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

German trade surplus and another mad Trump claim

Germany has posted a record trade surplus on its current account. This really means that Germany has exported more than it imported. It should be noted that both exports and import values grew, but export values grew faster.

Trade surpluses are not 'good' and deficits are not 'bad'. There should be a broad balance over time on the current account. If there are persistent deficits this suggests that a country will build up foreign debt and isn't competitive. A persistent surplus means that the Aggregate Demand in the economy is being boosted, leading to inflationary pressures and demand for the currency, to buy the exports, will force up the exchange rate.

Trump's trade advisor has accused Germany of using the weak value of the Euro to boost its exports. This bizarre claim is just another conspiracy theory. The value of the Euro is determined by the market and the European Central Bank (ECB) is independent of governments in setting monetary policy.

The claim does however allow us to realise that Germany is concerned to reduce its trade deficit because of the effect it has on the domestic economy. As pointed out in the article Germany has taken steps to boost domestic demand in order to stimulate demand for imports. Some of the measures are detailed in the article.

Not for the first time though the article demonstrates that the Trump administration is just batshit crazy.

The size of Germany's Current Account surplus compared to GDP for the last ten years, shows a growing issue.

The BBC article is here

This article is primarily of use to IB students in its detail. However the effects of a trade surplus and the effect of currency value is important knowledge for VCE students.

Look out for the 'J curve'

Economic theory tells us that when a countries currency depreciates (falls in value) that export prices fall, import prices rise and that following the law of demand the level of net exports, X - M, (the balance of trade or current account) will grow.

It's not quite as simple as that. Firstly it takes time for the change in export and import volumes to occur. At first they will stay the same. This means at first export values stay the same (valued in the country's currency) and import values rise (values in the country's currency). So the balance of trade, or current account or net exports at first gets worse.

Providing the Marshall-Lerner conditions hold over time exports grow as foreigners realize they are now cheaper and imports fall as domestic customers switch to home produced alternatives. Therefore the reaction of net exports should be to initially worsen, then improve, and when plotted against time this looks like a 'J'.

 

Following the Brexit vote the value of the British pound fell, up to 20%. Therefore we might expect to see a J-curve effect on the British trade balance.

The data does not yet show this clearly. One reason is that the effect from t1 in the diagram above to the point where the current account turns into a surplus is thought to be about a year and a half. As we are six months in to the process we should only have seen a worsening of the trade balance so far.

 

UK Balance of trade December 2015 to November 2016 (latest data available in Jan 17)

The data shows the initial worsening we would expect in the balance of trade after the late June vote and fall in the pounds value. This isn't a smooth J-curve though.

The reason that we don't see a textbook J-curve is because all variables don't stay the same. In 1967 the UK devalued the pound in a fixed exchange rate system from 1:US$2.8 to 1:US$2.4. And that rate remained fixed until 1971. Therefore there was certainty and stability in the exchange rate after 1967. That isn't true of the current situation, where the pound continues to fluctuate in value in a free floating exchange rate system.

 

UK Pound value against US$ Jan 2016 to Jan 2017

As is clear from the path taken by the UK pound against the US$ there remain variations in value. This is partly because of changing business and consumer confidence as more news arises over the likely results of Brexit.

Therefore we should be looking for evidence of a J-curve effect, but remember we don't live in a world where one change is followed by stability of all variables that allow us to see the elegant relationship the textbooks tell us about. But it should be there, just partially obscured.

The Independent covers the latest trade figures here

This topic is of specific interest to IB students for their international economics section of the course. However the effect of the changing value of a currency is equally important to VCE students as the fall in the exchange rate of the A$ since 2012 and especially since 2014 is highly significant.

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.

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

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.

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.

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.

Rising student numbers and the exchange rate

There has been a large rise in the number of foreign students in Australia this year. This is in sharp contrast to the situation in 2011 when numbers plumbeted and Monash University offered 400 voluntary redundancies to its staff.

According to recent figures there has been a rise of 12% in overseas students in 2015/16 with the increase in students from China being a huge 23% higher than last year.

When this size of change occurs it is fair to say that something has changed in the market. It could be a change in a condition of demand or supply. However the turnaround in numbers has nothing much to do with extra places becoming available or a sudden jump in the reputation of Australian education.

The reason that Australia is a popular student destination again is all to do with the exchange rate. In 2011 the Australian dollar (AUD) bought US$1.1, today it will buy about 73 US cents. This makes it much cheaper for foreign students to study in Australia. The relative price of Australian educational institutions has fallen and so overseas students have switched from the alternative (substitutes) course.

The chart below shows the exchange rate of the AUD against the US$ since 2009.

The rise in student numbers is one example of how the competitiveness of the Australian economy has improved as a result of the depreciation of the Australian dollar. The result has been a boost to those sectors of the economy which reply on export markets, including manufacturing. As a result Australia is recovering from the end of the mining investment boom rather better than anticipated.

Business Insider provides details on the student numbers here

IB students will want to consider whether the Marshall-Lerner conditions are met and the ultimate effect on the Current Account balance. There will, of course, inevitably be a rise in the volume of exports and a reduction in the volume of imports.

This article is of great importance to VCE students as this is an important demand side influence on the Australian economy. IB students should also be equally interested in the article as an example of the impact of floating exchange rate regimes.

UK trade deficit

The UK has just recorded a record trade deficit on the Current Account. At 7% of GDP for the last quarter it is quite a large one.

The BBC article linked below describes what a trade deficit is and why running one might be a bad thing and when it can be coped with. Overall an excellent educational article on a current event.

I want to talk about why the trade deficit has widened and what it's implications are.

The UK economy grew in the last year. By 2.5% according to the latest data. That is actually quite high compared to the rest of the EU and other developed countries. As imports are a function of income economic growth means higher imports. (M = mY where M = total value of imports, m is the fraction of income spent on imports, known as the marginal propensity to import, and Y is Real GDP or national income.) So if a country grows faster than its trading partners it can expect its imports to grow faster than its exports.

The UK has recently seen a fall in the value of the Pound (a depreciation). This will make exports cheaper and imports more expensive so an improvement in the current account balance will follow if the Marshall-Lerner conditions are met. The chart below shows the UK pound against the US$.

 

The recent fall in the pound is seen clearly in the graph. So why has the UK current account not improved? The Marshall-Lerner conditions certainly apply to the UK. The answer lies in the J-Curve effect, the current account worsens before it improves because the UK Pound value of imports rise while the Pound value of exports remains the same after the depreciation.

We should also consider the impact on UK Aggregate Demand (AD). (X - M) is a component of AD and so this worsening current account will act as a drag on UK growth, at least until the J-Curve effect works through to an improvement in the Current Account deficit.

The BBC article is here

VCE students will find the article an excellent explanation of the significance of foreign debt. IB students will also understand the process of the depreciation of a currency and the application of both the Marshal Lerner conditions and J-Curve effect. All students should consider the impact of a larger Current Account deficit on the wider economy through AD/AS analysis.

Monetary policy in 2015

The role of the Reserve Bank of Australia (RBA) in monetary policy is to maintain the rate of inflation, on average, at 2% to 3% over the economic cycle.

The tool that the RBA has to achieve this is the interest rate (cash rate). They can adjust the cash rate to influence the level of Aggregate Demand in the economy. Lower interest rates encourage consumption, investment and exports (through a lower exchange rate). The higher the level of Aggregate Demand the greater is the upward pressure on inflation. 

So the RBA monitors the level of economic activity in the economy (such as the rate of growth of GDP and other indicators of Aggregate Demand such as consumer spending) and attempts to set interest rates so that inflation meets its target.

The article below looks at the likelihood of an interest rate cut in Australia soon. This is based on low inflationary pressures particularly the fall in oil prices and the fall in the rate of activity in the construction industry. 

There are many influences on the rate of inflation, often these influences conflict (a mixture of 'headwinds' and 'tailwinds'), but at present the overall effect seems to be for lower inflation. That demands an interest rate cut to encourage higher Aggregate Demand.

The Guardian article is here

Greg Jericho's summary of important changes in the Australian economy in 2014 is below, which gives some wider context.

Jericho's review is here

China - the most important demand side factor

There is no doubt that demand side factors have been important in Australia in the last four years.

The main driver of the Australian economy recently has been the mining boom, caused by very strong exports to China. China has experienced nearly a decade of growth rates above 10% and that demanded a great deal of mineral resources.

Now the Chinese economy is growing more slowly. It's still growing, but now by only 7.2% a year. But that's still growth isn't it?

Chinese growth demanded a great deal from the mineral suppliers of the world and supply constraints meant that the prices of commodities rose quickly. Australia saw the Terms of Trade rise substantially and that made Australia a lot better off. The Mining Resources Boom.

Today most mineral producers have expanded capacity compared to just four years ago. Australia has developed mines, opened new ones and improved port and railway facilities to allow the export of more mineral resources. World supply has expanded.

But now Chinese growth is slowing and demand for mineral resources is moderating. Mineral prices are falling as the graph of the iron ore price shows.

This means a lower value of exports for Australia, and a falling Terms of Trade. Whatever way you look at it the demand side of the economy is weakening.

This means lower Exports and Investment (as the 'Age' article linked below shows a port development has been shelved) and so lower Aggregate Demand. The multiplier effect will cause National Income to fall further and this means fewer jobs.

Last year everyone thought the Terms of Trade (then at a record high) would feature in the exam. You would be very brave not to revise this topic for 2013.

The Age reports some consequences of lower Chinese growth here