Is Economics Irrelevant in the Absence of Scarcity?

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Readers Question Is the study of economics irrelevant in the absence of the concept of scarcity? It would make a good interview question. The difficult thing is trying to imagine what a society would be like if it had no scarcity. One thinks of the imaginary desert island, with abundant resources and a lone Robinson …

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Did Generous Welfare Payments Cause the Recession and Unemployment?

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Casey B. Mulligan, from the University of Chicago suggests a theory for a major cause of the great recession and the rise in US unemployment post 2008. – Higher welfare payments.

..Redistribution, or subsidies and regulations intended to help the poor, unemployed, and financially distressed, have changed in many ways since the onset of the recent financial crisis. The unemployed, for instance, can collect benefits longer and can receive bonuses, health subsidies, and tax deductions, and millions more people have became eligible for food stamps.

Economist Casey B. Mulligan argues that while many of these changes were intended to help people endure economic events and boost the economy, they had the unintended consequence of deepening-if not causing-the recession.

The Redistribution Recession – Oxford University Press

us unemployment
US Unemployment – was it caused by generous benefits?

There is also an article here at the NY Times (paywall): A Keynesian Blind Spot.

The decline of home construction is not the primary reason that our labor market remains depressed: Keynesian policies are

…

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Why Did Europe Expect Fiscal Consolidation to Work?

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Readers Question. Can you explain why the Government and Economic Commentators  are talking about a multiplier (in relation to budget cuts) of between 0.5 and 1, whereas I always thought that the GDP multiplier was bigger than this.

Just to summarise a multiplier of 0.5 would mean fiscal consolidation (spending cuts) of £1bn, would lead to a drop in GDP of only £0.5bn. In other words, they hoped fiscal consolidation would be successful and only have a limited impact on reducing economic growth rates.

However, evidence from the IMF and other studies have shown the fiscal multiplier has proved much higher. In fact a multiplier of up to 2. (for every spending cut of £1bn, we have seen GDP fall £2bn. See: Fiscal multiplier and European austerity).

Essentially, this shows the limitations of using economic models which are applied during very different economic circumstances. If you look at previous attempts at fiscal consolidation undertaken during strong economic growth (e.g. Canada in 1990s), a multiplier of 0.5 would be quite reasonable.

However, there was an unwillingness to admit that the economic situation in the aftermath of a financial crisis and liquidity trap was very different.

 

Why might the Government and European Commentators expect  a multiplier of 0.5?

To some extent, I answered this yesterday on the post – why austerity will increase the budget deficit. But, just to recap, the may have hoped for a multiplier of 0.5 because:

1. Expansionary monetary policy. With spending cuts, usually a Central Bank can cut interest rates and loosen monetary policy so that there is a boost to demand to offset the impact of tax increases and spending cuts.

  • But, the EU and UK government should have realised that interest rates were already at record lows in 2010. Quantitative easing has done little to boost spending in the UK. In Europe, the ECB has never showed any real sign of loosening monetary policy in response to fiscal consolidation. In fact in 2011, the ECB increased interest rates over misplaced fears on inflation.

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Employment Rates – Population ratio

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A look at some varying employment rates across OECD countries.

employment-rates-working-population

Source: OECD short term Labour Market stats

Employment rates are determined by the number of people of working age, who have a job.

The employment rate excludes:

  • People who are unemployed. – actively seeking work and willing to take work
  • People who are students
  • People who take early retirement.
  • People on disability or sickness benefits.
  • Parents staying at home to look after their kids.

Implications of Employment Rates

  • A fall in the employment rate to less than 70% is an indicator that the economy is working well below full capacity.
  • The government will be losing out on employment tax revenue
  • The government will be paying more on welfare benefits to support those out of employment.

 

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Austerity will Increase UK’s debt burden

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According to the National Institute for Economic and Social Research (Niesr), fiscal consolidation in the UK is likely to increase the UK’s debt burden. Or to put it in layman’s terms there will be ‘pain, but no gain’ They model the impact of fiscal consolidation in both ‘normal’ times (scenario 1)  and in the current …

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Independent Currency and Economic Performance

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Why have countries in the Eurozone faced greater difficulties in promoting economic recovery?

How does a country with its own currency find greater flexibility in overcoming a recession?

1. Impact of Currency and Bond Yields

eu-bond-yields-7-countries

A striking feature of recent years is that countries in the Eurozone have been significantly more susceptible to rising bond yields. By comparison, the UK and US who have their own currency, have seen falling bond yields, despite high budget deficits.

Firstly, if you have your own currency, your Central Bank has the ability to print money and buy government bonds if necessary. Therefore bond markets know that a country like the UK is unlikely to have a liquidity crisis. I.e. if not enough people buy bonds on one occasion, the Central Bank can step in and buy the necessary bonds. This creates certainty and removes fears over a temporary liquidity crisis. (it doesn’t solve a solvency issue but, apart from Greece, most Eurozone economies are not insolvent)

However, countries in the Eurozone don’t have this luxury. There is no Central Bank willing to step in and buy bonds (at least not without very protected wrangles and uncertainty)

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The impact of changing the inflation target

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Readers Question: The task of MPC is to stabilise inflation at 2%. Current inflation is around 5% and the Bank of England has to tighten the Monetary policy to control the inflation. If the Government revises the inflation target and set it to 5%, then what would be the effect on the economy and what …

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Data on extent of austerity in UK

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Following on from previous posts – How much has government spending been cut – | How was budget deficit cut by 25%?.

It will be useful to republish some data from Mainly Macro – on a post UK austerity and some facts

UK Cyclically adjusted primary deficit

2010
2011
2012
2013
IMF 2
-6.1
-3.9
-2.8
-1.5
OECD [3]
-5.8
-4.1
-3.0
-1.9

The cyclically adjusted deficit strips away the part of the deficit related to the economic cycle. The actual budget deficit is much higher – because in a recession, borrowing increases as tax revenues fall and welfare payments increase.

A primary deficit takes away interest payments.

The cyclically adjusted primary deficit could also be viewed as the ‘underlying structural deficit’

The sharp fall in the cyclically adjusted primary deficit from 6% of GDP to 1.5% GDP in 2013, shows a contractionary fiscal policy – the combination of spending cuts / freezes and tax increases.

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