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Better Off on Benefits?
2009-09-23 12:17:00
The poverty trap occurs when there is no incentive to get a better paid job because of the lost benefits, and increased taxes and other costs.The unemployment trap occurs when there is no incentive to get a job because, you are better off on unemployment benefits than working.Reading our local newspaper, the Oxford Mail, I was intrigued about their story suggesting many single mothers said there was no point for them to get a job. Quite a few people interviewed said, they would like to work, but, if they did they would be worse off because of the lost benefits and extra costs involved.For example, one mother said that currently she received £70 a week benefits (£40 of income support and £30 child tax credit. She is also exempt from paying council tax (about £800 a month) and her rent of £75 a week is paid for her. In addition their are many benefits in kind for people on income support (free prescriptions).If you include the free rent, the government is paying over £150 a wee...
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Interest Rate Forecasts 2010 and Beyond
2009-09-22 08:54:00
Readers Question: Where can I find a reliable forecast of interest rates over the next 5 years. I have seen wild claims of everything from a minus figure in 2010 to 15%. I am interested in likely mortgage rates. Is it likely that interest rates could rise by 1% a year over the next 5 years?Predicting interest rates is difficult. At the start of 2008, when interest rates were 5%, and inflation was above the governments inflation target, how many people would have predicted within 12 months, interest rates would have fallen to 0.5%?Like many economic factors, interest rate forecasts are more likely to be accurate in the short term than the long term. I think most economists would be reluctant to forecast interest rates more than 1 or 2 years in advance. To predict interest rates in 5 years time, you might as well throw a couple of dice - hence the variety of interest rate forecasts you may have come across. In fact many economists are reluctant to get into forecasting because you are ...
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The Problem With Saving
2009-09-21 10:14:00
As many taxi drivers will tell you, the problem with the economy is we got ourselves into too much debt. - Too much personal debt, too much corporate debt and too much government debt.So since debt is such an intrinsic part of the current crisis, it is perhaps counter intuitive to explain why debt is not always bad and a rise in savings may create problems as well as benefits.Source: B of E quarterly report 2009 (web link)As this graph shows, saving ratios fell since 1995. Even adjusted for inflation, the saving ratio fell to record levels in 2008. The graph also shows the decline in personal wealth - mostly linked to falling house prices and to a lesser extent falling stock markets.However, the factors that caused a fall in the savings ratio have been reversed and the savings ratio is likely to rise sharply over the next few months / years.These factors include:Greater uncertainty over unemployment. Fear of unemployment encourages people to save as a precautionary measureLower asse...
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Rise In Youth Unemployment
2009-09-17 11:31:00
The first signs of economic recovery are welcome, but, it can't hide the fact there is a huge amount off spare capacity in the economy. And perhaps the worst feature of this recession is the sharp rise in youth unemployment. Statistics suggest 1 in 5 of 16-24 year olds are unemployed. The number of jobless in this age group rose from 928,000 to 947,000. (link)It suggests that unemployment is worse than official figures suggest. Using the claimant count method we have an unemployment rate of 8%. But, this hides the people who are economically inactive but not counted as unemployed. It may also reflect demographic changes that are causing a shrinking working population at the older age group.Total unemployment rose 210,000 to 2.47m in the three months to July, taking the jobless rate to 7.9% as measured by the claimant count.RelatedUK Unemployment rateUnemployment in the UK
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US China Economic Relations
2009-09-16 09:07:00
The relationship between China and the US reminds you of a couple permanently squabbling with each other - but no matter how much they find fault with their partner, they know they couldn't live without each other.China and US is a classic love hate relationship. It is an intriguing example of how economic ties can bind in a way that political ideology never could.Statistics for US China Economic Relations .The US has a large trade deficit with China. In 2008, it stood at $268 billion. (US trade deficit stats)For every $1 China spends on US goods, US citizens spend $4.46 in China.Exports to the United States account for 6 percent of China’s entire economic output.US exports to China account for 0.5% of US GDP. In a trade war, there would be one clear loser. (China US trade at NY Times)Because of this large trade surplus China has substantial foreign currency reserves. With these foreign currency reserves, China has accumulated $2 trillion in foreign reserves, mostly in Treasury bo...

Bank of England's Interest Rate Decisions
2009-09-15 08:12:00
The Bank of England have responsibility for setting interest rates. There is a brief overview of how they set interest rates here.Since the Bank of England was made independent, in theory, there is greater transparency with the Bank of England publishing the minutes of minutes into deciding interest rates.But, behind the closed doors, recent revelations suggest it is not just a polite gentleman's club. According to David Blanchflower, a former member of the MPC, a divisive battle was played out before the Bank's dramatic decision to cut interest rates by 1.5% in November. (see: New Statesman)David Blanchflower was critical of the Banks model of deciding interest rates and predicting the state of the economy. He argues the Bank relied too much on theoretical models which came to place an unwarranted emphasis on the risks of inflation and underestimated the growing evidence of recession and financial crisis."I focused on the empirical data suggesting Britain was heading for recessio...
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Financial Meltdown History
2009-09-14 10:31:00
A year ago, the US investment bank, Lehman Brothers went bankrupt. After helping to bailout Bear Sterns, the mortgage giants - Freddie Mac and Fannie Mae, and other banks, the US monetary authorities felt they had to draw a line in the sand and let banks face up to the consequences of their reckless behaviour and poor decisions.The impact of allowing Lehman Brothers (with a a balance sheet of $600bn) to go bankrupt was to create a firestorm of financial panic, which threatened to engulf the whole financial system.Why Did Lehman's Bankruptcy Cause So Many Problems?Lehman were involved in underwriting other bank and company loans. Many people who had been dealing with another company were taken aback to find the bankruptcy of Lehman left them out of pocket even though they had not directly dealt with them.Until Lehman went Bankrupt, the markets implicity believed that no big bank would go bankrupt. Banks were a safe investment, because markets felt banks wouldn't go bankrupt. The fa...
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Pessimistic Growth Forecasts
2009-09-10 16:03:00
After one of the deepest recessions since the Great Depression, there have been the first signs of positive economic growth, but despite this there are still many potential problems for the economy going into 2010.Many economists predict a sluggish recovery with the chance of the economy stagnating or growing very slowly over next 12 - 18 months. This will be bad news for unemployment and the government desperate for improved tax receipts.Factors Which Make Recovery DifficultRates can Only Rise. The number of mortgage defaults has been less than predicted. This is because many are surviving due to the exceptionally low interest rates. As the economy recovers and interest rates rise, many homeowners may struggle to survive. It is the same for people with other types of personal debt. Any rise in interest rates will hamper economic growth.Taxes will rise. The government is reluctant to maintain a large budget deficit of over 10% of GDP in the medium term. Several tax cuts are schedule...
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Obama Making Great Depression Mistakes?
2009-09-08 11:05:00
According to a report by economists Charles Rowley of George Mason University and Nathanael Smith of the Locke Institute There are "troubling similarities" between the US President's actions since taking office and those which in the 1930s sent the US and much of the world spiralling into the Great Depression . The new pamphlet, published by the Institute of Economic Affairs has been endorsed by Nobel Laureate James Buchanan, who said:"We have learned some things from comparable experiences of the 1930s' Great Depression, perhaps enough to reduce the severity of the current contraction. But we have made no progress toward putting limits on political leaders, who act out their natural proclivities without any basic understanding of what makes capitalism work." In particular, the authors, claim that the White House's plans to pour hundreds of billions of dollars of cash into the economy will undermine it in the long run.To some extent I agree with their analysis. I agree i...
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Fears That Didn't Materialise
2009-09-07 11:01:00
It is nearly a year since the dramatic collapse of Lehman Brothers. At one time last year, the financial and economic system looked to be entering into meltdown with quite a few cataclysmic predictionsThe worst fears haven't materialised. That doesn't mean things are good. We are still looking at the worst recession since the 1930s and one of the highest levels of unemployment in the post war period. Combined with record levels of public debt it makes for a difficult few years. But, I guess its something that it could have been a lot worse.Banking Collapse.After Lehman's unexpected demise, and banks not lending to each other. It looked like a frozen credit market could cause many banks to fall like Domino's. It raised the spectre of the 1930s when 100s of US banks went bankrupt contributing to the Great Depression.The global banking bailouts may have been badly managed - with the tax payer getting a raw deal; it was also rather sickening to see incompetent rich Wall Street Banke...
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Is The Recession Over?
2009-09-04 10:35:00
A recent report by the OECD suggested global growth was recovering quicker than expected.After the shock of Q1, the OECD is now forecasting 0 or positive growth for many countries.Annualised Quarter on Quarter GrowthQ1 2009US - 6%Japan - 11%Eurozone - 9.2%Germany - 13%UK - 9.3%Q4 2009 (forecast)US 2.4%Japan - 0.9%Eurozone -2.0%Germany -1.8%UK - 0.0%These are still forecasts and given the uncertainty, they could be different.The only three countries to technically come out of recession are Japan, Germany and France. Both Germany and France posted positive growth in Q2 of 2009.However, even when a country returns to positive economic growth, it doesn't mean the recession will feel like it is over.Firstly, there is always a chance that a period of positive growth may be followed by more quarters of negative growth. For example, Japan posted annualised quarter growth of 3.3% in Q2 2009, but is forecast to slip back into recession with negative growth in the fourth quarter of 2009.Also,...
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Why Are Sensible Policies Often Politically Unthinkable?
2009-09-03 12:13:00
Often economic policies which make good sense and can leave everyone better off are dismissed as being politically unthinkable. How does this come about?Let us take an example of a Congestion Charge.Driving into city centres causes negative externalities such as pollution, congestion and higher fuel consumption. People can spend hours of their life stuck in traffic jams, but despite the wastage of congestion they do not want a tax neutral congestion charge which would reduce pollution, reduce the length of traffic jams.If a government raises revenue from a congestion charge, it can use this money to reduce other taxes. This is why we say this is 'tax neutral' - the overall tax burden hasn't changed. We are just paying different taxes. The only difference is that the taxes are now forcing people to make more efficient choices which lead to less pollution and congestion. (since the London Congestion charge was introduced traffic volumes fell, average traffic speeds increased and p...
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Frugality and the Economy
2009-09-02 10:25:00
The recent boom was remarkable in the record levels of consumer spending and consumer debt. Against a backdrop of rising house prices, consumers undertook record levels of personal debt leading to a fall in personal savings rates. In both the UK and US, personal saving rates fell close to 0%.Since the housing market and economy abruptly turned, this consumer extravagance has evaporated as nervous householders have looked to pay off debts, increase their saving and save some money for a rainy day (prospect of unemployment).Even as the US economy recovers - (e.g. manufacturing output bouncing back and confidence returning), there appears to be no return to the mantra of borrow and spend. The US consumer has gained a taste for frugality and it may last for a lot longer than just this period of economic recovery. In the long run, the change in attitudes of consumers and banks may prove to be at least one benefit of this current economic crisis.This new preference to save can be seen thr...
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Tax Rises and Recovery
2009-08-31 11:24:00
Between now and the general election, the government is planning tax rises of close to £10bn. Mostly these tax rises involve the ending of previous tax cuts.The 2p rise in petrol tax, which was delayed when oil prices were high last year, will come into effect Sept 1st.The car scrapage scheme will be phased out by Feb 28th 2010The 2.5% reduction in VAT will Jan 1 2010.50% Income tax rate will be introduced April 1stEnd of Stamp Duty on houses less than £175,000 Jan 1stGiven the size of the government's budget deficit it makes sense for tax cuts to be reversed, at some stage. These tax cuts were supposed to be temporary in order to boost spending in a depressed economy. Recently, we have seen signs of recovery and though the economy is still far below full capacity, at least some of the fiscal expansion can be reversed.The danger is that if the recovery is more fragile than many hope, the tax rises could snuff out the nascent recovery and plunge the economy back into a double digi...
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Why Are You A Teacher?
2009-08-19 16:44:00
As an economics teacher, the most frequently asked question by my students is (apart from can I have more time for my homework?) - Why did you become a teacher, when you could have gone to the City and earned lots more money?Well, three pretty good reasons for being a teacher are July, August and December. This August holidays, I am in the US again, so posts may be limited over the next week.When I finished University, I had a pretty good idea what I didn't want to do. Quite high up on the list was working long hours in an office - whatever the monetary renumeration may have been. Therefore, I choose a type of teaching which enables part time work. Basically, in my case I placed a higher value on leisure time than most of my fellow graduates. Later, I felt a certain smug satisfaction as they recounted how they found themselves working a 70 + hours a week in their law firm and having no time to spend all the money they were earning.We always have choices and there are certainly draw...
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Europe's Recovery
2009-08-18 08:37:00
With the German economy having declined by 6% since 2008, it came as welcome relief to see a modest growth in German GDP during the last quarter. France also showed a modest economic recovery in the last quarter.Germany has benefited from the renewed Chinese growth and investment and their own fiscal stimulus. After their finance minister openly criticised Keynesian expansionary fiscal policy, Germany pursued it anyway. IMF figures show the German fiscal expansion was larger as % of GDP than US.Yet, the sluggish Euro area recovery is hardly cause for celebration. The peripheral areas of the Euro struggle with the hangover from their housing bubble bursting. Countries like Italy, Ireland and Spain are still showing a decline in GDP and are struggling to find an engine of growth since the collapse in their construction and housing sectors.Given the nature of Euro monetary policy, there will be concern over the development of a two speed recovery.Both Germany and France were relatively...
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High Debt and Low Interest Rates
2009-08-17 10:14:00
In an era of rising budgets deficits, an important question to pose is how much can governments borrow?Typically, higher government borrowing raises these issues:High er borrowing leads to higher interest rates as governments need to attract more people to buy bonds. This rise in interest rates is known as financial crowding out and can lead to lower growth.Higher borrowing leads to higher taxesHigher borrowing can create inflationary pressure, if the borrowing is financed by increasing supply of money.Higher borrowing can risk destabilising the exchange rate if markets fear there is a real inflationary pressure.Higher Borrowing can cause resource crowding out because the private sector has less funds for investment because it is holding more government bonds.However, some of these textbook problems often do not occur in reality. - especially, when the economy is in recession and private saving rates are rising.As Brad de Long notes (link), in the past 12 months, the US treasury has ...
More About: Interest Rates , Debt , Interest , Rates

Pound Sterling Future
2009-08-16 09:56:00
At the end of 2008, some were fearing a collapse in the Pound , suggesting it was finished as a currency. I felt these fears were exaggerated. (Run on the Pound - What's the Panic?) (Is Pound collapsing?) True, the UK economy has significant problems, but, the UK is hardly unique in facing high government borrowing, a deep recession and the need to pursue quantitative easing. At the end of 2008, I felt the Pound would stabilise and recover a little. There were good reasons for the weak pound in 2008, but, they had been overdone.In 2009, the Pound has recovered, showing that even economists can be right occasionally. Now the Pound has recovered, it is closer to its fair value measured against purchasing power parity.The future outlook for the Pound looks more uncertain. The rise of the pound this year was hardly a reflection of underlying strength of the Pound. It was more due to the relative weakness of the other countries.With France and Germany showing signs of emerging from reces...
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Money Supply Data and Graph
2009-08-14 10:32:00
Figures for money supply growth have a history of being unreliable. In the early 1980s, the UK's experiment with monetarism was effectively abandoned after the link between money supply growth and inflation was much looser than text models suggested. However, the slow growth of money supply is an indication of the continuing difficulties in bank lending. It is also an indication why the Bank of England have continued with the policy of quantitative easing.Graph of UK M4 Annual GrowthSee also:Link between money supply and inflation.Money Supply growthFor a more dramatic illustration of the state of the economy, GDP statistics show the depth of falling output.As mentioned in the previous post - outlook for UK economy. GDP growth is expected to reach a record 12 month annual fall of 5.5% this year.Given the fall in GDP, it is hardly surprising that unemployment is increasing in the UKGraph of Unemployment Rates
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Economic Forecasts for 2010.
2009-08-12 09:12:00
It is a difficult time for economic forecasting. At the start of 2008, many economists were predicting only a mild slowdown. The scale of the recession took many by surprise. It seemed that whenever the worst was over, more unexpected bad news came along.Given the parlous state of the economy at the end of 2008, expectations were pretty low for 2009. Given the dismal expectations at the start of the year, things have not turned out quite as bad as the worst forecasts. This does not mean the economy is doing well. It just means, that it could have been a lot worse. (for example, markets were recently cheered by the fact US unemployment only rose 0.5m last month - they expected a lot worse)Forecasting for 2010 is difficult given the mixed signals still coming from economy. Despite the recent positive news, it seems the Bank of England is still fearing deflation and a Japanese style double dip recession. Their recent message pulled no punches saying this is one of the worst recessions ...
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How Bad was the 1970s Economy?
2009-08-12 09:07:00
The Great Depression and the failure of classical economics to provide a solution led to the rise of Keynesian economics. In particular, an active fiscal policy to maintain full employment was a key element of the post war consensus.However, many felt that the 1970s, proved the failure of Keynesian economics. Against a backdrop of stagflation, neo-classical economists such as Milton Friedman came back into fashion and this led to the adoption of Monetarist policies in the early 1980s - in both US and UK.However, was the 1970s such as failure?Inflation did rise significantly. This was a combination ofAn external shock - rise in oil pricesMonetary policy too looseWage price spiral magnified by relatively powerful trades unions.Despite the high inflation, living standards did rise during the decade.Unemployment did rise in the 1970s, but, it was much lower than the unemployment experienced during the 1980s.There was a break down in the simplistic Phillips curve showing a trade off bet...
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Why Have House Prices Stopped Falling?
2009-08-11 10:10:00
We have witnessed the worst contraction in bank lending for many decades. Mortgage lending has slumped as banks have retreated into their shells, trying to recoup their bad losses. The recession is also one of the most severe since the 1930s, with output falling by a record level in early 2009. Yet, despite the economic slump, house prices appear to be stabilising with the unexpected prospect of finishing the year higher than they started.True house prices have fallen 25% since their peak. But, they could hardly be described as cheap. Looking at First time buyer affordability. They are much higher than in the post 1992 slump.House Price to Earnings Ratio for First Time BuyersThe house price to earnings ratio for first time buyers is still over 4.0 Compared to 2.2 in 1994.Looking at Mortgage Payments there is a similar storyFurthermore, it is not even clear whether first time buyers are any better off now than in 2007. Affordability has increased a little, but banks are now requiring...
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Mortgage Lending in UK
2009-08-07 11:21:00
Against a backdrop of very low housing activity, UK house prices appear to be stabilising.During periods of house price falls, there are often monthly aberrations. However, the Halifax three month trend showed its first positive rise (of 0.8%) since 2007. This suggests that the most pessimistic house price forecasts for 2009, now look too bearish. The Institute of Chartered Surveyors have now changed their forecast from a fall of 10% to a small rise.Mortgage lending in June also showed a small increase. But, it remains far below pre 2007 levels. This indicates a house price recovery is based on the very low interest rates and continued shortage of housing, rather than a renewed enthusiasm of banks to lend mortgages.Quarterly Mortgage Lending StatisticsStatistic for Monthly UK Mortgage LendingMonthly Figures for Recent Mortgage Lending. Source: CMLRelatedLong Run Prospects for UK house prices

Profits of Banks
2009-08-04 09:28:00
After narrowly avoiding the need for Government bailouts, Barclays posted profits of £2.98bn in the first six months of 2009. HSBC also posted profits of $5bn in the first 6 months. This growth in profits was despite a rise in bad debts. International bad debts at Barclays rose from £2.54bn to £4.56bn. The best area of growth was from investment banking. Retail banking is still struggling from recession and rise in mortgage arrears.Whilst these two banks didn't get direct funds from the government, they have benefitted from the taxpayers guarantee to the banking system. The government has agreed to underwrite the whole banking system with guarantees of over £100bn. Quantitative easing has also helped maintain liquidity at a time when interbank lending froze up.Critics of the banks will say that there reckless behaviour created a crisis which required taxpayers to bail them out. Despite the record bailout, it wasn't enough for the banks credit crisis to avoid the deepest recess...
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Problems of Economic Downturn
2009-08-02 10:49:00
Readers Question: Have we addressed the core reasons for this economic downturn?The core reasons for this economic downturn:Credit Crunch - bank losses and consequent decline in bank lendingFalling House prices Falling consumer spending due to confidence and declining asset valuesCredit Crunch. The main reason for the severity of this current economic downturn was the funds lost by banks in various subprime lending schemes. The huge losses by major banks led to a restriction of credit harming ordinary economic activity.To some extent this has been addressed through painful and expensive government bailouts. For example, in the UK, the government have increased public sector debt by £141bn due to financial sector bailouts.These bailouts helped to calm the panic that was threatening the markets. But, normal lending conditions have still not returned. There is also concern that banks may have more losses to write off - especially as house prices continue to fall and the recession lea...
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