People's Quantitative Easing

People’s quantitative easing

13 September 2015

Jeremy Corbyn, the newly elected leader of the Labour Party, is proposing a number of radical economic policies. One that has attracted considerable attention is for a new form of QE, which has been dubbed ‘people’s quantitative easing’.

This would involve newly created money by the Bank of England being directly used to fund spending on large-scale housing, energy, transport and digital projects. Rather than the new money being used to purchase assets, as has been the case up to now, with the effect filtering only indirectly into aggregate demand and even more indirectly into aggregate supply, under the proposed scheme, both aggregate demand and aggregate supply would be directly boosted.

Although ‘conventional’ QE has worked to some extent, the effects have been uneven. Asset holders and those with large debts, such as mortgages, have made large gains from higher asset prices and lower interest rates. By contrast, savers in bank and building society accounts have seen the income from their savings decline dramatically. What is more, the indirect nature of the effects has meant time lags and uncertainty over the magnitude of the effects.

But despite the obvious attractiveness of the proposals, they have attracted considerable criticism. Some of these are from a political perspective, with commentators from the right arguing against an expansion of the state. Other criticisms focus on the operation and magnitude of the proposals

One is that it would change the relationship between the Bank of England and the government. If the Bank of England created money to fund government projects, that would reduce or even eliminate the independence of the Bank. Independence has generally been seen as desirable to prevent manipulation of the central bank by the government for short-term political gain. Those in favour of people’s QE argue that the money would be directed into a National Investment Bank, which would then make the investment allocation decisions. The central bank would still be independent in deciding the amount of QE.

This leads to the second criticism and that is about whether further QE is necessary at the current time. Critics argue that while QE of whatever type was justified when the economy was in recession and struggling to recover, now would be the wrong time for further stimulus. Indeed, it could be highly inflationary. The economy is currently expanding. If banks respond by increasing credit, the velocity of circulation of narrow money could rise and broad money supply grow, providing enough money to underpin a growing economy.

Many advocates of people’s QE accept this second point and see it as a contingency plan in case the economy fails to recover and further monetary stimulus is deemed necessary. If further QE is not felt necessary by the Bank of England, then the National Investment Bank could fund investment through conventional borrowing.

The following articles examine people’s QE and look at its merits and dangers. Given the proposal’s political context, several of the articles approach the issue from a very specific political perspective. Try to separate the economic analysis in the articles from their political bias.

Jeremy Corbyn’s proposal
The Economy in 2020 Jeremy Corbyn (22/7/15)

Articles
People’s quantitative easing — no magic Financial Times, Chris Giles (13/8/15)
How Green Infrastructure Quantitative Easing would work Tax Research UK, Richard Murphy (12/3/15)
What is QE for the people? Money Week, Simon Wilson (22/8/15)
QE or not QE? A slippery slope to breaking the Bank EconomicsUK.com, David Smith (23/8/15)
We don’t need “People’s QE”, basic economic literacy is enough Red Box, Jonathan Portes (13/8/15)
Is Jeremy Corbyn’s policy of ‘quantitative easing for people’ feasible? The Guardian, Larry Elliott (14/8/15)
Corbynomics: Quantitative Easing for People (PQE) Huffington Post, Adnan Al-Daini (7/9/15)
Corbyn’s “People’s QE” could actually be a decent idea FT Alphaville, Matthew C. Klein (6/8/15)
Jeremy Corbyn’s ‘People’s QE’ would force Britain into three-year battle with the EU The Telegraph, Peter Spence (15/8/15)
Would Corbyn’s ‘QE for people’ float or sink Britain? BBC News, Robert Peston (12/8/15)
Strategic Quantitative Easing – public money for public benefit New Economics Foundation blog, Josh Ryan-Collins (12/8/15)
People’s QE and Corbyn’s QE Mainly Macro blog, Simon Wren-Lewis
You can print money, so long as it’s not for the people The Guardian, Zoe Williams (4/10/15)

Questions

1. What is meant by ‘helicopter money’? How does it differ from quantitative easing as practised up to now?
2. Is people’s QE the same as helicopter money?
3. Can people’s QE take place alongside an independent Bank of England?
4. What is meant by the velocity of circulation of money? What happened to the velocity of circulation following the financial crisis?
5. How does conventional QE feed through into aggregate demand?
6. Under what circumstances would people’s QE be inflationary?

Upper Sixth Revision

Interest rates – too low, for too long?

25 January 2017

Interest rates have been at record lows across the developed world since 2009. Interest rates were reduced to such levels in order to stimulate recovery from the financial crisis of 2007–8 and the resulting recession. The low interest rates were accompanied by extraordinary increases in money supply under various rounds of quantitative easing in the USA, UK, Japan and eventually the eurozone. But have such policies done harm?

This is the contention of Brian Sturgess in a new paper, published by the Centre for Policy Studies. He maintains that the policy has had a number of adverse effects:

•	There will be nothing left in the monetary policy armoury when the next downturn occurs other than even more QE, which will compound the following problems.
•	It has had little effect in stimulating aggregate demand and economic growth. Instead the extra money has been used to repair balance sheets and support unprofitable businesses.
•	It has inflated asset prices, especially shares and property, which has encouraged funds to flow to the secondary market rather than to funding new investment.
•	The inflation of asset prices has benefited the already wealthy.
•	By keeping interest rates down to virtually zero on savings accounts, it has punished small savers.
•	By rewarding the rich and penalising small savers, it has contributed to greater inequality.
•	By keeping interest rates down to borrowers, it has encouraged households to take on excessive amounts of debt, which will be hard to service if interest rates rise.
•	It has lowered the price of risk, thereby encouraging more risky types of investment and the general misallocation of capital.

Sturgess argues that it is time to end the policy of low interest rates. Currently, in all the major developed economies, central bank rates are below the rate of inflation, making the real central bank interest rates negative.

He welcomes the two small increases by the Federal Reserve, but this should be followed by further rises, not just by the Fed, but by other central banks too. As Sturgess states in the paper (p.12):

In place of ever more extreme descents into the unknown, central banks should quickly renormalise monetary policy. That would involve ending QE and allowing interest rates to rise steadily so that interest rates can carry out their proper functions. Failure to do so will leave the global financial system vulnerable to potential shocks such as the failure of the euro, or the fiscal stresses in the US resulting from the unfinanced spending plans announced by Donald Trump in his presidential campaign.

Although Sturgess argues that the initial programmes of low interest rates and QE were a useful response to the financial crisis, he argues that they should have only been used as a short-term measure. However, if they were, and if interest rates had gone up within a few months, many argue that the global economy would rapidly have sunk back into recession. This has certainly been the position of central banks. Sturgess disagrees.

Articles
Damaging low interest rates and QE must end now, think thank warns The Telegraph, Julia Bradshaw (23/1/17)
QE has driven pension deficits up, think-tank argues Money Marketing, Justin Cash (23/1/17)
Hold: The ECB keeps interest rates and QE purchases steady as Mario Draghi defends loose policy from hawkish critics City A.M., Jasper Jolly (19/1/17)
Preparing for the Post-QE World Bloomberg, Jean-Michel Paul (12/10/16)

Paper
Stop Depending on the Kindness of Strangers: Low interest rates and the Global Economy Centre for Policy Studies, Brian Sturgess (23/1/17)

Questions

1. Find out what the various rounds of quantitative easing have been in the USA, the UK, Japan and the eurozone.
2. What are the arguments in favour of quantitative easing as it has been practised?
3. How might interest rates close to zero result in the misallocation of capital?
4. Sturgess claims that the existence of ‘spillover’ effects has had damaging effects on many emerging economies. What are these spillover effects and what damage have they done to such economies?
5. How do low interest rates affect interest rate spreads?
6. Have pensioners gained or lost from QE? Explain how the answer may vary between different pensioners.
7. What is meant by a ‘natural’ or ‘neutral’ rate of interest (see section 3.2 in the paper)? Why, according to Janet Yellen (currently Federal Reserve Chair, writing in 2005), is this somewhere between 3.5% and 5.5% (in nominal terms)?
8. What are the arguments for and against using created money to finance programmes of government infrastructure investment?
9. Would helicopter money be more effective than QE via asset purchases in achieving faster economic growth? (See the blog posts: A flawed model of monetary policy and New UK monetary policy measures – somewhat short of the kitchen sink.)
10. When QE comes to an end in various countries, what are the arguments for absorbing rather than selling the assets purchased by central banks? (See the Bloomberg article.)

Upper Sixth Revision

The UK productivity puzzle

27 January 2017

UK productivity growth remains well below levels recorded before the financial crisis, as Chart 1 illustrates. In fact, output per hour worked in 2016 Q3 was virtually the same as in 2007 Q4. What is more, as can be seen from Chart 2, UK productivity lags well behind its major competitors (except for Japan).

But why does UK productivity lag behind other countries and why has it grown so slowly since the financial crisis? In its July 2015 analysis, the ONS addressed this ‘productivity puzzle’.

Among the many reasons suggested are low levels of investment, the impact of the financial crisis on bank’s willingness to lend to new businesses, higher numbers of people working beyond normal retirement age as a result of population and pensions changes, and firms’ ability to retain staff because of low pay growth. While these and other factors may be relevant, they do not provide a complete explanation for the weakness in productivity.

The lack of investment in technology and lack of infrastructure investment have been key reasons for the sluggish growth in productivity. Many companies are prepared to continue using relatively labour-intensive techniques because wage growth has been so low and this reduces the incentive to invest in labour-saving technology.

Another factor has been long hours and, for many office workers, being constantly connected to their work, checking and responding to emails and messages away from the office. The Telegraph article below reports Ann Francke, chief executive of the Chartered Management Institute, as saying:

“This is having a deleterious effect on the health of managers, which has a direct impact on productivity. UK workers already have the longest hours in Europe and yet we’re less productive.”

Another problem has been ultra low interest rates, which have reduced the burden of debt for poor performing companies and has allowed them to survive. It may also have prevented finance from being reallocated to more dynamic companies which would like to develop new products and processes.

Another feature of UK productivity is the large differences between regions. This is illustrated in Chart 3. Productivity in London in 2015 (the latest full year for data) was 31.5% above the UK average, while that in Wales was 19.4% below.

This again reflects investment patterns and also the concentration of industries in particular locations. Thus London’s financial sector, a major part of London’s economy, has experienced relatively large increases in productivity and this has helped to push productivity growth in the capital well above other parts of the country.

Another factor, which again has a regional dimension, is the poor productivity performance of family-owned businesses, where ownership and management is passed down the generations within the family without bringing in external managerial expertise.

The government is very aware of the UK’s weak productivity performance. Its recently launched industrial policy is designed to address the problem. We look at that in a separate post.

Articles
UK productivity edges up but growth still flounders below pre-crisis levels The Telegraph, Julia Bradshaw (6/1/17)
Weak UK productivity spurs warnings of living standards squeeze The Guardian, Katie Allen (6/1/17)
Productivity gap yawns across the UK BBC News, Jonty Bloom (6/1/17)
The UK productivity puzzle Fund Strategy. John Redwood (26/1/17)
Productivity puzzle remains for economists despite UK growth in third quarter of 2016 City A.M., Jasper Jolly (6/1/17)

Portal site
Solve the Productivity Puzzle Unipart

Report
Productivity: no puzzle about it TUC (Feb 2015)

Data
Labour Productivity: Tables 1 to 10 and R1 ONS (6/1/17)
International comparisons of UK productivity (ICP) ONS (6/10/16)
Gross capital formation (% of GDP) The World Bank

Questions

1. In measuring productivity, the ONS uses three indicators: output per worker, output per hour and output per job. Compare the relative usefulness of these three measures of productivity.
2. How would you explain the marked difference in productivity between regions and cities within the UK?
3. How do flexible labour markets impact on productivity?
4. Why is investment as a percentage of GDP so low in the UK compared to that in most other developed countries (see)?
5. Give some examples of industrial policy measures that could be adopted to increase productivity growth.
6. Examine the extent to which very low interest rates and quantitative easing encourage productivity-enhancing investment.

Upper Sixth Revision

The lost decade: reflections by Bank of England chiefs

7 December 2016

In two recent speeches, the Governor of the Bank of England, Mark Carney, and the Bank’s Chief Economist, Andy Haldane, have reflected on the growing inequality in the UK and other countries. They have also answered criticisms that monetary policy has exacerbated the problem. As, Andy Haldane puts it: 

It is clear monetary policy has played a material role in lifting all boats since the financial crisis broke. …[But] even if monetary policy has lifted all boats, and could plausibly do so again if needed, that does not mean it has done so equally. In particular, concerns have been expressed about the potential distributional effects of monetary policy.

Jan Vlieghe [member of the Monetary Policy Committee] has recently looked at how monetary policy may have affected the fortunes of, among others, savers, pension funds and pensioners. The empirical evidence does not suggest these cohorts have been disadvantaged to any significant degree by the monetary policy stance. For most members in each cohort, the boost to their asset portfolios and the improved wages and profits due to a stronger economy more than offset the direct loss of income from lower rates [of interest on savings accounts].

Andy Haldane’s speech focused largely on regional inequality. He argued that productivity has grown much more rapidly in the more prosperous regions, such as London and the South East. This has resulted in rising inequality in wages between different parts of the UK. Policies that focus on raising productivity in the less prosperous regions could play a major role in reducing income inequality.

Mark Carney’s speech echoed a lot of what Andy Haldane was saying. He argued that expansionary monetary policy has, according to Bank of England modelling, “raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak”. And the benefits have been felt by virtually everyone. Even savers have generally gained:

That’s in part because, to a large extent, the thrifty saver and the rich asset holder are often one and the same. Just 2% of households have deposit holdings in excess of £5000, few other financial assets and don’t own a home.

But some people still gained more from monetary policy than others – enough to contribute to widening inequality.

Losers from the lost decade
Mark Carney looked beyond monetary policy and argued that the UK has experienced a ‘lost decade’, where real incomes today are little higher than 10 years ago – the first time this has happened for 150 years. This stalling of average real incomes has been accompanied by widening inequality between various groups, where a few have got a lot richer, especially the top 1%, and many have got poorer. Although the Gini coefficient has remained relatively constant in recent years, there has been a widening gap between the generations.

For both income and wealth, some of the most significant shifts have happened across generations. A typical millennial earned £8000 less during their twenties than their predecessors. Since 2007, those over 60 have seen their incomes rise at five times the rate of the population as a whole. Moreover, rising real house prices between the mid-1990s and the late 2000s have created a growing disparity between older home owners and younger renters.

This pattern has been repeated around the developed world and has led to disillusionment with globalisation and a rise in populism. Globalisation has been “associated with low wages, insecure employment, stateless corporations and striking inequalities”. (Click here for a PowerPoint of the chart.)

And populism has been reflected in the crisis in Greece, the Brexit vote, Donald Trump’s election, the rise of the National Front in France, the No vote in the Italian referendum on reforming the constitution and the rise in anti-establishment parties and sentiment generally. Mainstream parties are beginning to realise that concerns over globalisation, inequality and a sense of disempowerment must be addressed.

Solutions to inequality
As far as solutions are concerned, central must be a rise in general productivity that increases potential real income.

Boosting the determinants of long-run prosperity is the job of government’s structural, or supply-side policies. These government policies influence the economy’s investment in education and skills; its capacity for research and development; the quality of its core institutions, such as the rule of law; the effectiveness of its regulatory environment; the flexibility of its labour market; the intensity of competition; and its openness to trade and investment.

But will this supply-side approach be enough to bring both greater prosperity and greater equality? Will an openness to trade be accepted by populist politicians who blame globalisation and the unequal gains from international trade for the plight of the poor? Carney recognises the problem and argues that:

For the societies of free-trading, networked countries to prosper, they must first re-distribute some of the gains from trade and technology, and then re-skill and reconnect all of their citizens. By doing so, they can put individuals back in control.

For free trade to benefit all requires some redistribution. There are limits, of course, because of fiscal constraints at the macro level and the need to maintain incentives at the micro level. Fostering dependency on the state is no way to increase human agency, even though a safety net is needed to cushion shocks and smooth adjustment.

Redistribution and fairness also means turning back the tide of stateless corporations.

… Because technology and trade are constantly evolving and can lead to rapid shifts in production, the commitment to reskilling all workers must be continual.

In a job market subject to frequent, radical changes, people’s prospects depend on direct and creative engagement with global markets. Lifelong learning, ever-greening skills and cooperative training will become more important than ever.

But whether these prescriptions will be accepted by people across the developed world who feel that the capitalist system has failed them and who look to more radical solutions, whether from the left or the right, remains to be seen. And whether they will be adopted by governments is another question!

Webcast
Roscoe Lecture Bank of England on YouTube, Mark Carney (5/12/16)

Speeches
One Car, Two Car, Red Car, Blue Car Bank of England, Andrew Haldane (2/12/16)
The Spectre of Monetarism: Roscoe Lecture, Liverpool John Moores University Bank of England, Mark Carney (5/12/16)

Articles: Andrew Haldane speech
Bank of England chief economist says monetary stimulus stopped ‘left behind’ from drowningIndependent, Ben Chu (2/12/16)
BoE’s Andrew Haldane warns of regional growth inequality BBC News (2/12/16)
‘Regions would have faced contraction’ without rate cuts and money printing Belfast Telegraph (2/12/16)
Bank of England chief: UK can be transformed if it copies progress on Teesside Gazette Live, Mike Hughes (2/12/16)

Articles: Mark Carney speech
Governor’s ‘dynamite’ warning on wages and globalisation Sky News, Ed Conway (6/12/16)
Mark Carney warns Britain is suffering first lost decade since 1860 as people across Europe lose trust in globalisation The Telegraph, Szu Ping Chan and Peter Foster (5/12/16)
Mark Carney: we must tackle isolation and detachment caused by globalisation The Guardian, Katie Allen (6/12/16)
Bank of England’s Carney warns of strains from globalization Reuters, William Schomberg and David Milliken (6/12/16)
CARNEY: Britain is in ‘the first lost decade since the 1860s’ Business Insider UK, Oscar Williams-Grut (7/12/16)
Carney warns about popular disillusion with capitalism BBC News (5/12/16)
Some fresh ideas to tackle social insecurity Guardian letters (7/12/16)

Report
Monitoring poverty and social exclusion 2016 (MPSE) Joseph Rowntree Foundation, Adam Tinson, Carla Ayrton, Karen Barker, Theo Barry Born, Hannah Aldridge and Peter Kenway (7/12/16)

Data
OECD Income Distribution Database (IDD): Gini, poverty, income, Methods and Concepts OECD
The effects of taxes and benefits on household income Statistical bulletins ONS

Questions

1. Has monetary policy aggravated the problem of inequality? Explain.
2. Comment on Charts 11a and 11b on page 19 of the Haldane speech.
3. Does the process of globalisation help to reduce inequality or does it make it worse?
4. If countries specialise in the production of goods in which they have a comparative advantage, does this encourage them to use more or less of relatively cheap factors of production? How does this impact on factor prices? How does this affect income distribution?
5. How might smaller-scale firms “by-pass big corporates and engage in a form of artisanal globalisation; a revolution that could bring cottage industry full circle”?
6. Why has regional inequality increased in the UK?
7. What types of supply-side policy would help to reduce inequality?
8. Explain the following statement from Mark Carney’s speech: “For free trade to benefit all requires some redistribution. There are limits, of course, because of fiscal constraints at the macro level and the need to maintain incentives at the micro level”.
9. Mark Carney stated that “redistribution and fairness also means turning back the tide of stateless corporations”. How might this be done?

Upper Sixth Revision

How behavioural economics can help you stick to New Year’s resolutions

5 January 2017

Many or us make New Year’s resolutions: going on a diet, doing exercise, spending more time studying. But few people stick to them, even though they say they would like to. So how can people be motivated to keep to their resolutions? Well, the experiments of behavioural economists provide a number of insights into the problem. They also suggest various incentives that can be used to motivate people to stick to their plans.

Central to the problem is that people have ‘time inconsistency’. They put a higher weight on the benefits of things that are good for them in the future and less weight on these benefits when they have to act now. You might strongly believe that going to the gym is good for you and plan to go next Monday. But when Monday comes, you can’t face it.

Another part of the time inconsistency problem is the relatively high weighting given to short-term gratification – eating chocolates, watching TV, spending time on social media, staying in bed. When thinking about whether you would like to do these things in, say, a couple of days’ time, you put a low weight on the pleasures. But thinking about doing them right now, you put a much higher weight on them. As the well-known saying goes, ‘Hard work often pays off after time, but laziness pays off now’.

So how can people be motivated to stick to their resolutions? Behavioural economists have studied various systems of incentives to see what works. Some of the findings are as follows:

•	People are generally loss averse. To get us to stick to New Year’s resolutions, we could devise a system of penalties for breaking them, such as paying 20p each time you swear!
•	Given people’s time inconsistency, devising a system whereby you get treats after doing something you feel is good for you: e.g. watching TV for 30 minutes after you’ve done an hour’s revision. Rewards should follow effort, not precede them.
•	Having simple clear goals. Thus rather than merely saying ‘I’ll eat less’, you devise a meal plan with menus that meet calorie and other dietary goals. Rather than saying, ‘I’ll exercise more’, you commit to going to the gym at specific times each week and doing a specific amount of each exercise.
•	Ritualising. This is where you devise a regime that is feasible to stick to. For example, you could always write a shopping list to meet your dietary goals and then only buy what’s on that list; or you and your flatmates could have a rota for household chores.
•	Social reinforcement. This is where people have a joint plan and help each other stick to it, such as going to the gym at specific times with a friend or group of friends, or joining a support group (e.g. to lose weight, or give up drinking or smoking).
•	Avoiding temptation. For example, if you want to give up chocolate, don’t have any in the house.
•	Using praise rather than criticism. People generally respond better to positive incentives than negative ones.

Behavioural economists test these different incentive mechanisms to see what works best and then to see how they can be refined. The testing could be done experimentally, with volunteers being given different incentives and seeing how they respond. Alternatively, data could be collected on the effects of different incentive mechanisms that people have actually used, whether at home or at work.

The advertising and marketing industry analyses consumer trends and how people respond to pricing, quality, display, packaging, advertising, etc. They want to understand human behaviour so that they can ‘direct’ it in their favour of their clients. Governments too are keen to find ways of encouraging people to do more of things that are good for them and less of things that are bad.

The UK government’s Behavioural Insights Team looks at ways people can be ‘nudged’ into changing their behaviour, see the blog A nudge in the right direction?

But back to New Year’s resolutions, have you made any? And, if so, have you thought about how you might stick to them? Have you thought about the incentives?

Podcast
Dan Ariely talks “Payoff” WUNC 91.5: North Carolina Public Radio, Dan Ariely talks to Frank Stasio (3/1/17)

Articles and blogs
50 New Year’s Resolution Ideas and how to Achieve Each of Them Lifehack, Ivan Dimitrijevic (31/12/16)
5 New Year’s Resolutions You Can Keep (With The Help Of Behavioral Science Research)Forbes, Carmen Nobel (3/1/17)
The science behind keeping your New Year’s resolutions BT, SNAP PA (30/12/15)
The Guardian view on New Year resolutions: fitter, happier, more productive The Guardian, Editorial (3/1/17)
The Behavioral Economics of Your New Year’s Resolutions The Daily Beast, Uri Gneezy (5/1/14)
The psychology of New Year’s resolution The Conversation, Mark Griffiths (1/1/16)
Apply Behavioral Economics for a Better New Year Wharton Blog Network, William Hartje (16/1/14)
The Kardashians Can Help Your New Year’s Resolutions Huffington Post, John Beeby (29/12/16)
Using economics to score with New Year resolutions The Hindu, Venky Vembu (4/1/17)
Be It Resolved The New York Times, John Tierney (5/1/12)

Goal-setting site
stickK ‘Set your goals and achieve them!’

Questions

1. Explain what is meant by time inconsistent behaviour. Is this the same as giving future costs and benefits a lower weighting than present ones (and hence having to discount future costs and benefits)?
2. Give some examples of ways in which your own behaviour exhibits time inconsistency. Would it be accurate to describe this as ‘present bias’?
3. Would you describe not sticking to New Year’s resolutions as ‘irrational behaviour’?
4. Have you made any New Year’s resolutions, or do you have any plans to achieve goals? Could you alter your own personal incentives and, if so, how, to make it more likely that you will stick to your resolutions/goals?
5. Give some examples of ways in which the government could ‘nudge’ us to behave in ways that were more in our own individual interests or those of society or the environment?
6. Do you think it’s desirable that the advertising industry should employ psychologists and behavioural economists to help it achieve its goals?

Upper Sixth Revision

Economic forecasts: are they of any value?

9 January 2017

Economic forecasting came in for much criticism at the time of the financial crisis and credit crunch. Few economists had predicted the crisis and its consequences. Even Queen Elizabeth II, on a visit to the London School of Economics in November 2008, asked why economists had got it so wrong. Similar criticisms have emerged since the Brexit vote, with economic forecasters being accused of being excessively pessimistic about the outcome.

The accuracy of economic forecasts was one of the topics discussed by Andy Haldane, Chief Economist at the Bank of England. Speaking at the Institute for Government in London, he compared economic forecasting to weather forecasting (see section from 15’20″ in the webcast):

“Remember that? Michael Fish getting up: ‘There’s no hurricane coming but it will be very windy in Spain.’ Very similar to the sort of reports central banks – naming no names – issued pre-crisis, ‘There is no hurricane coming but it might be very windy in the sub-prime sector.” (18’40″)

The problem with the standard economic models which were used for forecasting is that they were essentially equilibrium models which work reasonably well in ‘normal’ times. But when there is a large shock to the economic system, they work much less well. First, the shocks themselves are hard to predict. For example, the sub-prime crisis in 2007/8 was not foreseen by most economists.

Then there is the effect of the shocks. Large shocks are much harder to model as they can trigger strong reactions by consumers and firms, and governments too. These reactions are often hugely affected by sentiment. Bouts of pessimism or even panic can grip markets, as happened in late 2008 with the collapse of Lehman Brothers. Markets can tumble way beyond what would be expected by a calm adjustment to a shock.

It can work the other way too. Economists generally predicted that the Brexit vote would lead to a fall in GDP. However, despite a large depreciation of sterling, consumer sentiment held up better than was expected and the economy kept growing.

But is it fair to compare economic forecasting with weather forecasting? Weather forecasting is concerned with natural phenomena and only seeks to forecast with any accuracy a few days ahead. Economic forecasting, if used correctly, highlights the drivers of economic change, such as government policy or the Brexit vote, and their likely consequences, other things being equal. Given that economies are constantly being affected by economic shocks, including government or central bank actions, it is impossible to forecast the state of the macroeconomy with any accuracy.

This does not mean that forecasting is useless, as it can highlight the likely effects of policies and take into account the latest surveys of, say, consumer and business confidence. It can also give the most likely central forecast of the economy and the likely probabilities of variance from this central forecast. This is why many forecasts use ‘fan charts’: see, for example, Bank of England forecasts.

What economic forecasts cannot do is to predict the precise state of the economy in the future. However, they can be refined to take into account more realistic modelling, including the modelling of human behaviour, and more accurate data, including survey data. But, however refined they become, they can only ever give likely values for various economic variables or likely effects of policy measures.

Webcast
Andy Haldane in Conversation Institute for Government (5/1/17)

Articles
‘Michael Fish’ Comments From Andy Haldane Pounced Upon By Brexit Supporters Huffington Post, Chris York (6/1/17)
Crash was economists’ ‘Michael Fish’ moment, says Andy Haldane BBC News (6/1/17)
The Bank’s ‘Michael Fish’ moment BBC News, Kamal Ahmed (6/1/17)
Bank of England’s Haldane admits crisis in economic forecasting Financial Times, Chris Giles (6/1/17)
Chief economist of Bank of England admits errors in Brexit forecasting BBC News, Phillip Inman (5/1/17)
Economists have completely failed us. They’re no better than Mystic Meg The Guardian, Simon Jenkins (6/1/17)
Five things economists can do to regain trust The Guardian, Katie Allen and Phillip Inman (6/1/17)
Andy Haldane: Bank of England has not changed view on negative impact of Brexit Independent, Ben Chu (5/1/17)
Big data could help economists avoid any more embarrassing Michael Fish momentsIndependent, Hamish McRae (7/1/17)

Questions

1. In what ways does economic forecasting differ from weather forecasting?
2. How might economic forecasting be improved?
3. To what extent were the warnings of the Bank of England made before the Brexit vote justified? Did such warnings take into account actions that the Bank of England was likely to take?
4. How is the UK economy likely to perform over the coming months? What assumptions are you making here?
5. Brexit hasn’t happened yet. Why is it extremely difficult to forecast today what the effects of actually leaving the EU will be on the UK economy once it has happened?
6. If economic forecasting is difficult and often inaccurate, should it be abandoned?
7. The Bank of England is forecasting that inflation will rise in the coming months. Discuss reasons why this forecast is likely to prove correct and reasons why it may prove incorrect.
8. How could economic forecasters take the possibility of a Trump victory into account when making forecasts six months ago of the state of the global economy a year or two ahead?
9. How might the use of big data transform economic forecasting?

Upper Sixth Revision

The housing market: feeling the pinch

12 May 2017

According to the Halifax house price index, house prices fell in the UK in the three months to April. This is the first quarterly fall since 2012. The Nationwide index (see below), shows that prices in April were 0.4% lower than in March (although the 3-month rate was still slightly positive).

The fall in house prices reflects a cooling in demand. This, in turn, reflects a squeeze on household incomes as price rises begin to overtake wage rises. It also reflects buyers becoming more cautious given the uncertainty over the nature of the Brexit deal and its effects on the economy and people’s incomes.

The fall in demand is also driven by recent Bank of England rules which require mortgage lenders to limit the proportion of mortgages with a mortgage/income ratio of 4.5 or above to no more than 15% of their new mortgages. It is also affected by a rise in stamp duty, especially on buy-to-let properties.

Despite the fall in prices, this may understate the fall in demand relative to supply. House price movements often lag behind changes in demand and supply as people are reluctant to adjust to equilibrium prices. In the case of a falling market, sellers may be unwilling to sell at the lower equilibrium price, believing that a lower price ‘undervalues’ their property. Indeed, they may not even put their houses on the market. This makes prices ‘sticky’ downwards. The result is a fall in sales.

Eventually, such people will reluctantly be prepared to accept a lower price and prices will thus fall more. Once people come to expect price falls, supply may increase further as vendors seek to sell before the price falls even more. So we could well see further falls over the coming months.

Lower house prices and falling sales is a picture repeated in many parts of the UK. It is particularly marked in central London. There, estate agents have begun to offer free gifts to purchasers. As The Guardian puts it:

London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a ‘burnt-out core’ according to buying agents Garrington Property Finders, prompting developers to offer ever greater incentives to lure buyers.

… Land Registry figures show that in the heart of the city’s financial district, average property prices plummeted from £861,000 at the time of the EU referendum to £773,000 in February, a decline of 15%, although in London’s outer boroughs prices are still up over the year.

But lower property prices are good news for first-time buyers, although some of the biggest falls have been in the top end of the market.

The fall in property prices may continue for a few months. But population is rising, and with it the number of people who would like to buy their own home. Once real incomes begin to rise again, therefore, demand is likely to resume rising faster than supply. When it does, house prices will continue their upward trend.

Articles
UK house prices in first quarterly fall since 2012 BBC News (8/5/17)
UK house prices fall again in April as buyers feel the pinch The Guardian, Angela Monaghan (28/4/17)
Buy a home, get a car free: offers galore as London estate agents struggle to sell The Guardian, Patrick Collinson (3/5/17)
London is now one of the five cities with the lowest house price growth in the UK City A.M., Helen Cahill (28/4/17)
London Housing Market Property Bubble Vulnerable To Crash The Market Oracle, Jan Skoyles (3/5/17)
A key indicator of a healthy housing market is flashing red in London Business Insider, Thomas Colson (29/5/17)

House Price Data
UK House Prices – links to various sites Economic Data freely available online – Economics Network

Questions

1. Why are UK house prices falling?
2. What determines the rate at which they are falling? How is the price elasticity of demand and/or supply relevant here?
3. How does speculation help to explain changes in house prices? How may speculation help to (a) stabilise and (b) destabilise house prices?
4. Draw a demand and supply diagram to show how house transactions will be lower if the market is not in equailibrium.
5. Why are house prices falling faster in central London than elsewhere in the UK?
6. Why are rents falling in central London? How does this relate to the fall in central London property prices?
7. How has the Help to Buy scheme affected house prices? Has it affected both demand and supply and, if so, why and how?
8. How do changes in residential property transaction volumes relate to changes in property prices?
9. What market imperfections exist in the housing market?

Upper Sixth Revision

Macronomics

11 May 2017

The French have elected Emmanuel Macron as their new President. He claims to be from the economic centre. But just what does this imply for his vision of how the French economy should be run? What policies is he likely to put in place? Can these policies rightly be described as ‘centrist’? In practice, some of his policies are advocated by the centre right and some by the centre left.

He wants to institute policies that are pro business and will have the effect of stimulating private investment, increasing productivity and resulting in faster economic growth.

His pro-business policies include: reducing corporation tax from its current 33.3% to 25%, the hope being that firms will invest the money that this will free up; reducing labour taxes on companies for employing low-wage workers; making the current 35-hour working week less rigid by giving firms greater ability to negotiate special arrangements with trade unions.

Other policies drawn from the centre right include reducing the size of the state. Currently, general government spending in France, at 56.5% of GDP, is the highest of the G7 countries. Italy’s is the next highest at 49.6%, followed by Germany at 44.3%, Canada at 40.8%, the UK at 39.4%, Japan at 36.8% and the USA at 35.2%. President Macron wants to reduce the figure for France to 52% over his five-year term. This will be achieved by cutting 120,000 public-sector jobs and reducing state spending by €60bn. He plans, thereby, to reduce the general government deficit from its 2016 level of 3.4% of GDP to 1% by 2022 and reduce the general government debt from 96.0% of GDP to 93.2% over the same period.

Drawing from centre-left policies he plans to increase public investment by €50bn, including €15bn on training, €15bn on green energy and €5bn each on transport, health, agriculture and the modernisation of public administration. But as this additional expenditure is less than the planned savings through greater efficiency and as GDP is projected to grow, this is still consistent with achieving a reduction in the general government deficit as a percentage of GDP. He has also pledged to extend welfare spending. This will include making the self-employed eligibile for unemployment benefits.

M Macron isalso strongly supportive of France’s membership of the EU and the euro. Nevertheless he wants the EU to be reformed to make it more efficient and achieve significant cost savings.

Articles
Macronomy: What are Emmanuel Macron’s economic plans? BBC News, Simon Atkinson (8/5/17)
Factbox: Emmanuel Macron’s presidential election policies Reuters, Brian Love (14/4/17)
What Analysts Are Saying About Macron’s Victory Bloomberg, Chris Anstey (8/5/14)
The Main Points of Emmanuel Macron’s Economic Programme NDTV, India (9/5/14)
Can Emmanuel Macron solve France’s economic riddle? The Guardian, Larry Elliott (30/4/17)
Why Emmanuel Macron’s bid to haul France out of its economic malaise will be harder than he thinks The Telegraph, Szu Ping Chan and Tim Wallace (30/4/17)
Macron’s policies on Europe, trade, immigration and defence Financial Times, Hannah Murphy (7/5/17)
French presidential election: Investors, economists and strategists react to Macron’s victoryIndependent, Josie Cox (8/5/17)

Questions

1. Compare the performance of the French, German and UK economies over the past 10 years.
2. Why does France have much lower levels of inequality and much higher productivity than the UK?
3. How would (a) a neoliberal and (b) Keynesian economist explain the slow growth performance of France?
4. Give some other examples of centre-right economic policies that could be pursued by a centrist government.
5. Give some other examples of centre-left economic policies that could be pursued by a centrist government.
6. How do M Macron’s policies differ from those of the (a) Conservative, (b) Labour and (c) Liberal Democrat parties in the manifestos for the 2017 General Election in the UK?
7. What economic difficulties is M Macron likely to find in carrying out his policies?
8. Would you describe M Macron’s macroeconomic policies as demand-side or supply -side policies? Explain.
9. What specific economic policies does France want Germany to pursue?