The good side to exchange rate depreciation

The exchange rate of the UK Pound against other currencies has fallen considerably in 2016, the result of the vote to leave the EU. The cause of the fall is actually based on the view that the UK economy will do less well outside the EU than in it.

The chart shows the value of the pound against the US$ over 2016.

The pound has performed in a similar way against other currencies.

What does this mean? Firstly UK imports are more expensive because more pounds have to be given to buy each foreign good or service than before. This can lead to higher inflation as the price of imported goods and services in pounds rises and it makes UK consumers worse off.

On the plus side British exports are cheaper as far as foreigners are concerned. This will allow British firms to raise the level of exports. As long as the Marshall-Lerner conditions hold this will mean that the UK will experience rising net exports (X - M) and so a boost to Aggregate Demand and economic growth.

The article below explains how the British tourist industry is already experiencing a rise in demand and expects 2017 to be an exceptionally good year. A silver lining for Brexit?

The Guardian article is here

This article is an excellent example for International Economics for IB and can equally be used to illustrate the effect of changing exchange rates for VCE students. Note the Marshall-Lerner conditions are only part if the IB syllabus.

Scarcity, choice and opportunity cost

The fundamental problem of economics is scarcity. There are infinite wants, but limited resources and so all societies have to make a choice about which wants to satisfy. The cost of that choice is called the opportunity cost and is defined as the next best alternative forgone.

An example of these concepts is seen in the article linked below, which describes how the health service for England has rejected the use of a cancer treatment because they do not consider the benefits to be worth the costs.

A few words on health provision in the UK. The National Health Service (NHS) provides healthcare free at the point of use. No member of the British public, or indeed visitors, are charged for NHS care although there may be a small charge for prescriptions. The service is paid for from general taxation which means that those not working, the old or the young are not required to have contributed to tax in order to benefit. There is little need, or requirement, to have private health insurance and only 9% to 11% of the population have it.

The NHS therefore provides healthcare from a budget allocated by the government. This is, by definition, limited and the NHS must decide on the most effective way to allocate the resources it has between alternative uses.

This is a classic case of scarcity, choice and opportunity cost. The drug the article is concerned with treats a form of breast cancer that affects about 1200 women a year. It costs 90,000 GBP (AU$153,000) a year and is estimated to extend life for the average patient by around nine month.

The decision to deny access to the drug seems callous. It is really quite distressing to those who will be denied access. But what is the opportunity cost of providing the treatment? What could the NHS do with 108 million pounds a year otherwise? Of course the answer is quite a lot and hence the decision not to fund the drug.

The diagram below shows a PPF for the NHS.

As the NHS has a limited budget they cannot simply buy more of all cancer treatments. If they provide extra breast cancer treatments by reallocating resources from point A to point B there will be CD more breast cancer patients treated, but EF fewer patients treated with other forms of cancer. This is the inevitable consequence of scarcity. The opportunity cost of providing CD more breast cancer treatments is, in this case, EF fewer other treatments.

The Guardian article is here

This is a fundamental principle for all economics students when starting their course. This is a particularly unpleasant exampleto illustrate these central concepts.

The effect of Trump on the US economy

We are condemned to live in interesting times, and one of the most interesting things is what Trump's Presidency will do to the US economy.

Joe Stiglitz, a Nobel winning new-Keynesian economist, has written an opinion piece on what he thinks will happen. Some of this is beyond the new Year 12's at present, but will become clear soon. Notice in particular how Stiglitz links together different policy areas as a change affecting one part of the economic system affects others.

For example the idea that the USA will invest more than it presently saves to 'boost' economic growth leads to a rising current account deficit, which reduces Aggregate Demand and so dampens economic growth.

Stiglitz's implies Trump is just a blow-hard who does not understand economics. Can't argue with that.

Stiglitz's article is here

Pretty much essential reading for all IB students. Keep this bookmarked to refer back to.

How economies are highly interdependent

I found the article below while looking through papers on newspapermap.com. It is about how Brazil's recession is affecting Argentina's economic growth. It also details how some other injections into the circular flow will help Argentine growth in 2017.

The key here is that exports are an injection into the circular flow, but depend on foreign income, not domestic income. Therefore as Brazil suffers its 'worse recession in 100 years' their major trading partner suffers a fall in Aggregate Demand too.

This article lends itself to AD/AS analysis and discussion of multipliers. It could be taken to be an article on international trade, but for me would be best suited to a macro IA that discusses how changes in injections have a multiplier effect and to discuss the impact on the economy, government, taxpayers etc.

The article from the Buenos Aires Herlad is here

Shifting consumer preferences

The sales of fish fingers (frozen processed fish in breadcrumbs) is on the rise, Fish fingers were a popular 1970's dish, but declined in popularity over time. This is a perfect example of changing conditions of demand.
                
We know that the relationship between the price of a product and the quantity demanded will obey the law of demand. However the quantity of a product will vary while the price remains the same due to changing conditions of demand which shift the demand curve.

As the 1980's and 1990s' progressed real incomes rose. Changing real income is a change in the conditions of demand and revealed that fish fingers are inferior goods. The demand curve for fish fingers shifted to the left, while demand for substitutes for fish fingers, normal goods, shifted to the right. This might have included the wonderful Chicken Kiev in the 1980's and pre-prepared meals such as curry's in the 1990's.

The demand curve for fish fingers now appears to be shifting right once again and it's not the law of demand that is causing it. Rather the concerns about the dangers of processed meant, such as bacon and sausages, is being credited with the change. As the demand for the substitute goods shifts left the demand for fish fingers shifts back to the right. The result is that more fish fingers are being bought at the market price, while fewer sausages and bacon rashers are purchased.

The diagram below shows the effect. The demand curve in each market shifts from D to D' as tastes and preferences, another condition of demand, changes for each good.
                                             Fish fingers                        Sausages

 

The article from the Daily Telegraph below explains some other factors and provides some numbers on the changes in quantities. If you are considering this for a microeconomics IA you should draw your own diagrams and incorporate the numbers.

Note that the rise in fish finger consumption could also be due to falling real incomes in the UK, particularly in lower income households. That is the income effect and shows fish fingers are still an inferior good. 

The Daily Telegraph article is here

 

Effects of the UK sugar tax

The article below is not suitable itself for an IA. However it makes important points about the effectiveness of the proposed UK sugar tax that would be useful material to help analyse any sugar tax or anti-obeisity measure.

Therefore very useful for those revising their IA's or the 2017 year 11's.

The BBC article is here

US raises interest rates

The US Central Bank, The Federal Reserve Bank, (the Fed) has raised interest rates in the US from 0.5% to 0.75%.

This may not seem like much, but for the fact this is only the second rise in ten years. (Note that 0.25% is the usual change in rates around the world.) It reflects the recovery of the US economy from the deep problems caused by 'The Great Recession' and signs that Aggregate Demand  and economic growth is picking up.

Note the factors which the Fed have cited as reasons for the rise. Clearly not everything is going really well, but AD is rising. They also seem to be taking account of the fiscal boost President-elect Trump is proposing.

Why should the Fed act now when inflation is so low (below target) and Trump has yet to unleash his 'hope for the best' economic policies on the USA and the world? The answer lies in the 'long and variable' lags in monetary policy. It will take at least 18 months for this interest rate rise to have full effect, and possibly two years. 

Another Chairman of the Fed, William McChesney Martin famously stated that the job of the Federal Reserve is "to take away the punch bowl just as the party gets going",  recognising the long lags in policy. (That is raise interest rates early in the upward part of the business cycle and not wait until inflation is already rising.)

US Federal Funds Rate December 2005 to December 2016

The Sydney Morning Herald covers the story here

This article is about monetary policy and how decisions are made. AD/AS analysis can be applied to it and analysis of why the decision has been made can be discussed.

Monetary policy in the EU

Here is another possible IA topic. The European Central Bank (ECB) is to extend its Quantitative Easing (QE) programme by nine months, but won't buy as many bonds each month.

You will recall that QE is like printing money to expand the money supply. The ECB buys bonds from the public adding to their cash holdings. This increases liquidity in the market and forces down yields on all financial assets. The hope is that this encourages households and firms to spend money (boost AD).

The question is, will it work? The phrase 'pushing on a piece of string' is often used to suggest that under current circumstances it will have little effect. But can it do any harm?

Notice that the Euro depreciated. This may help make Euro Area exports become more competitive if that situation persists.

The BBC covers the story here 

This story is about monetary policy, but 'unconventional monetary policy'. It is a good topic for an IA. Again you may want to find other sources where the article leaves you more to say.

Justifying protection in the book market

Books in Australia are expensive. Really expensive. It has been well known that buying books from Amazon or 'The Book Depository' and having it shipped from the UK or USA has been cheaper than walking down to Dymocks. The reason is protectionist measures imposed by the government.

It is illegal to import for resale any book that an Australian publisher has the rights to. Therefore if an Australian publisher sells a book at $50 and a UK or US publisher sells the book for $15 then buying it in Australia leaves the consumer $35 worse off and until the internet there was nothing you could do about it.

The rules that cause this are called the 'parallel import rules' and have applied in several sectors. Recently the government accepted the recommendations of a report that all such rules should be abolished.

The argument for the rules on books has been that it protects Australian authors. By protecting Australian publishers from competition this raises all book prices.  Therefore the Australian authors can be published because the returns from Australian publishing are high enough to justify the investment.

Of course the big loser is the Australian book buyer. They pay more for all books, regardless of who wrote them. The big gainers are Australian publishers who can charge more because they are protected from competition from international publishers. For example a Harry Potter novel could be published overseas and in Australia but the overseas copy cannot be sold in Australian bookshops despite being a third of the price.

Would fewer Australian authors be published if the rules were dropped? Probably, but only because their product was uncompetitive - that is consumers preferred overseas alternatives. That is improving allocative efficiency.

Would fewer people be employed in the publishing industry if the rules were dropped? Certainly, because printing overseas is very much cheaper than printing in Australia. This means improved productive efficiency. (Many point out that overseas printing is also of much higher quality as their equipment and technology is superior. Improved allocative efficiency too.)

Would fewer people be employed in book selling in Australia? Probably not. Lower prices will increase book sales if the law of demand is right. Of course they may be employed differently to at present, but there is no reason why bookselling should see less activity at all.

Therefore the parallel import rules are an example of old fashioned protectionism with little to recommend it. The losers are the Australian public who will see their consumer surplus transferred to publishers or lost completely.

The Guardian covers the story here

This story is relevant to both IB and VCE students. IB students will study protectionism in international economics and VCE students will also look at the goal of external stability and policies to achieve it.

Australia is not 'half way' to recession.

Yesterday it was revealed that in the September quarter the Australian economy shrank by 0.5%. Some commentators chose to say that Australia was 'half way to recession' on the basis of the semi-technical definition that a recession is two quarters of declining real GDP.

The fact that Australian GDP has fallen is remarkable and looking at the reasons for this is a very important exercise. There are many articles on the fall in. output that might make useful Macro IA's for the IB students.

The article below is from the Guardian Australia and as always has lots of data and opinion. The opinion makes it unsuitable for an IA article itself, but it can help you write a commentary.

What could be the causes of the fall in real GDP?
Falling AD?
AS not growing fast enough?

Certianly plenty to apply in this story to the AD/AS model.

The Guardian article is here

See above - this is classic IA topic stuff. Causes, consequences and policy implications galore. For VCE students an absolute must to read as well.

India's withdrawal of bank notes

At what was in effect no notice, on 8th November, India announced that all 500 and 1000 rupee notes would cease to be legal tender. That is 86% of the cash in the Indian economy.

This is quite a shock to the system, after all 90% of India's transactions take place in cash. Yet the bulk of the Indian population apparently support the move, despite having to queue for hours to deposit their now otherwise worthless notes into bank accounts.

The reason the government took this radical step is to reduce tax evasion. India has a massive corruption problem where only 1% of people pay income tax, largely because transactions go unrecorded because they take place in cash.

The move is designed to make people deposit their cash in banks and to make more future transactions through the banking system.

Those who deposit large amounts will be asked to prove they paid tax, or be taxed on it. From then on transactions will largely have to be transparent through the banking system as people can only obtain a limited amount of cash in new notes. Therefore in the future they can be taxed fairly.

This is a bold attempt to deal with the informal or black economy. Developing countries lack the tax base to raise the money governments need to fund infrastructure and other development projects. Of course it is unclear whether the Indian governments bold (reckless?) plan will work.

The BBC explain the motives here

This is an article that is relevant to Development Economics, the last topic in the IB syllabus. However it is well worth looking at now for use later. 

UK Sugar Tax

Much has been written on the sugar tax in this blog. The article below is posted to allow those in the 2017 Year 11 cohort to have a chance to use in their microeconomics IA. Remember all articles must be less than a year old at the time of writing.

The BBC cover the sugar tax here

A twist on protectionism

Donald Trump probably has a brain which can only carry 140 characters at once. It would explain many of his policy statements, where the consequences of what he says gets missed out of his thought process. (Apologies, but he is such an easy target.)

The latest policy 'burp' from Trump is that he will impose a 35% tariff on the goods made by any American firm which has switched production out of the USA to another country.

The aim is to reduce the price competitiveness that the move will bring to the firm and so make it less attractive to move. This, Trump believes, will keep more jobs in the USA.

Analysis of this protectionist policy measure might be quite useful. Many points to make so I'm going to dot point them.

• If 100% successful the measure would keep uncompetitive (inefficient) jobs in the USA - this means everyone is worse-off in the long run.
• The firms remaining in the USA will therefore loose their overseas markets to firms that do move (possibly from EU countries).
• The loser from this policy is the USA consumer, wherever the goods are made. They either pay more for goods made in the USA or more for goods made abroad, reducing consumer surplus.
• The obvious problem might be that the firms move export sales production overseas while keeping domestic sales production in the USA. All the gains go overseas in this scenario.
• There is likely to be retaliation from the country which hosts the firms, as their exports are now being taxed.
• This policy breaks the WTO rules and therefore is illegal.
• The policy misses the really important point that the USA needs to move to industries that are high value and knowledge based, not try to hang on to low value manufacturing jobs.
• The cost advantage of moving abroad may well be more than 35%, so it still pays to move abroad.

CNN covers the story here

This topic comes under the International Economics topic for IB and is a good example of the new protectionism (economic nationalism) which is becoming popular. The problem is it goes against hundreds of years of economic knowledge on the gains from trade. An IA on this could look at the impact of a tariff, resource allocation or the impact on the various stakeholders.

Unemployment figures and policy

There have been a lot of stories on unemployment recently - see my posts on Australia's unemployment figures hiding the true state of the economy for example. Below is a link to one on US unemployment.

US unemployment is falling as the economy adds jobs. This has led the US Central Bank - the Federal Reserve Bank of America - to suggest interest rates will rise. Why? Because inflationary pressures are likely to be building, monetary policy works with a long lag and a small rise now should help prevent a problem in a couple of years. (Note more rate rises will certainly be needed over the next year.

See if you can find an article that doe not do too much of the analysis for you to use as an IA source.

The BBC article is here

Australian Sugar tax

This post is really a marker for those who will be undertaking Year 11 IB in 2017.

The sugar tax has been a topic of discussion in many countries in the last year. The Grattan Institute has issued a report and the Green party have drafted legislation on an Australian sugar tax. As discussed in previous posts it is a good idea as it helps deal with a negative externality of consumption.

Deputy Prime Minister Barnaby Joyce has called the tax 'Bonkers mad'. Takes one to know one.

The ABC covers the story here

An IA article must not be more than twelve months old when the commentary is written. Previous articles and taxes highlighted on the blog will be out of date for the 2017 Year 11 cohort, but not this!

A minimum wage for South Africa

South Africa has struggled with unemployment for many years. Until 1994 there was not an accurate figure, but it was thought to be as high as 40% and  it has never been less then 20%. In addition those in work earned low wages, often as 'day labourers' often working just one or two days each week.

It is perhaps surprising in a country with a background of inequality and low employment that no minimum wage has been established. It is now proposed that one is set.

There are arguments for and against this measure.

It will establish a wage floor that will protect the low paid from exploitation. This is very important when people are desperate for work and employers will allow competition to cut wages to below a 'living wage' level. (In effect the profits of firms are being raised through this.) It will also go some way to reducing inequality in the labour market.

Against it are the point that it might lead to more unemployment if the rate is set too high. Also it does nothing to raise the income level of those who do not work.

It seems unlikely that the minimum wage proposed is too high as the government appear to be starting at a low wage, perhaps with the idea of raising it over time. It seems more likely that it will force businesses to pay more to workers and prevent them from exploiting the large pool of competing labour they draw on.

There will be winners and losers in this, but it does seem a long overdue measure.

The BBC cover the story here

The concept of a minimum wage arises in the micro section of the IB course, but the concept of inequality is part of the macro course. Therefore this is something that could easily be turned into a Macro IA. Consider also the effect of AD of raising wage levels and the effect on AS of raising firms costs.

Australian wages growth at record low

The growth in wages in Australia is about half the rate it was four years ago at 1.9%. In a stark contrast to the period of the 1970's and 1980's this is a cause for concern.

During the 1970's Prices and Incomes policies, where governments tried to limit pay rises to control inflation, subdued wages growth would be the cause for celebration. This is because firms costs are closely linked to the prices they charge as wages make up a significant proportion of those costs. Therefore the low rise in wages indicates that inflation in Australia is likely to stay low for now.

In fact inflation is so low that it is a significant cause for concern. It indicates a low level of Aggregate Demand (AD) growth, which is threatening Australia's overall economic growth.

The cause of this low wage growth has several roots. One is the end of the mining investment boom of course and the adjustment of the economy to non-mining sectors. However usually low wages growth is associated with rising unemployment (the Phillips Curve relationship) and in Australia unemployment has been trending downwards.

As noted in several other posts the unemployment figures are misleading. In fact there is growing part-time work and underemployment. In addition the participation rate is falling as people leave the labour market. This is making the unemployment rate look lower as it is calculated using the formula:

Unemployed

                   Employed + Unemployed     x 100

As those not participating in the labour market are counted as neither employed or unemployed the falling participation rate leads to a lower recorded unemployment rate (i.e. they would be unemployed if looking for work).

The ABC provides an excellent commentary with data on this story below.

The ABC story is here

This is an excellent subject for IA's in macro. Note the ABC article has too much analysis to be a good base article, but there should be plenty of articles out there that deal with the story without spoiling the chance to analyse what is going on.

Free trade is the way to prosperity - but now it is under threat.

Donald Trump's election will provide a great many challenges, including a threat to the environment. The greatest threat will, however, be to free trade and so the prosperity and wellbeing of the whole world.

That might sound a bit dramatic, and I am trying not to be political here. The fact is that specialization and trade are the basis of all the gains we have made in the standard of living and anything that restrict that makes us worse off. This is a lesson known for many years and most persuasively put by Smith and Ricardo and refined by J.S. Mill and all economists working in the field since.

There are costs of free trade. The one that is presently causing people like Donald Trump to get elected is that some industries decline due to trade. For one place to specialize in a good or service others cannot. This means some people lose their jobs in industries which are uncompetitive. People so affected tend to be pretty unhappy about it.

Economists point out that while some industries decline, others grow and so resources in a country transfer from one industry to another. The result is improved efficiency in the allocation of resources and a higher standard of living for everyone. The costs of adjustment are temporary.

It's a difficult sell, but until now we have relied on the education, good sense and long term vision of those in government to do no more than slow transition and cushion the blow for those affected. Now we have people being elected who are happy to pander to those who shout loudly, but don't have the necessary perspective. Make no mistake if the free trade arrangements we have worked so hard to build over more than one hundred years are unwound we will all suffer.

There are many articles out there on this issue right now. Below is the Guardian's.

The Guardian article is here

Egypt floats it's currency to gain advantage

Egypt has announced that its currency will move from a fixed to a floating exchange rate from Sunday. In anticipation of a decline in the value of the Egyptian Pound it has been devalued in the fixed rate system by 48% (almost certainly to prevent speculative gains).

This is a pretty rare event and hardly ever seen in the opposite direction (floating to fixed), so its probably a permanent move, which is important for our analysis.

The Egyptians hope that the depreciation/devaluation (both are going to occur floating/fixed regimes) will boost their economy. The competitiveness of Egypt as a tourist destination will be greatly improved, and this is their most important industry. Whether this will be enough to persuade tourists to return is another issue as the country has been very unstable recently.

Notice in the article the Egyptians acknowledge that it will take eighteen months 'to see changes' and this is possibly a reference to the 'J-Curve' effect.

Notice how maintaining the fixed exchange rate has caused significant problems for Egypt recently and the examples of how they have tried to maintain the chosen fixed rate.

There is a massive downside to this move. Imported goods will cost more and this is going to impact on the poorest households the most as imported food and fuel rise in price. There will be a significant impact on the distribution of income.

Will this move actually work? Well that will depend in part on the Marshall-Lerner conditions being met. If they are then Egypt will see an improving current account balance and a reduction in the rate they are accumulating foreign debt. However the problem of tourism isn't one of price (or Price Elasticity of Demand), rather the demand curve for Egyptian holidays by foreigners shifted violently to the left due to the political instability the country has experienced.

In the long term, and this must be seen as an irreversible move, the potential gains may only be fleeting. Egypt will gain competitiveness initially, however their high inflation will continue to erode that. Further they will now have to cope with the unpredictability of a floating exchange rate and it might be expected that the Egyptian Pound will be quite unstable in the longer term bringing a large dollop of uncertainty to the already hard pressed businesses of Egypt.

Note that floating the exchange rate is one condition of IMF help to the country. This is another issue, but space dictates it can't be dealt with here.

The NYTimes covers the story here

This story is really for IB students. It has relevance to both International Trade and Development economics and is an excellent modern example of the debate between fixed and floating exchange rates.

Income inequality - a cause for concern?

In Australia the degree of income inequality is increasing. That's what the data tells us, although frustratingly 2012 is the last year for which we have reliable data.

That data shows that the Gini-coefficient for Australia has risen by a greater degree than in all but two other OECD countries. This in a period when, by the same measure, around half of OECD countries saw a more even distribution of income, but with a slight rise in inequality on average.

A survey reported in The Guardian says that most Australians feel that inequality has become worse and that it harms society by creating social division.

The chart gives a summary of Australia's income and wealth.

Recall that income is a flow concept, it shows how much money households receive each month or year, whereas wealth is a stock concept, it shows the assets households have accumulated over time. The two are related as unequal distribution of income will generally mean that wealth will accumulate to high income households who can afford to save, while poorer ones cannot.

How to deal with income inequality is a matter of debate, as is the idea of what a 'fair' distribution of income is. The survey shows there is little agreement on how to proceed, although typically for Australia they do agree someone other than themselves should bear the burden. Perhaps surprisingly there is significant opposition to an estate duty (inaccurately called an inheritance tax in the article) which taxes you when dead, rather than when alive. It has much to recommend it.

The Guardian reports the survey here

The goal of income distribution is downgraded in importance in the 2017 VCE study design, but is still very relevant. IB students can be asked an essay question on this in Paper 1 and policy measures are an essential part of that.

Depreciation of a currency isn't a cure all.

Many people like to see their currency get weaker in a floating or fixed exchange rate regime. this is because it causes export prices to fall and their country becomes more competitive. Few economists recommend depreciation as a policy for good reason, but politicians and manufacturers continue to call for it.

The UK has recently seen a 20% fall in their currency, the pound (GBP), against the dollar. Some now expect there to be a revival in British manufacturing and a rise in growth and jobs as a result. It is unlikely.

Of course a depreciation of a currency does make exports cheaper. There will be a rise in exports as a result, but there are many considerations before we can say this is unambiguously good.

Firstly the Current Account of the Balnance of Payments will only improve if the Marshall-Lerner conditions are met and the sum of the price elasticities of exports and imports sum to more than one. They will.

Mentioning imports is of course more than important. Import prices will rise with a depreciation and so will inflation. If firms rely on imported components then their costs will rise too. And let's not forget the humble holiday maker - it's not more expensive to holiday abroad. Those who champion UK manufacturing will say 'holiday in the UK', but how much rain and fish and chips can they really stand?

There is also the problem that depreciation only masks deeper problems, such as fundamentally low productivity, poor design and low quality. Temporary relief is at best provided by a depreciation which can easily be reversed. Further it isn't possible for all countries to depreciate their currency because exchange rates are a relative measure of value. A series of competitive devaluations will be at best inflationary and fruitless.

The most sensible thing ever said about depreciations is that 'there are just more questions' once they have occurred.

The article below examines the likely effect of the UK's recent depreciation.

The Guardian article is here

Primarily an example for IB students it raises very important questions about the pros and cons of floating exchange rates and the likely effects of exchange rate movements. Never forget the Marshall-Lerner conditions for HL candidates. VCE students will however recognise the effects of the changing value of the Australian dollar and the likely effects on the Australian economy and the macroeconomic goals.

Increasing industry concentration a concern

Economists have long understood that competition between firms brings the advantages of lower prices, improved quality and greater consumer choice. This is because firms deliver on these or they will be competed out of the market. 

The Australian Competition and Consumer Commission (ACCC) chairman has warned that market concentration (the percentage of market share held by the biggest firms) has risen to a level where consumers are possibly going to be worse off.

If a firm has monopoly power then they typically charge more and sell less, but earn higher profits. Over the last few decades mergers and takeovers have led to a very high proportion of Australian output being concentrated in the top 100 firms.

This provides a problem for the ACCC who regulate competition. The article below suggests that a change of rules whereby the firms that merge or want to takeover another have to prove the result will not harm competition. At present the ACCC have to prove it would harm competition.

An interesting point made by the ACCC is that if we want the benefits of economies of scale to work through to lower prices then we have to maintain a competitive environment. In other words a merger/takeover may improve productive efficiency but harm allocative efficiency.

The ABC cover the story here

This article deals directly with competition policy in Australia so is directly relevant to VCE economics. This is a part of IB economics also, and the harm that monopolies do to efficiency is often visited on Paper 1 of Higher Level in questions on the theory of the firm.

Headline inflation rise hides continued sluggishness

The Australian CPI figure released yesterday showed a significant jump in inflation, and for some this was great news s at least inflation headed back towards the target range of the Reserve Bank of Australia (RBA). This is almost certainly a false hope.

Looking at the figures it is clear that the massive rise in fruit and vegetable prices, largely due to massive flooding affecting supply, has made the CPI figure look more healthy than it really is. Take that out and the underlying rate of inflation actually fell.

Australia's headline and underlying inflation compared

The low inflation figures show that economic growth the Australian economy continues to slow down, and this is not good news. The end of the mining boom is severely affecting WA and the Northern Territory, but indicators don't show massive growth in the rest of Australia that will compensate.

Once again Greg Jericho in The Guardian provides excellent analysis and data of the inflation figures and considers the likely impact on monetary policy settings.

The Guardian article is here

VCE students are especially urged to understand the pressures in the economy at present - demand side pressures on policy settings. The article makes use of the Australian underlying inflation measures which are required knowledge.

IB students can use this as an example of inflation and monetary policy. The article is particularly strong at looking at how the various factors link together to give an overview of the health of the economy and the process and implementation of monetary policy.

Exploring Australia's unemployment rate a little more

Australia's unemployment rate is falling. That should be good news. However as pointed out a couple of posts ago this is not as straightforward as it seems.

The labour market is complex and what appears to be a substantial fall in unemployment masks a rise in part-time work, a fall in the participation rate and sharply different experiences of workers based on age and gender.

This article analyses the figures, using plenty of data in charts. The conclusion is that headline figures can appear good, but mask a serious problem.

As I made many relevant points before on Queensland I won't write much here. It is critical that you read the article to the end however.

The Guardian article is here

This is an article that provides vital information for VCE candidates on what is happening to unemployment in Australia.

IB candidates are also able to use this as an example and look at the key issues of measuring unemployment and should also consider how such unemployment can be cured. Note this article is not suitable for an IA as it is an analytical article - it does the job the IA should do, but there should be other articles out there on the latest unemployment figures (hint hint).

What is the best way to achieve equity?

Equity is a measure of fairness, and therefore a matter of opinion. The difference of opinion extends beyond what the best distribution of income is to how we should achieve it.

Some people believe that the way to achieve equity is through evening up in-work income. That can be done by raising minimum wages and taxing incomes progressively. Others believe that the best path is to pay benefits to those who require additional income. Both approaches will help reduce income inequality.

In Australia there is presently a debate between government and Trade Unions on the setting of the minimum wage. Australia has for many years had a very high minimum wage, but it has been falling in terms of the proportion of average wages this represents.

The Trade Unions want the minimum wage raised so that it is maintained at 60% of average incomes. The government does not want to commit to that because it fears that this may raise unemployment. (That would be cause real wage unemployment where the minimum wage in some industries is set above the market equilibrium.)

This is actually an argument of equity vs efficiency. There is no doubt that a high minimum wage promotes equity, the difference in take home pay will be made smaller. However it may harm efficiency.

Markets work through incentives. Earning  higher profit incentivises  firms to lower costs and improve quality in order to sell more products. It is a similar issue with workers, they are incentivised to work through wages. Higher wage rates attract more hours of work from workers.

If the minimum wage is too high there are two possible detrimental effects.
1. Firms cannot pay different rates of pay to different workers below the minimum wage
 A worker who is more productive should earn more than one who is less productive. However if both workers value to the firm is less than the minimum wage then both receive the same wage or, possibly, neither is employed.

2. The incentive to work harder and achieve improved skills and position is removed when there is equality in payment. The rational choice is to do the easier job yet get paid the same. Any move towards greater equity in income risks enhancing this effect and the economy suffers.

Overall this means that the economy is denied the competition it needs to achieve productive and allocative efficiency and as a result resources are misallocated.

There is no right answer to the question of the 'best' distribution of income. The trade-off between equity and equality is a real one though and must be considered in any policy proposal.

The Guardian covers the story here

This matter is of value to VCE students as the minimum wage is a key part of policy for the goal of equity. For IB students this has wider implications including the causes of unemployment and supply side policy.

Unemployment - the headline figures can disguise the truth

In Australia the rate of unemployment has generally been falling. This is usually good news, but there are other subtle points to consider, such as the situation in Queensland where the fall in unemployment might be hiding a more serious problem.

The unemployment rate is measured from a base figure of those people of working age who are looking for work or in work. This group are participating in the labour market, those who choose not to or cannot work are disregarded. The proportion of working age people active in the labour market is therefore called the participation rate.

The fact some people decide not to look for work can affect the unemployment figures and the article below gives an example of this. Unemployment in Queensland is falling, but some claim that this is because some people are so fed up with not finding a job they are simply giving up. If you are not seeking work you are no longer counted as unemployed and the unemployment rate appears to fall.

The discouraged workers as they are known are still without work. The participation rate has fallen and, in the case of Queensland, the number employed falls, but the unemployment rate also falls.

This could indicate a very serious problem with a number of people simply becoming detached from the labourforce, suffering all the personal costs of unemployment, but receiving none of the help the unemployed should receive. In addition the economy is loosing out on all the output those people could produce if they were in work.

Australia's participation rate, since 2011 there has been a downward trend

The ABC cover the story here

This story applies equally to IB and VCE students. The problems of unemployment and the difficulty measuring it is a core concept. There are also links to economic growth and supply-side economics as those not working represent a loss of output and those not seeking to work a serious restraint on aggregate supply.

Losing and gaining from inflation

Continuing the UK pound theme today I will look at a story on the effects of higher inflation in the UK.

Inflation has been subdued across the world in recent years despite very expansionary monetary policies being pursued by all central banks. In the UK inflation is well below the Bank of England target of 2% and in August was just 0.6% on the CPI measure. It has rocketed to 1% in September.

So far there is only anecdotal evidence that the fall in the value of the pound is responsible, but import prices will rise with the near 20% fall in the value of the pound since June. This would cause cost-push inflation and will compliment the demand-pull inflation that the Bank of England are encouraging by their recent reduction in interest rates to 0.25%.

The article, again from the BBC, looks at the effects higher inflation might have on households. It points out that when inflation reaches a rate higher than wages growth then real incomes start to fall, making people worse off. It also notes that those on benefits, many of which are frozen in value until 2020, also lose out.

One group that is protected are those who receive the old age pension (that is everybody in the UK who are old enough, it is not means tested). The old age pension goes up by at least 2.5% a year, or inflation on CPI or wages growth - whichever is higher. This protects the old against an important cost of inflation.

Note the link in the article to 'winners' from inflation.

The BBC article is here

The costs and benefits of inflation is relevant to everyone. This provides a very useful survey of the issue facing people today with low inflation and the impact of rising inflation. 

Exchange rates as a shock absorber

Economies are subject to 'shocks'. Classic ones include the jump in the price of oil in the 1970's, the rise in commodity prices in the 2000's and the Gulf wars. When they occur there is an unexpected 'shock' to Aggregate Supply or Aggregate Demand (AD). This can result in inflation, unemployment or both in the domestic economy.

The diagram below shows the effect of a shock to AD, say the shock of Brexit to the UK economy reducing consumer and business confidence. This would reduce Consumption and Investment expenditure, shifting AD to the left.

One of the benefits that an economy with a floating exchange rate has in this situation is that the currency can depreciate and act as a 'shock absorber'. The shock of Brexit has led many to believe that the UK economy will perform less well in the future and this, they reason, will mean the UK currency, the pound, will be worth less as a result.

This has led to a lower demand to buy pounds and increased selling as people seek to hold their wealth in other currencies that are less likely to loose value. The falling pound (see two posts ago for that) has an important benefit for the UK economy. 

The lower value of the pound means that UK exports now cost less in foreign currency and import prices in the UK will rise. As a  result there will be a rise in the volume of exports and fall in the volume of imports (the law of demand). As long as the Marshall-Lerner conditions hold (and they will) this will mean a rise in the value of Net Exports (X - M) which is a component of Aggregate Demand. This will, at least partially, offset the fall in AD - absorbing part of the shock.

Many argue that this is exactly why the UK was wise not to join the Euro.

The BBC cover this story here

This is very much an IB post, and touches on macroeconomics and international trade. It is particularly useful as an example of the argument around single currency areas where asymmetric shocks are likely.

Monetary Policy ineffective?

As IB students move to looking at macroeconomic policy I will provide some articles that highlight some recent issues and also help give context to the importance of understanding the theory of policy is important to understanding its use in reality.

The article below makes lots of points. It talks about how the Australian Treasurer (Finance Minister) believes that Monetary Policy has become ineffective in boosting economic activity at present. It also talks about how Fiscal and Supply-side policy must work together to achieve macroeconomic goals.

I am going to concentrate on monetary policy here. Morrison asserts that further interest rate cuts (Australian interest rates have fallen from 4.75% to 1.5% since 2012) will do nothing to stimulate the economy. This is suggesting that the transmission mechanism by which lower rates stimulate economic activity and raise the price level has stopped working.

The theory, which you will learn, suggests that lowering interest rates will raise Consumer and Investment spending and probably Net Exports, all components of Aggregate Demand. However when interest rates are very low many believe that the incentives to change behaviour cease to be significant. If coupled with lower consumer and business confidence even negative interest rates cannot help stimulate the economy on their own.

This is very much a current policy debate. Similar arguments are being had in Japan and Europe where the central banks not only set negative rates but are printing money to try to stimulate the economy.

Notice Morrison's use to the phrase 'pushing on a piece of string' - a classic term used to describe how lowering interest rates does nothing to solve a recession. The answer is more government spending and infrastructure investment. Of course that policy will be cheaper to finance when interest rates are low - so maybe low rates still have a role.

The Age covers the story here

Note that there is a lot of politics in this. Morrison, for example, refuses to acknowledge that more government spending is needed because the political priority is to cut spending to 'solve' the budget deficit. 

There are lots of articles on this argument - look for them for your IA.

The UK pound continues to fall

The exchange rates for the currencies of  most developed countries are 'free floating'. That is the value of the currency is determined by demand and supply in the foreign exchange market.

The foreign exchange market works to a great extent like any other market. The price of the currency rises when demand for the currency rises or supply falls. On the level of trade this means that when anyone wants to import, say British, goods they demand the pounds they need to pay British firms who supply them. There is then a market in pounds with those buying British goods and services demanding pounds and Britons selling pounds in order to gain the currency they need to import goods and services from other nations.

There is another aspect to currency markets however. The currency itself can be an asset and also a medium to invest in another country. Some people will want to invest their money in a country to get a higher return than they could elsewhere. Others will hold currency in order to make a capital gain, that is buy low and sell high.

This second reason to buy and sell currency makes the expectation of the future value of a currency very important. If you expect the value of a currency to fall you sell it before it does, this avoids a capital loss and prevents the advantage of getting a better interest rate being wiped out by the falling value of the currency.

Since Britain voted to leave the EU (in a travesty of a referendum) the pound has been falling in value.

The Pound against the US$ October 2015 to October 2016

The sharp fall on the day after the Brexit vote on June 23rd is clearly visible and so is the continued fall of the past two weeks.

The article linked below gives some reasons for this in particular. In summary these are:

*  Concerns that the UK economy will grow more slowly.

*  Concerns that the UK will not have free access to the EU single market after Brexit

*  That interest rates will not rise in the UK to prevent further domestic contraction (relative interest rates fall)

*  Concern that holding pounds will lead to a capital loss, due to the above reasons, so best to sell now.

Note the importance of expectations and risk in this system. It is crucial to behaviour.

The diagram below shows how the foreign exchange market for the pound might have behaved since June. Fewer buyers (who buys a currency with a way to fall leaving just 'trade' demand) D1 to D2 and more sellers (investors leaving for safer currencies) S1 to S2.

Note the links within the article that are worth exploring.

The BBC covers the story here

As this story is about the UK pound (GBP) this is most useful for IB students on how the floating exchange rate mechanism works. However VCE students should realise that the Australian dollar has the same floating system.

International Trade benefits the world, but not everybody in the world

Adam Smith and David Ricardo gave economics the theory of International Trade by 1817 (Smith 1776) and what they said remains the basis of the reason economists favour free trade over protection.

The theory says that countries should specialise according to their comparative advantage and as a result overall production will rise and these gains in output will be redistributed through trade (i.e. swapping of goods and services).

To achieve specialisation a country must grow some industries while others shrink (those in which other countries specialise). The result will be more jobs in some industries and less in others.

The loss of jobs is regrettable and is referred to as an 'adjustment cost.' Economists are fully aware of this cost and could explain to those who are now unemployed the overall benefit of the process. It will not be a popular message with the unemployed.

The World Bank is reported to have written a report confirming Smith and Ricardo's conclusions. The growth of free trade (Globalization) has led to overall more jobs, but some have lost out. They estimate 20% of job losses in some areas, like the USA, are due to free trade.

The problem is that there is no guarantee that a country will gain as many jobs through their specialization as they lose. Portugal is a good example. They have lost many jobs to lower cost manufacturing nations (such as Eastern Europe and China), but don't have the comparative advantage in high tech and knowledge based industries they need to replace those jobs.

So the World Bank report is basically saying Smith and Ricardo were right.

The BBC covers the story here

Road pricing in Melbourne - excellent idea

Infrastructure Victoria today issued a 200+ page interim report on future transport infrastructure planning in Melbourne. There is much in it that makes sense, including a cost-benefit analysis report showing which projects will yield more benefits than costs.

One of their proposals (and it is only an option) is to charge motorists $5 to enter the CBD. The aim is to reduce congestion by making people time their journeys differently and to move others on to public transport. The report suggests that 20% of journeys taking between 7am and 9am could be moved to other times.

This proposal is founded on the experience of many other cities. London, Singapore and Stockholm all have well developed charging schemes, although they are not all the same. London charges one amount between 7am and 6pm while Singapore varies the charge according to the time of day and level of congestion.

Road pricing schemes are highly effective when combined with other measures, such as improved public transport and subsidies of that system, park and ride schemes, car sharing schemes and high car parking charges for example. Without additional measures the price elasticity of demand is too inelastic for road pricing to make a significant difference, due to the essential nature of transport generally and the sheer convenience of driving your own vehicle.

Both major parties in Victoria rejected the proposed charges on the morning the report was published. So much for well considered long-term policy making. I have sent a letter!

The Age covers the story here

The ABC coverage is here

This article has some relevance to VCE as it deals with market failure (the negative externalities of using a car and congesting a road) and the price mechanism. IB students are much better equipped to investigate this topic using their knowledge of market failure and policy. (Good EE topic?)

Immigration is good for Australia

There have been calls for immigration to be halted, especially by the crazy right in Australia. However the consequences of halting migration would be dire, leaving Australians worse off.

The Age has written a piece describing the effect of halting migration. They point out that growth would slow, the workforce would age faster leading to a demographic imbalance and the government would face larger structural budget deficits. There are several other unpleasant consequences listed.

The article does miss one important point. Most Australian immigration is skilled migration. The immigrants go straight into the workforce without the need for expensive training and fill gaps that the economy would take years (decades) to fill itself. The result is that the supply-side of the economy is expanded (Long-run aggregate supply shifts to the right) and there is faster non-inflationary growth making everyone better off.

The unfortunate politics of immigration must be put to one side and the economic analysis of immigration considered more carefully to achieve a sensible solution. It is impossible to see a situation where Australia will not need at least 100,000 immigrants a year to avoid stagnating growth and an impossible pressure on the working population as the overall population ages.

The Age article is here

This article is directly relevant to VCE Unit 4 on Supply Side policy and to IB Macroeconomics (Paper 1). The impact of demographic changes is something that could easily put into an IB Internal Assessment piece using AD/AS analysis.

Sensible words

Gordon Brown as the UK Chancellor of the Exchequer (Treasurer or Finance Minister) had a 'Golden Rule'. Balance the budget of current expenditure over the economic cycle. That is he, like all sensible governments, separate the current and capital components of the government budget.

The article below says 'maybe this is a good idea?' Well while it is rather late this is a welcome contribution to the public debate.

It is not bad to borrow to invest!

The ABC article is here

Monetary policy in the Euro Area

Like many countries around the world the interest rate is at a record low. The European Central Bank (ECB) has kept its rate at 0% this month.

The Euro Area economy is growing slowly and inflation is so low that deflation is a real possibility. The response of the ECB has been to 'print' 1 trillion Euros of money and lower interest rates to encourage spending.

The ECB has been slower than most to act, partly because it has a 25 member committee that finds it difficult to agree. They may have acted far too late, or they may just feel that with rates so low and confidence so weak that monetary policy is ineffective.

There are lots of good stories like this around the world that will make good IA's.

The BBC cover the story here

Monetary policy is impotent - RBA Governor

The article linked below is as much an opinion piece as a news article (so not that suitable for IA's). However there is an important message in it. Monetary policy alone won't work to manage the economy.

Ever since the idiot Costello conned everyone into believing a Budget surplus was the equivalent of good economic management Australian governments have not really distinguished themselves in fiscal (budgetary) policy planning and execution. The one exception was the Rudd governments textbook response to the GFC.

Glenn Stevens, the retiring Governor of the RBA, has given a clear message to th government. Stop obsessing about the deficit, it isn't the problem, start spending on infrastructure to boost demand and build capacity.

VCE students will recognise this as a question of the policy mix. IB students will see the liquidity trap and he ineffectiveness to monetary policy as well.

The SMH article is here

As above for VCE and IB interest.

Japan stimulates economy - again.

Japan has announced another huge fiscal stimulus package to try and boost growth in the economy. Japan has tried a succession of such measures in recent years, but the Japanese economy continues to perform poorly.

The latest package has been described as an 'old fashioned short term stimulus, based on public works.' What we might call a Keynesian stimulus package. The Aggregate Demand and Supply diagram shows the hoped for effect of the measure.

 

The  brief details of the stimulus package are that the government will spend an additional US$275billion mainly over two financial years. This will boost Aggregate Demand (AD) by raising government spending (G), a component of Aggregate Demand. The government budget deficit will rise as a result. While there will be significant infrastructure spending in the package there is also going to be cash handouts to low income families.

The main aim of the package is to boost Consumption spending, the largest component of AD, which has been very slow to grow in Japan for many years. The overall effects are also expected to be short term only, a temporary boost to AD, partly to overcome any impact of the British Brexit vote on the world economy. 

The real question is will it work? This is the second fiscal stimulus package of the year in Japan and part of the 'Abenomics' approach of Japan's Prime Minister that aims to boost economy (a link explaining Abenomics is given below).

The stimulus is being made along with the supporting policies of expansionary monetary policy and deregulation and will shift the AD curve to the right. In the diagram above this shows a very successful expansionary fiscal policy that leads to non-inflationary growth (Real output rises from 0Y1 to 0Y2 with no rise in the price level.) 

However the diagram shows a simple Keynesian model. There might be crowding out, which reduces the impact of the stimulus, or if the monetarist/new-classical model holds the rise in demand will only lead to a short term output and employment boost and then inflation.

The BBC covers the story here

Abenomics is explained here

This article is most useful to IB students. It provides and excellent example of expansionary fiscal (budgetary) policy and raises the questions of effectiveness and the nature of mutually supporting macroeconomic policies. VCE students can certainly follow the logic of the policy and apply it to Australia's situation.

A small charge for plastic shopping bags leads to massive fall.

England introduced a 5p (about 10c) charge for plastic bags in supermarkets. After six months there has been up to a 90% fall in plastic bags used.

The motive is to reduce negative externalities of consumption which have led to market failure. Not only were the bags unnecessarily up scarce resources, they are made from oil so there are negative externalities associated with production too. Also the disposal of the bags has to be in landfill because they cannot be recycled.

This example is an excellent one of regulation (it's not a tax) that internalises the externality. People are forced to consider the costs of the resources used by the imposition of a price. The PED is actually very difficult to determine as the price was originally zero, however we might at this stage suggest that there has been a highly elastic response!

The story is covered here

This is a great example for IB students and for VCE students it also illustrates the effect of using prices to correct market failure. It is unusual as it is a regulation rather than  tax, but clearly a 5p tax would have the same effect (while raising virtually no money).

South Australia places 15% tax on gambling

Australia is unusual among developed countries, it does not tax gamblers. This is unusual for two reasons, firstly gambling is a demerit good, and secondly Australians gamble a lot and it is unusual for a government not to take advantage of taxing a popular activity.

Statistically Australians are the worst gamblers in the world. The chart below shows this.

The problem with gambling is that it represents a market failure because gambling is a demerit good and an imperfect information good.

Gambling is a demerit good because:

The actions of the gambler affect third parties, such as their families. This is a negative externality of consumption.

The result of gambling can place costs on others to help gamblers rehabilitate.

Therefore there are negative external costs associated with gambling.

Gambling is an imperfect information good because gamblers rarely understand the full effects of their actions on themselves. They gamble because they hope to win  in a system where the odds are designed to ensure overall gamblers loose. While short term gains are possible over time gamblers loose in aggregate.

The market situation is shown in the diagram below.

The idea of taxing gambling is therefore a good one. Taxes will move a market towards the social optimum (MSB = MSC at Qopt in the diagram.)

The real question is, will the South Australian tax work to solve the market failure? Will those who gamble realize that the price of betting has risen? Is the demand for gambling going to prove so inelastic that there is little change in behaviour (it is an addiction). Also will taxing the firms in this way simply lower profits of bookmakers rather than affect individual behaviour.

The ABC cover the story here

RBA cuts interest rates to new record low

The Reserve Bank of Australia (RBA) has cut its cash rate to 1.5%. This means that interest rates charged and paid by banks should drop too.

The rate cut is the latest in a succession of cuts as shown by the chart below.

In the last four years the RBA has now halved its cash rate (3% to 1.5%). The aim of this expansionary monetary policy is to try and stimulate household consumption (C), business investment (I) and to some extent moderate the rise in the Australian dollar (AUD) to help maintain competitiveness in overseas markets. The rate cut will affect these variables via the monetary policy transmissions mechanism, although many doubt they will be that effective.

The reason that the RBA cut rates are given by their statement: extracts below.

"The global economy is continuing to grow, at a lower than average pace."
"Commodity prices are above recent lows, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years."
"In Australia, recent data suggest that overall growth is continuing at a moderate pace, despite a very large decline in business investment."
"Recent data confirm that inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time."

However there are some indicators that suggest that rates need not be cut. This is typical in any period and the RBA has to decide on the balance the forces to make its decision. They identify:

"Several advanced economies have recorded improved conditions over the past year..."
"Labour market indicators continue to be somewhat mixed, but are consistent with a modest pace of expansion in employment in the near term. "
"Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector."

There are several concerns about monetary policy. These include will cutting rates at such low levels actually promote any change in behaviour, i.e. will cutting rates work? There is concern that the cut in rates simply shows how desperate the economic situation is and so any influence rate cuts have is overwhelmed by lower business and consumer sentiment.

There is also criticism that the RBA have badly mismanaged the situation for years and have failed to learn from other central banks. The Guardian article below explores this.

The ABC looks at the rate cut here

The Guardian discusses RBA policy here

VCE students will be interested in the conduct of monetary policy by the RBA and how this is likely to effect the Australian economy, in particular how it might work through the monetary transmission mechanism. Also the factors that are influencing Aggregate Demand in Australia are highlighted by this decision. IB students should also be interested in the RBA overall policy that is discussed in The Guardian ad how appropriate their actions have been in recent years given the time lags involved in policy and the influence of relative interest rates.