Quantitative WHAT?!

What is 'quantitative easing'?

Def: Quantitative easing was proposed in 2008 as a way of providing an additional monetary stimulus to reduce the impact of recession. Interest rates had already been reduced as far as they could be, and banks were still finding it difficult to maintain lending. Early in 2009, the Bank of England began buying bills and bonds, exchanging them for cash which would increase bank deposits. This has the effect of increasing the money supply and giving banks more liquidity. Many other central banks implemented similar policies at the same time. (In the US it is called credit easing.)

This is sometimes described as printing money and, if carried too far, it could lead eventually to inflation. But at the time it was introduced there was a significant risk of deflation occurring, which could turn out to be even more problematic.


IF YOU ARE STILL CONFUSED...

Look at this interactive graphic!


http://www.ft.com/cms/s/0/8ada2ad4-f3b9-11dd-9c4b-0000779fd2ac.html#axzz1aPdTCTu8


Quantitative easing is a government monetary policy occasionally used to increase the money supply it increases the money supply by flooding financial institutions with capital, in an effort to promote increased lending and liquidity. Under this policy, the authorities buy up bonds either from banks or from the commercial sector. There are two potential benefits. The higher the price of a bond, the lower the interest rate the borrower has to pay; so the "yield" – the interest rate – on government bonds falls. Since many interest rates, including mortgage rates for example, are set with reference to gilt yields, QE should therefore help to drive down borrowing costs. Investors are likely to use the extra money from QE to buy something else – shares, for example. That should push up the price of a whole range of assets, boosting wealth and creating demand right across the economy.



Did it work? Will it work? The Bank of England recently published research suggesting that the initial £200bn bout of QE, starting in 2009, boosted GDP by around 1.5 percentage points – though given that the UK still experienced its worst recession in living memory, it was hard to feel the benefit at the time. But other economists, argue that QE1 – combined with the effect of a much larger programme of asset purchases in the US – just handed banks lots of extra money which they used to speculate on commodities such as oil, boosting their price, pushing up inflation and making life even harder for cash-strapped consumers. 

The chancellor, George Osborne, said at the conference in Manchester that the Treasury was drawing up measures to increase the supply of credit to small and medium-sized businesses, which have repeatedly complained that they are missing out on loans from the crisis-hit banks. Ed Balls will gleefully remind Osborne that while in opposition, he described QE as "the last resort of desperate governments".

In my opinion, quantitative easing is not the best way of helping the economy, because the 'printed money' will be 'lost in the banks' and there will be no significant credit easing. There are more efficient, direct ways of creating growth, e.g. creating new jobs and investing in job bureaus.

That's what I think, 

MANU

What are you driving?

What type of tax is VAT? Illustrate the effect of such a tax on a diagram and explain why the higher the price of the good, the bigger the impact of the VAT rise. How might this impact inflation?

VAT (Value Added Tax) is a type of a consumption and regressive tax. It is a tax on spending on goods and services and its value, as a percentage of households’ budget, increases inversely with the income rate.

Let’s take a 2,5% VAT rise in the UK. If you buy a cheap good (e.g. a pencil) the increase in price will not be so significant as if you decide to buy an expensive product (e.g. a car). Therefore, VAT has a larger effect on expensive items.

Increasing VAT rates could cause cost-pushed inflation, but on the other hand it could provide an incentive for people to spend less or import and, consequently, lower the inflation.

"Coupled with a 5% monthly rise in petrol prices, gas and electricity price hikes and another solid rise in food prices, this [the VAT rise] could lift the headline inflation rate up to about 4.2%," said Vicky Redwood, senior UK economist at Capital Economics.

Why are car sales expected to fall in the UK over the coming year? Given this expected trend, what might we expect to see in terms of car prices?

Car sales are expected to rise mainly because of VAT rise (from 17.5% to 20%) and forecasted public sector job losses. In order to change this situation car prices are likely to fall to encourage people to buy more.

What impact might rising petrol prices have on new car purchases? What figure would you expect to see for cross elasticity of demand?

Higher oil prices are likely to increase fuel-efficient (or electric) new cars. The cross elasticity of demand would be a positive number, because these products are subsidies. For example a 10% rise of oil prices would cause the demand for new cars to increase by 20% and figure of the cross elasticity of demand would be 2.

How might the expected decline in car sales affect the UK economy over the next 12 months?

Further decline in car sales could cause higher unemployment and lower confidence among investors. Paul Everitt, the boss of Britain's automaking association SMMT, said that he expected demand to strengthen in the second half of 2011.

What type of market structure is the car industry?

Car industry is a monopolistic competition with many independent buyers and many independent sellers.  Main characteristics of monopolistic competition are:

1. All firms produce similar yet not perfectly substitutable products.

2. All firms are able to enter the industry if the profits are attractive.

3. All firms are profit maximizers.

4. All firms have some market power, which means none are price takers.

Read more: http://www.investopedia.com/terms/m/monopolisticmarket.asp#ixzz1Z5KRebIB

How did the car scrappage scheme help car sales?

The car scrappage scheme was introduced to help the motor industry cope with falling sales after the recession. The government estimates that 4,000 jobs with manufacturers and suppliers were supported. Under the car scrappage scheme owners of cars at least 10 years old could get £2,000 off the price of a new vehicle. This encouraged people to buy new cars (with positive effect on the economy, as well as, on environment).

What might explain the different trend seen in the German car industry?

Germany is the Europe’s largest car market and produces most luxurious and expensive cars in the world. The demand for luxury goods is inelastic and, consequently, German car industry did not suffer as much as in the UK. What is more, the German government has provided much more efficient and quicker help for the industry by implementing the scrappage scheme. 

That's what I think,

MANU

oh, EUROzone!... What have you done?

What is the relationship between interest rates and inflation. Why have the ECB and the Bank of England reacted differently to rising inflation?

There are two types of inflation: cost-push (caused by higher production costs – oil, labour or import prices) and demand-pull (caused by higher demand for goods). There are two ways for the government to control it (fiscal and monetary policy). The fiscal policy is about taxes and government spending and monetary is about interest rates. If interest rates are low it enables people to spend more and that causes demand-pull inflation. On the other hand, if the economy grows too fast, the central bank of a country can decide to increase interest rates in order to reduce people’s demand and lower inflation.

In the UK interest rates have remained at the same, historically low level of 0.5% since March 2009, while in the Eurozone they were increased from 1% to 1.25% and there is a pressure for further rise due to the increasing economic growth in most of countries. Why are there two different reactions to rising inflation?

Raising interest rates increase the cost of borrowing, and there are concerns this may cause the UK to fall back into recession.

"Premature rate increases will have negative effects on growth and jobs. With wage increases remaining subdued, we strongly urge the MPC to hold its nerve and avoid taking any action that may risk derailing the recovery." said David Kern, the BCC's chief economist.

The ECB decided to increase interest rates to lower the inflation by decreasing demand.

""Monetary data continue to point to a modest recovery in euro area money and loan growth," While the data in itself do not indicate upside risks to price stability that require further monetary tightening, they are further proof that the economic situation has changed substantially since 2009 -- which is why the ECB thinks that extremely low interest rates are no longer appropriate.” said Christoph Balz, economist at Commerzbank.

Is the inflation currently being experienced in the Eurozone cost-push or demand-pull? Illustrate your answer with the help of a diagram.

The inflation in the Eurozone is cost-push due to, for example, higher oil prices. If prices of production and transport go up it causes prices of the product to raise. 

"The combination of high oil prices, a strong euro, and fiscal and monetary tightening has started to dent the economic mood in the euro zone," said Martin van Vliet, economist at ING. 

What is the relationship between interest rates and the exchange rate?

An increase in interest rates will raise the exchange rate, and vice versa. Higher interest rates attract inflows of funds from overseas and this rise in demand for pounds can push up the price of sterling.

Why is there some concern about the ‘economic sentiment’ indicator in the Eurozone?

The Economic Sentiment Indicator can be used as a measurement method of European Union’s economic strength. The five indicators are: Industrial Confidence Indicator; Services Confidence Indicator; Consumer Confidence Indicator; Construction Confidence Indicator and Retail Trade Confidence Indicator. The concern about it is that, the ESI shows the economic health of the EU more as a whole, than individually. Most EU members reported an increase in sentiment in 2010, it was mainly caused by the 4 points increase in Germany. Other countries that recorded a major increase were Poland (!), France and Italy. In contrast, the ESI remained weak in Spain, Portugal and Greece.

What is the relationship between interest rates and economic growth? Explain the process by which a change in interest rates could affect AD and then economic growth and employment.

An economic growth is an increase of value of output of goods and services in an economy over a period of time. It is measured mainly by GDP (or GNP). A raise in interest rates would cause people to spend less (lower demand) and, consequently, prices to fall. It would probably lead to lower economic growth (or a recession – two consecutive quarters of negative economic growth) and higher unemployment. On the other hand, reducing interest rates would cause just the opposite result. People would be able to spend more (assuming that their low confidence would not lead them to saving their money) and cause the economic growth, and lower unemployment.

Why is this interest rate rise (and possible further rises) likely to hurt countries, such as Ireland and Greece more than other countries within the Eurozone?

"The hike is unwelcome for peripheral countries, but arguably the core member states were in need of this move already some time ago," said ECB president Jean-Claude Trichet

Higher interest rates in these countries would cause lower consumer spending even more and increase unemployment. It would also hurt small businesses and individuals who are already have problems with repaying their loans. The economies of Greece, the Republic of Ireland and Portugal would remain trapped by large debts, high unemployment, weak consumer spending and uncompetitiveness.

That's what I think.

MANU

Hayek vs. Keynes

What's going on with the Eurozone?

There are 17 countries in the Eurozone and the problem with that are the differences in their economies (people often call it two-speed Eurozone). In the first quarter of 2011 the economic growth of these countries reached 0,8% (0,5% in the UK) and was influenced by impressive 1,5% growth in Germany, 1% in France and 0,8% in Greece. On the other hand, there are countries, for example Portugal, which fell into recession after two consecutive quarters of negative economic growth. 

What has contributed to the German, French and Greek economies surging ahead?
In the Europe’s biggest economy, Germany, the key factors of high economic growth were strong domestic demand, investment boom and, a higher than ever measured, rise in exports (especially to China and emerging countries in Eurozone) and imports. What is extremely important, as explained by George Osborne, the Chancellor of the Exchequer of the UK: “Germany shows what you can do if you fix the roof while the sun is shining”. Before the crisis in 2008/2009 they have implemented many reforms, which now gave them a huge advantage over other countries in the Eurozone. Cutting public spending, raising VAT and implementing labour reforms in good times saved them in bad times.

In France, the economy grew by 1% due to higher spending and investments. According to the economy minister of France, Christine Legarde, manufacturing had been a particularly stong driver of growth.

Greek growth could be partly explained by adjustments to the previous quarter’s data and higher exports.

Why is there such a north-south divergence in growth within the eurozone?

- dependence on tourism

- problems in one country cause the neighbours’ economy to slow down (Spain and Portugal for example)

- more industrialised countries, such as Germany or France, export more expensive goods to other parts of the world

What is the most suitable monetary policy for those countries growing more strongly?

Increasing interest rates would probably cause those countries do growth faster and higher. It would encourage people to save money more rather than spend it. It would also increase the value of the the euro and reduce inflation.

What is the best direction for interest rates and hence the value of the euro for countries, such as Spain, Italy and Portugal?

For these countries the best thing to happen is a reduction of interest rates and the value of the Euro. A decrease in interest rates lowers the cost of borrowing and that leads businesses to increase investment spending, and households to buy more goods. 

’The UK economy would be in a worse position if it were a member of the eurozone’. What are the arguments (a) for and (b) against this statement?
a) 1. Many differences between the members of Eurozone make it more unpredictable (2-speed zone)

2. The UK’s would be more connected to fluctuations of Euro caused by problems in southern European countries.

3. Interest rates would be set by the ECB and are the same in the whole zone (in terms of, for example, different times of recovery).

b) 1. Lower transaction costs, which improve export and import rates.

2. The growth in Germany, the biggest British trade partner in the EU, could improve the situation in the UK.

What is the relationship between interest rates, the exchange rate and growth?

If interest rates go up there is higher incentive for investors from abroad to put money in this country, which would cause a higher demand for currency and higher exchange rates. Increase of the value of the currency would decrease exports and possibly reduce or slow down economic growth.

- Crisis? What crisis?

Main characteristics of Poles are over-pessimism and lack of self-confidence. Try to imagine our reaction when during the recent financial crisis Poland was the only country with a positive economic growth. Oh, that was a surprise! (also for non-polish people). Of course, nobody (besides the ruling government) was very optimistic about that and everybody wanted to find negatives of this situation. But, even if we tried really hard, we had to admit that our economy IS strong.

How did it happen?

Dominique Strauss-Kahn, the ex-director of IMF said, “Thanks to strong economic institutions and commendable policy management, Poland has avoided the excesses seen in many other countries in recent years. And because there was sufficient fiscal space to adopt temporary stimulus measures, the impact of the crisis on growth was lessened. Indeed, as the largest economy in the region, Poland is leading the economic recovery.”

Polish businesses rely mainly on their own resources and are less dependent on loans compering to other countries’ which helped our economy. Also, Polish exports level is low (over 30% of GDP compared with 66% in Czech Republic). Other thing is that the consumer spending in Poland is relatively high. “An exceptionally strong rise in household incomes, caused by the growth in wages and social benefits and reduced tax burdens (lower pension contributions beginning from 2008 and lower personal income tax rates from 2009), will fuel rapid growth in consumption” (http://skarb.bzwbk.pl/_items/english/doc/pmr-0802en.pdf)

So, how was Poland affected by the economic turbulence of 2008/2009?

Firstly, as mentioned before, Polish GDP achieved the best and the only positive rate in the EU. In the first quarter of 2009 increased by 1.9% and in the second quarter by 1.4%.

Secondly, the inflation in 2010 was 2.6%, a significantly lower result than 3.5% year before. The decrease resulted mainly from stabilizing economic situation. 

Thirdly, according to the Polish Information and Foreign Investment  “unfortunately, the worldwide crisis brought huge jump in unemployment rate. In the worst month of 2010 it was 13.2%, the worst result since 2007. Recently unemployment has slightly decreased but still it is considered to be high.”

In conclusion, welcome to the 6th most attractive investment location in the world!

That’s what a think.

MANU

The credit crunch

The recent financial crisis affected the whole world. Why the Americans caused our problems again?! Can’t they think about the consequences of their actions?!... Why would anybody sell subprime mortgages?

Actually, it was not exactly like that. The risks were shared amongst other financial institutions. The risky loans were put together with other mortgages into packages and then divided in tranches sold to intermediaries. (You can imagine it as the game of pass the parcel.) Nobody could predict that everything would go wrong...

The credit crunch is a situation when a sudden shortage of funds for lending, leading to a resulting decline in loans available occurs. Recently it was caused by a sharp rise in defaults on subprime mortgages. It happened mainly because of the house prices rising and a sudden increase of interest rates. “Interest rates hit rock bottom in America in 2004 at just 1 per cent, but in June that year they began to rise. As interest rates jumped, US house prices started to fall and borrowers began to default on their mortgage payments sparking trouble for us all.” (http://www.timesonline.co.uk/tol/money/reader_guides/article4530072.ece). (Unpredicted) Lower house prices resulted in reduction of the value of mortgage loans and banks were no longer able to sell houses to recoup the loan.

The problems in the US impacted other economies very quickly. It got more difficult to buy a mortgage in other countries and the cash flow was slower, which caused problems around the whole world.

That’s what I think.

MANU