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

Reducing overtime (penalty) rates in Australia

There is a long tradition of paying workers extra when they work hours that fall outside the normal working week. In Australia these are called Penalty Rates, and called Overtime Rates elsewhere.

Australia has a strong labour movement and was the first country to establish the 'eight hour day', five days a week as standard. They guard their free time jealously and so a system of paying penalty rates to whoever works at certain times has grown up. A particularly difficult area is Sunday trading where many workers earn 'double time', including casual staff who might only work on Sunday.

Now the Australian Fair Work Commission have concluded an enquiry and recommended that the rates be reduced.

There are several points to be made on each side of the debate.

• Penalty rates allow low paid workers to boost their pay to a level where they can earn a reasonable living wage. Therefore reducing penalty rates may reduce equity in Australia. 
• Also penalty rates provide the incentive to workers to supply additional hours of work. When the incentive is removed then the capacity of the Australian economy will be reduced (affecting Aggregate Supply).

• Against these points must be set the higher costs penalty rates impose on businesses. these will now be reduced and consumers may benefit through lower prices and improved supply. The labour market will become more flexible and Australian competitiveness will be improved.

This measure is a supply-side policy that aims to lower costs and improve long-run growth.

The Sydney Morning Herald covers the story here

The ABC 7.30 report has a video here

This story is directly relevant to VCE students and represents an excellent example of Australian Supply-side policy. IB students can equally use it as an example.

A step towards freer trade

The Doha Round of the World Trade Organization (WTO) has been making little progress as many countries fail to agree to trade policy reform. Rather than wait for a general agreement the WTO agreed to implement a partial agreement known as the The Trade Facilitation Agreement (TFA).

The TFA essentially makes customs procedures easier, saving time and other costs. It is estimated that this will raise trade by $1trillion a year and be as effective as cutting all tariffs.

The benefits of free trade are well known. There is greater specilization and trade, resources are allocated more efficiently and consumer surplus will rise. Of course there will be losers, as resources are reallocated and some structural unemployment is caused. The key is to look at this as long-term gain at the price of some shorter term pain in a few sectors.

Note how long this agreement has taken however. At least fifteen years in the making, including three years to get countries to ratify the agreement. A big plus is that Developing countries will probably be winners from this agreement. Critics of the WTO have often suggested that they favour the developed countries, but this seems to make life easier to access the markets of the richer countries.

The BBC covers the story here

This story is most directly useful to IB students as it deals with global trade agreements and the WTO. However VCE students need to understand the benefits of trade and Australia is a party to all WTO agreements, so is also an example of Australian trade policy.

Sugar tax in Australia

The sugar tax is a rich topic for IA's in microeconomics. Australia is now starting discussions at State and Federal level on the possibility of introducing one. Look out for possible articles on this and save them up!

An example from the SMH here

A danger for Australia's economy

The ABC today report that the level of Australian household debt has reached 187% of disposable income. This is, they say, the highest in the world.

The problem is that this means that many households are close to not being able to afford to pay their debts (and interest) and buy the goods and services they need. If there was a rise in interest rates, or rise in unemployment this would see more and more households 'running out of money'.

The effect this will have on Australia is that Consumer spending would fall, leading to a lower level of Aggregate Demand (AD). This would put downward pressure on economic growth and could push Australia into its first recession since 1981.

Admittedly this is the 'disaster' scenario. There are other factors that simultaneously affect the economy. However it provides a constraint on the Reserve Banks ability to raise interest rates and should warn the government that further budget cuts and tax rises could combine to cause the recession everyone seeks to avoid.

Debt is a fact of life. It makes sense to borrow to buy a house. There is, however, a limit to the amount of debt a household can take on - the amount they can repay. If banks think households have reached their ability to pay then new loans will start to dry up and consumer spending will fall, leading to that fall in AD we feared. In that situation monetary policy becomes less effective, because lowering interest rates won't help much.

This is an important piece of background to Australia's current economic situation.

OECD data suggests Australia has high household debt, but not the highest

The ABC covers the story here