Category Archives: Macro

A2 Revision – Fiscal Policy

With the exam season just about to start in New Zealand I thought it appropriate to do some revision blog posts. In the CIE A2 paper there is always a macro policy question and it usually focuses on the conflicts between the different objectives. Below is a mindmap on fiscal policy that might be useful. Fiscal Policy involves the use of Government Spending and Taxation in order to influence the level of economic activity. The Government receives money through Taxation (T) and spends money through Government spending (G).

  • A budget deficit occurs when G > T
  • A budget surplus occurs when T > G

Japan and Argentina – bewilder macroeconomics

There is an old saying among economists: “throughout history there have been only four kinds of economies in the world: advanced, developing, Japan, and Argentina”.

The set of once-poor countries that are now rich include Japan, where the transition began more than 100 years ago, and some other East Asian countries such as Korea and Taiwan, whose transition started only 50 years ago and is now almost complete. But going the other way there is only one notable case of a country that started life relatively rich and ended up comparatively poor: this is the great puzzle or paradox of Argentina. In the late nineteenth century, it was among the top five countries in income per capita, richer than all European countries except Britain and on a par with other rich settler societies such as the United States, Canada, and Australia.

Japan and Argentina continue to confound macroeconomics. Below is a table comparing the Argentina and Japan at the moment. How different they are. It doesn’t look as if they will play each other in the Rugby World Cup as they are in different Pools. However if their macroeconomic conditions are anything to go by they should end up in the final

Source:

The Economist – Argentina v Japan – March 30th March 2019

50 basis points cut by RBNZ – are they going negative?

The 50 basis points of the OCR (Official Cash Rate) by the RBNZ took everyone by surprise. Cuts of this magnitude generally only occur when significant events happen – 9/11, the GFC, the Christchurch earthquake etc. However the US China trade dispute have significant implications for global trade and ultimately the NZ economy. The idea behind such a cut is to be proactive and get ahead of the curve – why wait and be reactionary.

The Bank has forecast the OCR to trough at 0.9 percent, indicating a possible further interest rate cut in the near future. The RBNZ believe that lower interest rates will drive economic growth by encouraging more investment but you would have thought that such low rates wold have been stimulatory by now. I don’t recall the corporate sector complaining too much about interest rates and according to the NZIER (New Zealand Institute of Economic Research) latest survey of business opinion only 4% of firms cited finance as the factor most limiting their ability to increase turnover. The problem seems to be an increase in input costs for firms which is hard to pass on to consumers.

Lower interest rates have a downside in the reduction in spending by savers and this could also impact on consumer confidence. Any hint of further easing seems to encourage financial risk-taking more than real investment. Central bankers have thus become prisoners of the atmosphere they helped to create. There is still a belief amongst politicians that central bankers have the power by to solve these issues in an economy and politicians keep asking why those powers aren’t being used.

Are negative Interest rates an option?

The idea behind this is that if trading banks are charged interest for holding money at the central bank they are more likely to make additional loans to people. Although this sounds good negative interest rates on those that hold deposits at the bank could lead to customers storing their money elsewhere.

The European Central Bank sees that negative interest rates have an expansionary effect which outweighs the contractionary effect. An example of this is Jyske Bank, Denmark’s third-largest bank, offered a 10-year fixed-rate mortgage with an interest rate of -0.5%. for a ten-year mortgage – in other words the bank pay you to take out a mortgage.

However negative interest rates is seen as a short-run fix for the economy. Getting people to pay interest for deposit holdings may mean that banks have less deposits to lend out in the long-run and this may choke off lending and ultimately growth in the EU.

Countries tax rates on the wrong side of the Laffer Curve

The laffer curve (named after American economist Arthur Laffer) indicates the relationship between the tax rate and the revenue gained by the government. If you charge a high tax rate it is unlikely that you will encourage people into work and therefore the tax revenue for the government is a lot lower if taxes had been lower. The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the far right of the curve), then all people would choose not to work because everything they earned would go to the government.

Economists have long used the Laffer curve to justify tax cuts, including:
Ronald Reagan in 1981 – resulted in lower revenues
George W. Bush in 2001 – resulted in lower revenues.
Donal Trump in 2017 – resulted in lower revenues

The Congressional Budget Office, a government watchdog, now reckons that US national debt will hit 95% of GDP by 2027, up from 89% two years ago before the tax cuts.

America (see graphic above) is not the only country that appears to be on the wrong side of Mr Laffer’s curve. A paper published in 2017 by Jacob Lundberg, estimates Laffer curves for 27 OECD countries. He found that only Austria, Belgium, Denmark, Finland and Sweden have top income-tax rates that exceed their revenue-maximising levels. However only Sweden could meaningfully boost revenue by cutting tax rates on high-income earners. Most countries, in other words, appear to have set their highest tax rates at or below the optimal rate suggested by the Laffer curve.

Source: The Economist – 19th June 2019 – Graphic detail

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