room do countries have?

The Economist has devised a composite measure of interest rates, deficits and debt which are mechanism that tend to be used by a country’s policymakers to cope with a recession.

Interest Rates
They assign a value of 100 which is maximum wriggling room – that is interest rates that are 10% or above. A value of 0 means there is no room to drop interest rates i.e. interest rate are 0%.

They assign a value of 100 to those countries that have budget surplus of 5% of GDP or above. A value of 0 is given to deficits of 15% of GDP or more.

They assign 100 to a country that, in the IMF’s view, can borrow a further 250% of GDP or more and 0 to those, including Greece, Italy and Japan, that it judges to be testing markets’ faith.

The chart below shows how countries rank. Norway, South Korea and Australia are top and have all kept their interest well clear of 0% and have very low debt levels. On average the rich world’s wriggle room has fallen by about a third since 2007. The leeway of hard-pressed countries such as Italy and Spain has shrunk by nearly half.
Wriggle Rom

If only Greece owned Apple

Apple Greece bailoutA HT to colleague David Parr for this piece from The Sydney Morning Herald. Apple are currently worth $US194 billion in cash and securities which equates to €178 billion. This means that Apple have enough to cover the €86 billion Greek bailout deal struck earlier in the week twice over — with a cool €6 billion still left over to maybe buy an island or a port. If Apple were a country, it’d be the 55th richest country in the world.

According to the World Bank’s most recent data on national wealth, Apple is now worth more than the following countries:

Belarus – worth $467 billion
El Salvadore – worth $364 billion
Guatemala – worth $548 billion
Iceland – worth – $268 billlion
Jamaica – worth $211 billion
Kenya – worth $366 billion
Luxembourg – worth $419 billion
Mongolia – worth $34 billion
Nepal – worth $151 billion
Nicaragua – worth $101 billion
Sri Lanka – worth $424 billion
Tunisia – worth $475 billion