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.

Penalty rates. A story to watch.

The Productivity Commission in Australia are looking at a variety of work practise's and this includes whether penalty rates are set appropriately.

Penalty rates are generally called 'overtime rates' in the rest of the English speaking world. It refers to the 'bonus' paid to workers who work extra hours over their usual working week or work at anti-social times, such as weekends. In Australia these rates continue to be set on a national level and for particular industry's.

Some argue that the rates set are too high. In some industry's the rates can be 200% of normal wages. The graph below shows the rates for the hospitality industry.

The traditional argument on penalty rates is that they lead to lower employment. The higher the wage rate then the lower the demand for labour. The same argument can be applied to the minimum wage. The graph below shows the effect of a penalty rate, PR, set above the market wage rate W. The effect is to lower employment by N - Nd hours when penalty rates apply. Notice that Ns - Nd hours of work are offered by workers, but are not taken up (involuntary unemployment).

Another way of looking at this is that penalty rates will cause firms costs to be higher. This leads to market prices being pushed up and so output, and so employment, in an affected industry is lower. The diagram below shows this with the industry or firm supply curve SPR reflecting the higher costs of penalty rates compared to no penalty rates, SNR.

There is some doubt about this analysis. When firms have a great deal of power relative to their employees, as they do in retail and hospitality, they might be able to force wage rates below market rates (W). This means that penalty rates protect workers from profit maximising employers. 

There is also not much evidence to suggest firms close down, or don't operate, when penalty rates apply. 

Below are some articles that look at this issue. The Productivity Commission will give its final report around July, it is worth being ready for it.

The ABC looks at Commission proposals here

Q&A fact check claims on penalty rates here

This is good analytical practice for IB and VCE economists. It might be a fruitful area for IA's or EE's for IB students.