Attempting to reduce debt after First World War

by

In the recent blog – Post-war economic boom and reduction in debt, we saw how the UK successfully reduced national debt as a % of GDP from 230% of GDP to 30% of GDP, over a period of 40 years. However, the story after the First World War was very different. The UK finished the …

Read more

National debt – mortgage comparison

by

Readers Question. You make the point that the debt to GDP fell in the post war period since the GDP rose faster than the debt but that still left the debt to be repaid and as such there was still the interest to be paid. I was expecting you to explain how the current debt …

Read more

Saving rates in the UK

by

It is not a good time to be a saver in the UK. Interest rates are 0.5% and inflation has been above 2% for a high proportion of the previous five years. Because inflation is higher than nominal interest rates, we are seeing negative real interest rates. This means many savers are seeing a decline in the real value of their savings. Pensioners who are relying on interest payments as income, are seeing a decline in their income.

Inflation and interest rates

inflation-base-rates-since-03

In most of the post-war period we have seen positive real interest rates – Base rates above the headline inflation. This means that savers are protected from the effects of inflation.

H0wever, 2008 marks a sharp contrast, with Bank of England base rates falling to 0.5% and inflation reaching above 5%.

In recent months, inflation has fallen to below 2%, but that is still higher than base rates of 0.5%

Effectively, you are getting 0.5% return on your saving, but prices are going up 2%, so the real value of your savings is falling by 1.5%.

Base rates and bank rates

The contrast between base rates and inflation looks very high. But, actually bank savings rates have not fallen as much as base rates. This is because banks were short of money in the credit crunch and were keener to attract deposits than lend money. Therefore, when the Bank of England cut interest rates to 0.5%, commercial banks were not so keen to reduce their own interest rates by as much. Usually commercial bank rates closely follow base rates, but after 2008 we see a break in this correlation.

saving-rates-base-fixed-instant

Source: Bank of England. Series IUMB6VJ | IUMWTFA

In 2008/09, base rates are cut from 5% to 0.5%, but fixed interest rates  (series IUMWTFA) only fall to 2.5 / 3%. Interestingly since mid 2012, fixed interest rates have continued to fall closer to 1%. This suggests the banks are less desperate to attract saving deposits and so can reduce interest rates.

It is a similar story with instant access saving rates (series IUMB6VJ) Since mid 2012, rates have fallen from 1.6% to 0.6%. This suggest the financial sector is in better health, but it means a poorer return for savers.

saving-rates-inflation-since-05

However, if you look around, you can still see higher fixed rates for those willing to ‘lock their money away’

It also depends how much money you can save. For example, according to ‘Money Saving Expert‘ you could get 3.25% if you can put £25,000 away for 5 years. – hardly a great deal, but you would just about get a positive real interest rate.

Should the Bank of England do more for savers?

In the past few years, many groups representing savers have felt they have been ignored – and the government / Bank of England should have done more to give a better rate of return for savers.

However, the past five years have seen declining living standards for most groups of people – real wages have fallen. Unemployment has been very high. The cost of renting has been very high. Given the general economic decline, savers have not been alone in seeing falling living standards. It is complicated by the fact that people with high levels of saving are more likely to be household owners. Homeowners have seen record low mortgage interest payments and rising house prices, which, to some extent, have offset the fall in the return on savings.

Young people without savings, but paying rent, have seen a bigger squeeze on their living standards.

However, someone who is relying on their savings to pay rent, is definitely in a bind.

Read more

Should the world adopt a unified currency?

by
global-currency

Readers Question: Should the world adopt a unified currency?

global-currency

I haven’t given it much thought; given the great difficulties of the Euro single currency within parts of the European Union, the idea of extending this to include even more disparate countries seems a non-starter.

From a philosophic point of view, I think the world is heading towards greater integration, and perhaps in a thousands of years we will global governments, global fiscal transfers and we could move towards a global single currency. But, this would require a completely different mindset of selflessness, breaking down parochial self-interest and seeing the world as one world-family.

Alas, I can’t see this spiritual evolution happening quickly. Some issues to consider in a single currency.

What happens when countries have different inflation rates, but the same currency? In Europe, countries with higher inflation rates (e.g. Greece, Spain, Portugal) were left with large current account deficits, lower exports and lower growth. A global currency, would see even bigger disparities in relative costs and competitiveness.

Single monetary policy. For a single currency to be practical, the assumption would be that you need a single monetary policy. That would be highly impractical and could be devastating for some economies who have different rates of economic growth. For example, we might have very low interest rates, but countries with fast rates of growth could see inflation. It might be more practical to have a single currency, but have regional variations in interest rates. I’m not quite sure how this would work or what the consequences would be. But, with a single global currency you would see a lot of capital flows from less prosperous countries – especially with any variation in interest rate.

Read more

Economic growth with falling real wages

by

The UK recovery paints an unusual situation. We have both positive economic growth and falling real wages. How can we have economic growth with falling real wages?

Real wages are not the only source of economic growth. We can see growth from other components of AD –

I (Investment), G (Government spending) plus net exports (X-M)

Also, it is possible for consumer spending to rise despite falling real wages (at least in the short term). For example, if spending is financed by borrowing or declining savings ratio. Consumer spending could also be financed through re mortgaging houses (equity withdrawal) against the backdrop of rising house prices.

Economic growth in the UK

economic-growth-quarterly

Since 2013 Q1, we have seen a decent rate of economic recovery. In the past 12 months – between Q2 2013 and Q2 2014, GDP in volume terms increased by 3.2%

Real wages

uk-real-wages-06-14

Real wages have been falling since the start of the great recession in mid 2008. In a recessing falling real wages are to be expected, but since the recovery, we might have expected real wages to match the growth in real GDP.

Why are real wages falling despite economic growth?

1. Flexible labour markets creating low paid employment. In this recovery, unemployment has fallen more rapidly than previous recessions. Evidence suggests the economy has been successful in creating new employment (often temporary / part-time/ self-employment). These new jobs are not particularly well paid. The recovery is good for job-seekers, but less good for those already in work. The relatively elastic supply of labour willing to take low paid jobs is keeping any wage growth low.

Read more

Economic impact of welfare freezes

by

Readers Question: What is the economic impact of proposed welfare benefit freezes proposed by Chancellor, Mr Osborne?

Mr Osborne has proposed a welfare freeze, worth £3 billion of savings over two years. This benefit freeze includes Jobseeker’s Allowance, Income Support, Child Tax Credit and Working Tax Credit, Child Benefit and Employment Support Allowance (paid to those judged capable of work). It does not include pensions, disability benefits and maternity pay.

The Treasury said that about 10 million households would be affected, roughly half of which are working.

The freeze will raise around £1.6bn in 2016/17, rising to around £3.2bn a year in 2017/18.

An argument for freezing welfare benefits is that it will help reduce the budget deficit and also – since 2007, average earnings (+17%) have been rising at a slower rate than working-age benefits (+22%.)

Economic effects

Aggregate Demand (AD) / economic growth. Welfare freezes will (ceteris paribus) reduce consumer spending, and lead to lower aggregate demand. It is an example of deflationary fiscal policy. It will be quite significant because people receiving welfare benefits have a high marginal propensity to consume because, on low incomes, they don’t have the luxury of saving – therefore, lower welfare benefits will directly lead to less spending in the economy.  Welfare freezes will also contribute to a decline in consumer confidence because it will be a visible reminder of economic hardship. Combined with other spending cuts of up to £24bn, there is still scope for these planned spending cuts to derail the economic recovery and cause lower growth or even a future recession.

However, the strength of the recent recovery suggests the UK may be in a better position to absorb austerity than a few years ago. Also, the chancellor can rely on the Bank of England to maintain a very loose monetary policy, which will help to offset the impact of this deflationary fiscal policy.

However, we still don’t know the position of the economy in a couple of years. there is evidence that the recovery still is unbalanced with low productivity growth and low real wage growth making the economy still vulnerable. Continued recession in Europe could  also act as a drag on the UK economy; it is possible that these commitments to spending cuts could hold back economic growth, that even monetary policy can’t overcome.

Deficit reduction. The spending cuts will contribute £3bn to saved spending, helping to reduce the budget deficit. However, it is still a small % of the current budget deficit (£93bn). Also, the reduction in deficit may be less than planned because it will cause a fall in tax revenues (e.g. less VAT receipts from lower spending) and also lower economic growth from the austerity measures.

Some economists argue that deficit reduction is essential and there is no alternative but to cut spending. They hope that cutting the deficit will reassure markets and business about the long-term strength of the economy. Other economists argue that recent evidence suggests people don’t gain confidence from austerity – but actually the opposite. (see: Confidence fairy)

Read more

Budget deficit targets

by

Politicians are often keen on making targets to eliminate budget deficits by a certain year. There is a strong political motivation to be seen as strong and committed to reducing government debt. Politicians who are vague about the debt are often heavily criticised and it is seen as poor politics. An advantage of budget deficit targets is that it ensure politicians have a stronger commitment to make politically difficult choices – raising taxes or cutting spending.

However, from an economic perspective targets for reducing budget deficits are not always as helpful as they may seem.

Benefits of budget deficit targets

There can be many sound economic reasons for reducing government borrowing. Just because a government can borrow, doesn’t mean it is desirable to.

  • It can prevent politicians choosing politically popular policies, such as tax cuts and spending increases. A deficit target can help prevent politicians putting off making difficult choices.
  • Without deficit reduction targets, some economists fear that there is an incentive to keep increasing the size of government spending, which crowds out more efficient private sector spending.
  • It can reassure markets that the government have a ‘responsible attitude to debt’ and are less likely to rely on printing money to finance the deficit and rely on inflation to inflate away the debt – which can reduce the real value of government bonds.
  • In some cases reducing the budget deficit can help lower bond yields because – with lower debt available on the market there is downward pressure on bond yields.
  • Some argue that budget deficit reduction gives consumers more to spend and firms to invest because the private sector have more confidence when the government is reducing its debt and is acting in a ‘responsible manner’. Others criticise this as being wishful thinking (see: Confidence fairy)

Problems of a budget deficit target

  • To stick to a strict budget deficit target may require tax increases / spending cuts at a time which is not appropriate for the economy. e.g. the UK economy is recovering, but if we increase income tax rates to improve tax receipts it may lead to lower growth and be counter-productive. See: Austerity can be self-defeating
  • Experience of Eurozone economies trying to meet budget deficit targets has been a deep recession.
  • Achieving an overall budget deficit means government have to finance investment spending out of tax revenue. But, arguably there is a better case for allowing government to borrow to finance investment.
  • A zero budget deficit is of doubtful value compared to other macro-economic objectives such as full employment, sustainable economic growth and low inflation.

Read more

Continue Shopping →
Item added to cart.
0 items - £0.00
Checkout