Why is US in Recession? (2008)

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Readers Question: Why is US in Recession?

According to the latest statistics provided by the Economist April 24th 2008

  • US economic growth is 2.4% year on year.
  • In the last quarter, growth is 0.6%. This is still a long way off the technical definition of a recession – negative economic growth for two consecutive quarters.

Nevertheless people have been predicting that the US will soon enter into recession. This is because

1. Credit Crunch. Banks have lost money in lending sub-prime mortgages, which involved high levels of defaults. It is not just mortgage companies who have been affected, but, banks who lent to the mortgage companies. The result is that there is a shortage of funds for borrowing and bank lending has become more difficult.

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Question on Carbon Trading Emissions and Global Warming

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Readers Question: “the only viable solution to the problem of global warming is an international agreement that sets a ceiling to the world’s production of carbon emissions, by allocating a quota to each country. The sum of the quotas being set equal to the agreed global maximum. countries should then be permitted to buy and sell their quotas”

In theory this scheme can provide a market-based response to the problem of global warming.

  • It would require countries to agree on a global maximum of carbon emissions. This level would presumably be less than current and would provide the necessary target to reduce emissions and help prevent global warming.
    If countries are given a quota, they would have an incentive to reduce carbon emissions. If they can pollute less than their quota they will be able to sell their quotas to other countries; if they pollute more then they will have the cost of buying more quotas.
  • This fiscal incentive should encourage the development of technology which leads to more efficient engines and reduces carbon emissions.
  • In theory, it is also socially efficient. i.e. a firm can pollute more if it feels it is worth the cost of buying more carbon permits.

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The impact of Government Borrowing on Industry

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The impact of government borrowing on industry.

Generally, government borrowing of over 3% of GDP and National Debt of over 60% of GDP is considered to be harmful and if government debt is too high it might start to deter foreign investment.

Budget balance

This is the amount the government need to borrow from the private sector. It occurs because the government is spending more than they receive in taxation. Problems of government borrowing include:

  • Crowding out of private sector. It is argued that high government borrowing can cause crowding out. This means private sector investment is reduced because the private sector are lending to the government instead of investing in more profitable private projects.
  • Liable to lead to higher tax and lower spending in the future.
  • Higher interest rates. It is argued that higher levels of government borrowing tend to put upward pressure on interest rates. This is because the government need to raise rates to attract sufficient people to lend them money.
  • High levels of borrowing may by symptomatic of poor government management. i.e failure to collect taxes and failure to control spending. This may indicate poor management of economy.

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Readers Questions III

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You are welcome to ask questions on Economics. However, due to volume of questions, I can no longer promise to answer all questions. I will post the answer on this blog, for everyone to benefit from. I shall try to answer the economics question and / or point to other resources but please bear in …

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Impact of increasing the rate unemployment benefits

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Readers Question. Explain the benefits of increasing the rate of unemployment benefit for

1. the unemployed, 2. society. Identify and costs that may result from such a policy.

Benefits of increasing unemployment benefits

  1. Provides more income, reducing relative poverty and improving living standards.
  2. Gives them support in finding the best job. If benefits are low, then they will be forced to get the quickest job they can find. But, this may not be suitable for their skills. Higher benefits enable the unemployed to take more time and find a job which matches their skills. This is also a benefit for society. For example, if someone leaves university, with a degree in astrophysics, we don’t want them working in McDonalds because unemployment benefits are too low to support their job search on leaving university. Basically, frictional unemployment is not a bad thing; sometimes it takes time to find the right job.
  3. Low unemployment benefits could fuel social unrest and encourage the unemployed to resort to crime to supplement their income. Unemployment is often associated with a feeling of social alienation leading to riots such as Brixton 1981 and Paris in 2006.

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Sustained and Temporary Inflation

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Readers Question: Can you please differentiate between the causes of once-off inflation and sustained inflation? A temporary period of inflation, also called one-off inflation, may be caused by: Temporary inflation in 2008 and 2011. Rising in tax rates. Suppose the chancellor announces a 10% rise in fuel duty. This means prices will rise. But, next …

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Student Loan Repayments Finished at Last

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I took out a student loan 13 years ago in 1995. I remember taking out the maximum possible loan, which in those days was about £3,800 over 3 years. Being an economist, I didn’t spend any of the loan but put it in a bank account and benefit from receiving a higher interest rate than that charged by the government (interest rate was equivalent to inflation rate).

For 4 years after graduating University, I never had to pay any money back because my salary was below the minimum amount.  The student came in very useful when I bought a house and I was able to use the £4,000 as part of the deposit.

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Why Are UK Retail Sales Increasing? (2008)

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Readers Question: explain why two sectors of the UK economy are growing faster than other sectors ?

According to the Office of National Statistics for March 2008

  • Retail Sales Volume Seasonally Adjusted (2000=100) increased to 140.3 an annual growth rate of 4.7%
  • Manufacturing grew at only 0.9%
  • Services grew at 3.2%

latest statistics at ONS

I have to admit I was a little surprised to see retail sales increase at 4.7%. Anyway it seems that retail sales and the service sector are still doing much better than manufacturing and production. These are some potential reasons.

Exchange Rate. Against the dollar, at least, the Pound has been strong. This makes our exports more expensive reducing demand. Manufacturing goods are often exported so would explain weakness of manufacturing sector. Imported goods become cheaper so may boost sales on the high street.

  • However, the pound has been weak against the Euro, our main trading partner, so I doubt how important this factor is.

Interest rates. The Bank of England has cut interest rates to 5%. In theory this should boost spending because it makes borrowing cheaper. This would explain increased retail sales and services because consumers will have more spending power.

  • However, the cuts in base rates have often not been passed on by banks. The credit crisis has led to a tightening of lending restrictions. This is why I was a little surprised to see retail sales growing so strongly.

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