Category Archives: Macro

Bill Phillips and the working MONIAC

When Bill Phillips is mentioned most people think of the Phillips Curve. However, while a student at the LSE, Phillips used his training as an engineer to develop MONIAC, an analogue computer which used hydraulics to model the workings of the British economy, inspiring the term hydraulic macroeconomics. A live demonstration of the only working MONIAC in the Southern Hemisphere. This is located in the Reserve Bank Museum & Education Centre, Wellington, New Zealand. The video below is very informative.

A2 Economics – Multiplier

Just been looking at the multiplier with my A2 class and here are some notes and a mindmap. An initial change in AE can have a greater final impact on equilibrium national income. This is known as the multiplier effect and it comes about because injections of demand into the circular flow of income stimulate further rounds of spending.

Multiplier Process

Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realize an increase in their

incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)

You can also use the following formula which represents a four sector economy

1 ÷ MPS+MRT+MPM

MPS = Marginal propensity to save

MRT = Marginal rate of tax

MPM = Marginal propensity to import

MPC = Marginal Propensity to Consume (of additional income how much of it spent)

e.g. $1m initial spending; MPC=.8

=> income generated = 1/(1-.8) = 1/.2 = 5

=   $5m

=> $4m extra spending ($1m initial, $4m extra spending, $5m total)

Use different equations depending on the information given.

e.g.: a) if the MPC is 0.5 – 50% of the income will be spent, 50% will be saved.

then MPS is 0.5 then the multiplier is 2 = 1/0.5 = 2

b) if the MPC is 0.8 – 80% of the income will be spent then MPS is 0.2 then the multiplier is 1/0.2 = 5

c) if the MPC is 0.9 – 90% of the income will be spent then MPS is 0.1 then the multiplier is 1/0.1 = 10

What is the effect of MPT – the marginal propensity to tax or t.

  • greater MPT would lead to less income being spent in the economy

Below is a very informative mind map that I copied from an old textbook.

Multiplier.png

China’s ghost cities – there needs to be another plan

Below is a very good report from 60 Minutes Australia that gives you an update on China’s ghost cities. Roughly 22 percent of China’s urban housing stock is unoccupied, according to Professor Gan Li, who runs the main nationwide study. That adds up to more than 50 million empty homes, he said. One solution that the government could use is property or vacancy taxes to try to counter the issue, but neither appears imminent and some researchers, including Gan, say what actually counts as vacant could be tricky to determine.

For so long China has relied on major infrastructure projects including building cities to drive growth figures in their economy. Historically China’s economic model was based on export-led growth, massive government injections into the economy and access to cheap money. This is not sustainable and although you can keep blowing up bridges and build cities that nobody lives in at some point it becomes unsustainable. Furthermore since the global financial crisis economies have increased protectionist policies to look after their own economy and this has been followed with by the potential trade war with the USA. Therefore the Chinese government need to refocus the growth of the economy on domestic consumption rather than building things – Gross Fixed Capital Formation. So much more C than I in the GDP Expenditure equation. EG:

GDP = C↑+ I↓+ G + (X-M)

Economic Developments for 2019

This is a good summary of economic developments to watch in 2019 – from Al Jazeera. Some of the key points are:

  1. Protectionist policies will remain and any truce between the US and China will be short-lived.
  2. The US is in an unsustainable boom – the fiscal stimulus will fade and this will be followed by two larger deficits – budget and external. The US is consuming far more that it is producing and it mirrors the 1980’s – Reaganomics.
  3. China is slowing down – as well as the protectionist issues as a result of the US trade policy there are tensions between the economic system of capitalism and the political system of communism. This combination is referred to as ‘Market Socialism’. The problems are associated with: economic growth v environmental problems, rural areas v urban areas, rich v poor. China’s movement away from oil to gas which benefits Qatar but to the detriment of the Saudi economy.
  4. The Gulf economies are taking a hit from the fall in oil prices and government budgets may have to be cut. Diversification from the dependence on oil is necessary to avoid the resource curse and with a growing youth population job creating is needed. Movement to a more knowledge-based economy and large infrastructure projects are becoming focus areas as a necessity.

Turkey’s economy – stuffed

Inflation at 25%, Central Bank interest rates at 24%, Lira down 30% in value since the start of the year. What hope is there for the Turkish economy?

Wages and salaries haven’t kept pace with inflation and the reduction in demand has led to higher unemployment. There is pressure on the central bank to keep interest rates to avoid the lira collapsing. However this makes it expensive for businesses to borrow money and thereby reducing investment and ultimately growth.

No pain no gain – there is no alternative for Turkey other than undertaking painful and unpopular economic reforms. Remember what Reagan said in the 1980’s “If not now, when? If not us, who?”  He was referring to the stagflation conditions in the US economy at the time and how spending your way out of a recession, which had been the previous administration’s policy, didn’t work.

In order to the economy back on track things will need to get worse but President Erdogan has the time on his hands as there is neither parliamentary nor presidential elections in the next five years. This longer period should allow him the time to make painful adjustments without the pressure of elections which usually mean more short-term policies for political gain. Beyond stabilising the lira, which helped to ease the dollar-debt burden weighing on the country’s banks and corporate sectors, the 24 per cent interest rate level the central bank imposed also brought about a long-overdue economic adjustment. A cut in interest rates discourage net inflows of investment from foreigners and the resulting depreciation would accelerate the concerns about financial stability and deteriorating business and consumer confidence. Below is a mind map as to why a rise in the exchange rate maybe useful in reducing inflation.

Questions about the next recession.

Ryan Avent of ‘The Economist’ considers how the next recession might happen — he asks the following questions:

  1. When will the next recession be?
  2. Where will it begin?
  3. Is the world prepared for a recession?
  4. What are the obstacles?
  5. What should governments do?

Very good viewing for macro policies – Unit 4 and 5 of the CIE A2 Economics course.

With the downturn in an economy, cutting interest rates has been the favoured policy of central banks. But the use of quantitative easing (QE) might mean the end of conventional monetary policy with rates already at record low levels – 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.

Liquidity Trap

Global Monetary Policy – why are US rates on the rise?

With the A2 mock exam next week here is a post on the theory and applied aspects of monetary policy. Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.

Further goals of a monetary policy are usually to contribute to economic growth and stability, to lower unemployment, and to maintain predictable exchange rates with other currencies.

Monetary policy is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values. See  mind map of Monetary Policy below.

What have caused US interest rates to increase?

The US economy has been at the forefront of the global upswing in the last couple of years and compared to other countries they are imposing a contractionary monetary policy – see graph.

The central bank in the USA, the Federal Reserve, are confident that the economy is nearly at full capacity and that inflationary pressures are starting to become evident. The main factors behind this are as follows and they all point towards an increase in aggregate demand.

  • Higher GDP growth
  • Rising investment in oil and gas industry
  • Strong consumer spending
  • Tax cuts
  • Strong employment growth
  • Tight labour market
  • Higher wages

The US is the only major economy to impose a significant contractionary monetary policy and the Fed has increased its interest rate six times in the last two years, and four more rate hikes are expected over the next 12 months. The UK and Canada have raised their policy rates tentatively, while Europe and Japan are still in the midst of unconventional easing programmes and interest rate hikes are a distant prospect. Whilst the Reserve Bank in New Zealand don’t expect rates to rise until early 2020.

Volvo Ocean Race and the Multiplier Effect.

I am quite an avid watcher of the Volvo Ocean Race with the daily race updates and the excellent graphics on their website – currently they are in Auckland before setting sail for Itajaí in Brazil. Most days they have news on the current positions of the yachts and who has made gains and losses in the last 24 hours. A recent race update dealt with the economic impact that the race has had on the Spanish economy and it just happens that I am covering the multiplier with my A2 Economics class.

The Multiplier Explained

Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realise an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.

The value of the multiplier can be found by the equation ­1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy
1 ÷ MPS+MRT+MPM

Source: CIE Revision Guide by Susan Grant

Impact of Volvo Ocean Race on Spanish Economy

PriceWaterhouseCoopers (PwC) conducted a study measuring the impact of the Volvo Ocean Race on the Region of Valencia and Spain. Some their findings are:

  • The impact in the Region of Valencia has grown to 68.6 million euros in GDP and 1,270 full-time equivalent jobs.
  • Hotels, restaurants and local business were the sectors to benefit the most.
  • Alicante received 345,602 visitors from October 11 to 22, 2017, (10.3% more than in 2014-15 and 17.6% more than in 2011-12).
  • The Volvo Ocean Race had a significant positive effect on national tax revenue, adding more than 41 million euros.
  • The media value directly linked to coverage mentioning the Alicante brand over the period of the race start exceeds 36 million euros.

The Volvo Ocean Race 2017-18 has added 96.2 million euros to the Spanish Gross Domestic Product (GDP), an increase of 7.6% over the 2014-15 edition. The race also generated the equivalent of 1,700 full time jobs in Spain, according to an economic impact study delivered by PriceWaterhouseCoopers (PwC) measuring the impact of the Volvo Ocean Race on the Region of Valencia and Spain.

The impact in the Region of Valencia grew to 68.6 million euros of GDP, a 3.3% increase on the 2014-15 edition. The sectors of activity that benefited the most were local businesses and restaurants, each by more than 10 million euros. In terms of employment, the equivalent of 1,270 full-time jobs were generated, a figure similar to the last edition.

The PwC study estimates a positive effect on tax collection in Spain of more than 41 million euros as a result of an increase in economic activity and employment generated by the Volvo Ocean Race 2017-18.

The actual value of the multiplier is not mentioned in the report but from all accounts the Volvo Ocean Race has had a very positive impact on Valencia.

Recession Recovery or He-cession She-covery?

Radio NZLast Sunday there was a very good interview with Canadian economist Armine Yalnizyan on Radio New Zealand’s ‘Sunday’ Programme (with Wallace Chapman). She mentions that the neoliberal policies of the last 30 years have seen income inequality grow and the collapse of consumer spending (C) the main driver of any domestic economy. There has been an increase in the proportion of income accruing to assets which worsens inequality in many countries. China would be an economy that has relied a lot on its export sector (X) for growth but is now trying to drive domestic demand (C) to generate growth. Remember that Aggregate Demand = C+I+G+(X-M). She makes the point that corporates favour the return for shareholders rather than for example
the wages of employees.

“We have this very unusual situation here where corporations are gaining in strength for a host of reasons, similar to the type of corporate power 100 years ago, in key sectors of the economy with less ability to either tax a proportion of the profits they make or regulate their activities.”

Boosting the minimum wage is stimulatory

She also mentions an increase in the minimum wage being stimulatory with lower income groups spending a much higher proportion of their income and thereby increasing consumption. And the vast majority of this spending happens in the domestic economy – C↑. Some have talked of wage inflation by increasing the minimum wage but with the fall in trade union membership and bargaining power this has been significantly reduced. In fact we have seen wage compression.

He-cession and She-covery

However later on in the interview I was interested to her explanation of He-cession and She-covery during the interview.

Recession = “he-cession” – more men tend to become unemployed as areas that are initially impacted by the downturn are manufacturing, mining, construction etc which are likely to be male dominated.

Recovery = “she-covery”: men who lose $30 an hour jobs wince at accepting $15 an hour offers, but women grab them to make sure the bills get paid.

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