Author Archives: Mark

Global remittances take a hit with Covid-19

Emerging economies have been affected in numerous ways by Covid-19. The following are just some:

  • Limited movement of their population
  • loss of export earnings
  • drop in foreign direct investment
  • fall in remittances.

Regarding the last one – the World Bank have estimated that global remittances will decline by 20% in 2020 – more than US$100bn – due to the Covid-19 pandemic and shutdown. There are expected to fall across the regions – see graph below:

In 2019 remittances reached a record US$554 billion but are estimated to be US$445bn in 2020. With the fall in foreign direct investment they have become even more important to low and middle income countries (LMIC). In 2019 remittances were greater than foreign direct investment and were the biggest source of capital in LMIC – 8.9% of GDP. This is especially prevalent when you consider that FDI is expected to plunge by more than 35% to LMIC in 2020.

The importance of remittances is also significant when pooling a poverty figures – it is estimated that a 10% increase in remittances reduces poverty by 3%.

A fall in remittances means:

  • less spending the economy as a whole
  • more people below the poverty line
  • more people unable to afford food, healthcare and basic needs

The World Bank estimate that in 2019 there were 272m international migrants of which 26m were refugees. As well there were in 700m migrants within a country providing financial support elsewhere. However with a downturn in the economy due to Covid-19 it is the foreign workers who are first to lose their job. 2021 might see a slight recovery with remittances set to rise by 5.6% to US$470bn but many things can eventuate over the next year.

A2 Economics – Wage Price Spiral and the Long Run Phillips Curve

Just covering this topic with my A2 class. Part of the CIE A2 macro syllabus focuses on the wage price spiral which relates to the Phillips Curve. Here are some excellent notes that I picked up from Russell Tillson in my early days teaching at Epsom College. As from previous posts, the Phillips Curve analysed data for money wages against the rate of unemployment over the period 1862-1958. Money wages and prices were seen to be strongly correlated, mainly because the former are the most significant costs of production. Hence the resulting curve purported to provide a “trade-off’ between inflation and unemployment – i.e. the government could ‘select’ its desired position on the curve.During the 1970’s higher rates of inflation than previously were associated with any given level of unemployment. It was generally considered that the whole curve had shifted right – i.e. to achieve full employment a higher rate of inflation than previously had to be accepted.

Milton Friedman’s expectations-augmented Phillips Curve denies the existence of any long-run trade off between inflation and unemployment. In short, attempts to reduce unemployment below its natural rate by fiscal reflation will succeed only at the cost of generating a wage-price spiral, as wages are quickly cancelled out by increases in prices.

Each time the government reflates the economy, a period of accelerating inflation will follow a temporary fall in unemployment as workers anticipate a future rise in inflation in their pay demands, and unemployment returns to its natural rate.

The process can be seen in the diagram below – a movement from A to B to C to D to E

Friedman thus concludes that the long-run Phillips Curve (LRPC) is vertical (at the natural rate of unemployment), and the following propositions emerge:

1. At the natural rate of unemployment, the rate of inflation will be constant (but not necessarily zero).

2. The rate of unemployment can only be maintained below its natural rate at the cost of accelerating inflation. (Reflation is doomed to failure).

3. Reduction in the rate of inflation requires deflation in the economy – i.e. unemployment must rise (in the short term at least) above its natural rate.

Some economists go still further, and argue that the natural rate has increased over time and that the LRPC slopes upwards to the right. If inflation is persistently higher in one country that elsewhere, the resulting loss of competitiveness reduces sales and destroys capacity. Hence inflation is seen to be a cause of higher inflation.

Rational expectations theorists deny Friedman’s view that reflation reduces unemployment even in the short-run. Since economic agents on average correctly predicted that the outcome of reflation will be higher inflation, higher money wages have no effect upon employment and the result of relations simply a movement up the LRPC to a higher level of inflation.

Moral hazard and Covid-19

Nobel Prize winning economist Paul Krugman defined moral hazard as:

Any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.

Companies exploiting moral hazard privatise the reward (they keep the profit) but socialise the risk (government bails them out if everything goes wrong)

Moral Hazard and the GFC
During the Great Depression more than 6000 American banks went bankrupt between 1930-33 and caused significant levels of unemployment. Learning from this event authorities believe that in future banks should be bailed out and this eventuated after the GFC in 2008. The main cause of the GFC was the sub-prime mortgage market where lenders faced a situation of moral hazard. Because the banks were taking on the risk the mortgage brokers, who sold the mortgages to the banks, didn’t really check whether the person taking on the mortgage could actually pay it back. Brokers were encourages to lie on the mortgage contracts about the income etc of their clients.

Moral Hazard and Covid-19
With corporate stimulus packages rolling out in most countries one wonders if there have been thorough enough checks on corporate behaviour. Issues like firing employees and bonuses to the top executives of companies have been prevalent in the past especially during the GFC. Then large businesses were favoured over small businesses. Today some of the wealthiest people made their money by borrowing from the banks to buy their own company shares in order to inflate its price. Following this they then sold their shares for a profit on the market. Now some of them are asking for bailouts as their company starts to struggle to survive. As well as government bailouts the central banks around the world have also engaged in the purchase of bonds and risky high-yielding debt. This is to ensure liquidity in the market but this intervention could shape how people perceive risk in the future and reward those institutions that behaved recklessly before the pandemic. Also more generous unemployment by the government might encourage people to be laid off and not seek work. However the time taken to minimise the moral hazard could have meant greater economic harm to the economy as a whole.

New Zealand economy and Covid-19 – importance of C+I+G+(X-M)

Below is a useful graph from the ANZ Quarterly Economic Outlook – full publication here. It covers Aggregate Demand in the New Zealand economy and the relative importance of each of the four components AD = C+I+G+(X-M).

C = Private Consumption
I = Business Investment
G = Government Consumption
(X-M) = Net Exports


Notice how consumption and investment become negative during the Covid-19 pandemic – over 15% of GDP in the first quarter of 2021. However it could be expected that net exports will start to bring in much needed growth in the economy – New Zealand is lucky to be a producer of food an inelastic product meaning the demand remains quite stable. With weak domestic demand there is no such need for imported capital goods as business investment starts to dry up. With net exports, Government spending also will be a significant part of a recovery and to offset the deficit in consumption (C) and investment (I).

Income from the tourism industry will be limited in New Zealand as the country closes its borders although domestic demand could offset some of this loss. But with a loss of income and job insecurity this spending might not be forthcoming.

The recovery will require a massive stimulus – monetary and stimulus. For the RBNZ negative interest rates might be considered as a policy option especially with a depressed labour market and the threat of deflation. As the ANZ point out in their publication there are plenty of long-term challenges ahead. But New Zealand is resilient, and has come into this crisis with a lot of advantages:

  • We have been in a position to respond to the outbreak quickly;
  • We produce a lot of essential goods domestically and our exports are still in demand;
  • We have a well-functioning health system and government;
  • We have plenty of fiscal firepower to respond;
  • The financial system is resilient; and
  • The exchange rate and monetary policy can provide a buffer.

Modern Monetary Theory (MMT) and Covid-19

Modern Monetary Theory says that you can basically print your own currency by having your own central bank, run large deficits, have full employment, have no inflationary pressure and do this year after year. Nouriel Roubini (see video below) warns that while large deficits and monetary stimulus make some sense during a short deflationary economic contraction, sustaining those policies for years, as he expects will happen, will lead to inflation and economic stagnation – stagflation.

However in a time of crisis like Covid-19 there seems to be a lot more justification for this type of policy over the short-term – when you have a collapse of economic activity, a recession, deflationary concerns and a major reduction in the velocity of circulation of money (MV=PT) – a sort of stag-deflation. At this time a ‘helicopter drop’ makes sense because we have a massive fall in supply as well as demand. But monetising fiscal deficits over a number of years produces a negative supply shock that reduces potential output and increases costs ending up with stagflation like in the 1970’s.

Background to MMT

MMT has its roots in the theory of John Maynard Keynes who during the Great Depression created the field of macroeconomics. He stated that the fact that income must always move to the level where the flows of saving and investment are equal leads to one of the most important paradoxes in economics – the paradox of thrift. Keynes explains how, under certain circumstances, an attempt to increase savings may lead to a fall in total savings. Any attempt to save more which is not matched by an equal willingness to invest more will create a deficiency in demand – leakages (savings) will exceed injections (investment) and income will fall to a new equilibrium. When you get this situation it is the government that can get the economy moving again by putting money in people’s pockets.

MMT states that a government that can create its own money therefore:

  1. Cannot default on debt denominated in its own currency;
  2. Can pay for goods, services, and financial assets without a need to collect money in the form of taxes or debt issuance in advance of such purchases;
  3. Is limited in its money creation and purchases by inflation, which accelerates once the economic resources (i.e., labor and capital) of the economy are utilised at full employment;
  4. Can control inflation by taxation and bond issuance, which remove excess money from circulation, although the political will to do so may not always exist;
  5. Does not need to compete with the private sector for scarce savings by issuing bonds.

Within this model the only constraint on spending is inflation, which can break out if the public and private sectors spend too much at the same time. As long as there are enough workers and equipment to meet growing demand without igniting inflation, the government can spend what it needs to maintain employment and achieve goals such as halting climate change.

How does it differ from more mainstream monetary policy – see table below.

Those against MMT are dubious of the idea that the treasury and central bank should work together and also concerned about the jobs guarantee. They argue that if the government’s wage for guaranteed jobs is too low it won’t do much to help unemployed workers or the economy, while if it’s too high it will undermine private employment. They also say that trying to use fiscal policy to steer the economy is a proven failure because politicians rarely act quickly enough to respond to a downturn. They can’t be relied upon to impose pain on the public through higher taxes or lower spending to quell rising inflation.

US unemployment figures – Great Depression again?

The number of people applying for unemployment benefit in the US over the last four weeks is astonishing – 22 million which represents 13% of the labour force. Some economists are suggesting that it will go above 15% in the next couple of months as the lockdown continues to impact businesses.

“There’s nowhere to hide,” said Diane Swonk, chief economist at Grant Thornton in Chicago told the New York Times. “This is the deepest, fastest, most broad-based recession we’ve ever seen.”

Getting money quickly to people who need it is essential to limiting the economic damage and heading off a prolonged downturn, economists say. Relying on state unemployment offices, however — which had been set up and staffed to deal with record-low jobless rates — has resulted in mammoth delays. New York Times

The graph below represent these figures in a historical context. It would not be surprising if the rate went above that of the Great Depression – 25%. However these estimates would be dependent on a L U V or W recovery – see previous blog post. The graph below is from GZERO.

Covid-19 and impact on the airline industry

The global airline industry has been one of those that has been hardest by Covid-19. In the US passenger volume is down 96 %, whilst globally losses have topped US$314bn worldwide. Based on booking patterns Air New Zealand will lose over NZ$5bn in revenue per year and a loss of 3.500 jobs. What makes it even worse is that the latest Oxford Economics forecast shows that the loss in global output could be double that of the GFC. This has implications on the speed of the recovery in air travel in the second half of 2020. The table shows that Asia-Pacific takes a big hit financially and is second behind Middle East/Africa (51%) with a 50% loss in RPK.

Source: IATA Economics

RPK = Revenue Passenger Kilometres is an airline industry metric that shows the number of kilometres traveled by paying passengers

IATA estimate that RPKs will decline by 48% in year-on year terms and passenger revenues will be US$314 billion lower this year compared to 2019- see table below. IATA note that a typical airline has cash to cover around two months of revenue loss.

Below is a short video from PBS Newshour with Paul Solman looking at the airline industry.

Post Covid-19 scenarios – New Zealand & Global economies

ASB bank published some of its forecasting for the Global and New Zealand economies and number of potential routes – read the full article here. They have come up with a central scenario which focuses on what is actually happening at the moment although we know how things can change. They then do an upside and a downside around this central forecast. They also published some graphs that relate to their scenarios – see below.

The ASB also noted that compared to other countries New Zealand is currently in a good position:

  • The economy is going into a deep but short-lived contraction – the economy will recover.
  • NZ has more fiscal and monetary ammunition than other countries.

Where the economy actual ends up – how long is a piece of string? Stay safe.

Why do developing countries like a strong currency?

In the majority of economics textbooks a depreciation of the exchange is beneficial to an economy especially those like developing countries which depend a lot on export revenue.

A fall in the value of the exchange rate will make exports cheaper and so acts as an implicit subsidy to firms that sell abroad. Exposure to world markets also helps companies in the developing world learn and improve.Finished imported products that are still purchased will be more expensive and some of these will count in the country’s consumer price index. Costs of production will be pushed up because the cost of imported raw materials will rise. Domestic firms may also feel less competitive pressure to keep costs and prices low.

A rise in the value of exchange rate will make exports more expensive in terms of foreign currencies, and imports cheaper in terms of the domestic currency. Such a change is likely to result in a fall in demand for domestic products. A higher exchange rate may also reduce inflationary pressure by shifting the aggregate supply curve to the right because of lower costs of imported raw materials. The price of imported finished products would also fall and there would be increased competitive pressure on domestic firms to restrict price rises in order to try to maintain their sales at home and abroad.

It has been traditional for developing countries to try and engineer a weaker currency to make their exports more competitive especially as this revenue is one way in which their economies can start to grow. China and other South East Asian economies adopted this strategy as they went through industrialising their economy. Empirical studies suggest that an undervalued currency boosts growth more in developing rather than developed economies.

Why then is it that some African countries still want to maintain a strong currency? Primary sector exports and overseas aid raises the demand for local currencies making them appreciate. Governments are concerned about a weaker currency as

  • Some are dependent on capital imports to finance infrastructure projects
  • It forces them to spend more income to pay back foreign debts.
  • Pushes up the cost of imported goods, including food, medicine and fuel – mainly impacts the city population who are more likely to complain to politicians.
  • Some companies in developing countries import a lot of their machinery and raw materials – additional cost to their production.
  • A weaker currency does make exports cheaper but this can be nullified by more expensive imports.

However all of this has been overshadowed by COVID-19. The pandemic is increasingly a concern for developing countries which rely heavily on imports to meet their needs of medical supplies essential to combat the virus.

OECD estimates on the impact of Covid-19 on economic activity

A recent OECD publication shows the economic disruption that is ahead of us. It looks as if the demand tap has been turned off with the lockdown with only essential services available. Some countries could see GDP being reduced by up to 29% – see graph. The majority of the impact comes from the loss of retail and wholesale trade although there are also notable cross-country differences in some sectors.

  • Germany (DEU) – 29% – closures of car industry
  • New Zealand – 28% – decline in tourist and leisure activities

Extending the same approach to other economies suggests that the impact effect of business closures could result in reductions of 15% or more in the level of output throughout the advanced economies and major emerging-market economies after the full implementation of confinement measures.

Many countries in which tourism is relatively important could potentially be affected more severely by shutdowns and limitations on travel.

At the other extreme, countries with relatively sizeable agricultural and mining sectors, including oil production, may experience smaller initial effects from containment measures, although output will be subsequently hit by reduced global commodity demand. As New Zealand has also got a significant primary sector does this graph over estimate the impact on its economy?

Source: Evaluating the initial impact of COVID-19 containment measures on economic activity