Manipulating supply to raise prices

OPEC is a group of countries that produce oil and in the 1970's formed a cartel to try and raise the revenue they received from oil production. They were very successful then, but today there are many oil producers who are not members of OPEC and so their ability to influence the market has declined.

There is more oil production capacity than there is demand, and presently more oil is produced than the market wants. This situation of excess supply has depressed oil prices.

OPEC has tried to reduce supply from its members, with the cooperation of a few other countries, in order to raise oil prices. They succeeded, but the agreement is running out and there is talk of extending it.

There are some useful areas to investigate.

1. The oil price has fluctuated in anticipation of the agreement being renewed and to news about the level of oil stocks. Why?
2. The members of OPEC have an incentive to agree production limits and then cheat by producing more. Is this always true in cartels?
3. Why is the oil market producing so much more than the market requires? (The move away from fossil fuels and the rate of economic growth are both relevant here.)
4. Who gains and who loses from the lower oil price?

The BBC covers the story here

A trade off for monetary policy

Since the global financial crisis interest rates in the UK (and the US, Europe and Japan) have been at record lows. The aim was to boost Aggregate Demand and avoid prolonged recession and promote faster recovery. An interesting trade-off has been highlighted as a result of this policy.

The low interest rates have indeed maintained UK output, according to a Bank of England economist, but the low rates have meant firms that should have ceased operations have been able to survive. Around 1.5 million jobs have been protected according to Andrew Haldane.

Of course saving jobs was exactly what the Bank of England were trying to do when they lowered rates. The unintended consequence of this action was that it reduced the costs of poorly performing firms. Those who were not efficient enough to earn the profits necessary to repay loans at 'normal' rates of interest have been able to survive ('Zombie firms' according to Haldane).

The impact has been to allow low productivity jobs to survive and this has led to poor improvements in productivity overall, because the productivity figures reported are an average over the whole economy.

Productivity is a measure of efficiency. It records how many inputs are required to produce a given level of output. For economic growth to deliver higher standards of living a rise in productivity year on year is crucial. The UK has a very poor productivity record generally and the low interest rates since 2008 have allowed this to get worse.

Haldane says that he is happy to have seen 1.5 million jobs saved rather than 2% productivity growth. At least 1.5 million people and their families will be agreeing with him.

The BBC article is here

As this is an article about the UK as an example it is directly useful to IB students. However VCE students can see the example of how all policy has trade-offs and policy actions often have unintended consequences, such as supporting inefficiency to reduce unemployment.

Record high underemployment in Australia

The latest unemployment figures for Australia show a number of worrying indicators.

• A rise in unemployment overall (to 5.9% of the workforce)
• A record high in underemployment (1.1 million people are employed but want to work longer hours)
• Falling numbers of full-time jobs 

This all helps explain why wages growth in Australia is also at record lows. There is simply too much supply in the labour market for wages to rise. This may be because of a number of reasons, for example, an increasing workforce (immigration and more young people joining the market than older ones leaving it), or lower demand for goods and services made by Australians leading to less demand for workers. 

The prospect of falling Aggregate Demand (AD) is clearly a possibility. At present the rise in commodity prices is helping to boost exports, assisting modest AD growth, but isn't really employing any more people (because its the value not the volume of exports which is rising).

This is going to present difficult policy options for the Government (budgetary/fiscal policy) and the Reserve Bank of Australia on interest rates.

The Guardian covers the story here

The Fed tries to keep 'ahead of the game'

Eddie George, the former Governor of the Bank of England, described the role of Monetary Policy as 'keeping ahead of the game'. By this he meant central banks have to act early, in anticipation of movements in the economy.

The Federal Reserve Bank of the USA (the Fed) has raised its base interest rate from 0.75% to 1. The base (or benchmark) interest rate is important because all other interest rates in an economy are like rafts to the base rates tide. When the tide comes in all the rafts go up. All US commercial interest rates (like personal loans, savings rates and mortgage rates) will rise as a result.

The article points out that the US, like the UK and EU, has an inflation target of 2%. In all three inflation is around that level, but only the Fed is raising rates. This is where Eddie George's phrase becomes relevant. Monetary policy has 'long and variable lags' and takes up to two years to take full effect. The Fed is anticipating changes in the US economy and setting higher rates for what will happen in the future.

This is a very good topic for a Macro IA and you should follow the interest rate changes in major economies. (Note the 'analysis' section of the BBC story below makes this an unsuitable article for an IA, because it is doing the job you need to do in the IA, but there are lots of other reports.)

The BBC article is here

While this is about UK monetary policy the basics of monetary policy are the same in Australia, so useful for both VCE and IB students.

Eddie George was an almost fanatical player of Bridge. He attributed his initil success at the Bank of England to playing with various important people!

Is Quantitative Easing working in Europe?

The European Central Bank has been fighting the danger of deflation in the Euro Area. Deflation is a sustained fall in the general price level so that the purchasing power of money rises.

The purchasing power of money rising sounds good! However it is generally caused by low demand and so low growth, or even falling output. The most recent period of prolonged deflation occured during the Great Depression, and nobody wants to go back to that. When prices are falling consumers will wait to buy good and services as they expect them to become cheaper. The result is a downward spiral of prices and output.

The ECB has been using conventional expansionary monetary policy, interest rates are now 0%, and unconventional monetary policy, they are printing Euros through Quantitative Easing, in order to boost Aggregate Demand (AD) and so economic growth.

The report below suggests that this is now having some effect, but it is far from certain that a sustained upswing in output, wages and prices has yet been achieved, so they will continue the policy. (Note the difference in headline and core inflation which indicates that there is still some way to go before there is a sustained recovery.)

The BBC cover the story here

Carbon emissions do respond to policy

In Australia it is common to come across both climate change deniers and those who deny that policy measures to reduce global warming will be effective. Often the claim is made that the policy measures do too much harm to people's livelihood's now to be worth the benefits later (dingos kidneys obviously).

The story below from the BBC reports on a record fall in UK coal use and as a result carbon emissions. It is a story that suggests when policy is properly applied it can have a significant impact.

In the case of the UK (and here you can read a combination of EU and UK policy) thare are a raft of complementary policies that have driven lower emissions.

Briefly the UK policy includes:

• Setting a carbon budget - a proposed limit to carbon emissions that falls over time
• Taxing carbon emissions, including a minimum tax on carbon.
• Subsidizing renewable energy.
• Promoting and funding a shift away from coal to cleaner fuels (move to low-carbon technologies)
• Funding public information of the dangers of global warming and ways to reduce carbon emissions.
• Subsidizing home improvements and strict regulation on new building standards e.g. insulation standards such as compulsory double glazing.

The message here is that one policy alone is not really that effective, but a combination of policies that raise the price and shift the demand curve to the left do have a significant effect.

One point to note is that serious attempts in UK policy on this issue began in 1990. While policy has intensified since 2006 there has been a fairly sudden change recently, as the article notes. Initially policy met an inelastic response to price changes and only minor changes that could be said to have moved the demand curve left. 

Now the policy has reached the 'tipping point'. We are observing an elastic response to price (see article) and behaviour has been changed. Economists knew this point would be reached, but predicting how much pressure needed to be applied to reach it was never clear.

David Pearce, you were right. I'm sorry you never lived to see it.

The BBC article is here

Two demand and supply news articles

These links are to articles you can apply demand and supply to

Strawberries in the UK

Demand for Bananas