Post Keynesian Economics, which I linked to last week, really is a great resource.
In particular I like the long series of posts explaining how the macroeconomy works and why we have a crisis. I was planning on writing something vaguely similar myself, but it gives a far clearer explaination.
So here it is, my own long(ish) post on Austrian Economics is nearly finished…
Production takes time and often is debt financed. Hence the key role of banks/finance in the business cycle.
Business investment plans are subject to much uncertainity about the future. Confidence matters.
Whilst demand for non-durables is fairly stable, demand for durables is one driver of the economy.
Physical investment is the key driver of the macroeconomy. And it’s very volatile.
Why do individual firms care about their stock price? It can make raising finance in the future more expensive.
The market is short terminist. Stock prices should mean that the best companies have the highest stock prices. In reality this rarely happens and as a result financing costs are mispriced. My own day job leads me to totally agree with this.
Stabilty breeds crisis. As Minsky argued, during periods of stability firms and households believe they can take on more and more debt. banks become confident and lend to them. Eventually we hit a point when the debt burden is too large and people become aware of it.
What markets are good at and where they fail. A fair summary that is not ‘anti-market’ but simply realistic.
Putting all the above together we get a decent understanding of how confidence, investment decisions, debt levels and stock prices move together. Eventually:
By late expansion, our animal spirits and expectations of profit are at their high point. This means stock prices are sky high, too, and stock holders’ tolerance for poor quarterly reports very low since they are used to hearing about successes. Banks are every bit as excited as everyone else and they have been approving loan after loan, accommodating the rising debt levels. In fact, banks are seeking out the high-risk customers now and, in the heady days of peak expansion, aren’t looking all that closely at credit-worthiness. Consumers are offered lots of good financing deals and those who did not partake in the buying before will now decide, “What the hell–if the Smith’s can afford a new plasma TV, so can we!”
At some point, someone somewhere says, “Whoah! Sales are way off of what we expected!” If the gap between expectations and reality is big enough, this can evolve into a full-blown crisis. The level of debt everyone is carrying makes us even more susceptible.
it is necessary to understand that the market is not the natural or default system for human society. It evolved and is a human, social invention. It is not, as I have heard people say (including some of colleagues!), the way we act when there are no rules. Capitalism is a particular set of rules. Because they are our rules, however, they feel natural to us, just as one’s native language does. Capitalism does some things very well and some things very poorly. Capitalism should serve us and not the other way around, so when we find something we don’t like, we should feel perfectly free to change it without upsetting some “natural” order. This is not to say that we shouldn’t be careful to think through the secondary and tertiary impacts of any policies, but that’s true regardless of what our topic is.
According to my analysis so far, where does the market let us down in our quest for output and employment? I have identified three specific problems:
1. The short-term focus of the stock market means that resources are misallocated and prices are overly volatile (see parts 5 and 6);
2. Because of the fact that the market for physical investment and consumer durable goods can be saturated, we get the irony of the fact that at the very moment when we should be enjoying the highest standards of living, the economy slips into recession (see parts 3 and 4);
3. Overconfidence leads people to take on too much debt (see part 7) and causes shock as agents panic when the economy turns down at the top of the expansion (see part 9).
Finally, post 13 gives some current policy recommendations.
uneven income distributions have weaker economies. There are several reasons for this, but one is the fact that the rich don’t spend much money. The same $10 million dollar salary spread over 100 people generates much more spending that it does if it’s all one person. Income distributions have been deteriorating for the past 40 years and they did the same thing before the Great Depression. Economic growth, when it comes, must be directed toward wage earners and not those scraping the profits off the top. As I mentioned in part 12, this is not a fairness issue, it’s a question of the survival of our system. We can address this through the tax structure, health care reform, and education. If the poor continue to get poorer, the core set of people of create demand for goods and services will be made impotent.
Two days ago I accussed the Governor of acting like a ‘political hack’.
Paul Waugh says:
The very idea of a Cabinet minister slagging the Governor of the Bank of England in such terms is certainly jaw-dropping stuff.
Normally I’d agree. But not when, to use the language of the school ground, he started it.
In other news the Bank have responded to my FOI request as I suspected they would:
We take “meetings” to refer to organised exchanges involving the Bank’s executive, as distinct from social or casual gatherings; and “representatives” to mean the leadership or staff of the conservative party, rather than simply members.
Like senior civil servants, Governors of the Bank have over many years held meetings with the leadership of the opposition parties.
Such meetings are held with the knowledge and approval of the administration of the day. They are necessarily private on both sides, owing to the risk of misunderstanding and misreporting. So although the fact of such meetings is acknowledged, we will neither confirm nor deny whether any particular meeting or series of meetings took place, nor provide dates or records should any be made.
New addition to the blog roll.
Really worth a read. Sample (and remember it’s American so we can forgive the use of ‘middel class’:
So what was the problem? Think about this: if, as a macroeconomic unit, we had the resources, technology, and productive capacity to produce all those houses, cars, TV’s, meals at nice restaurants, etc., then why did people have to go into so much debt??? Why weren’t our incomes sufficient to buy those absolutely-affordable goods and services without debt or at least with minimal debt? Therein lies the problem. We didn’t spend too much, we earned too little. Not only is there a systemic issue with respect to market economies being unable to generate a reasonable number of jobs for all those willing to work (see the discussion below), but income distributions have been becoming more and more uneven. Those who form the backbone of consumer demand, the middle class, have been losing relative income shares to the rich. This is all great fun for the rich in the short run, but it leads to what we have right now in the long run: falling sales, default, unemployment, recession, etc.
Hence, the focus of policy right now must not be on cutting back spending. Why should we? We can afford all that stuff, and buying it is what creates jobs and incomes for others. Rather, policy should create income and offer incentives for spending money. The private sector cannot do this alone because as we stand right now, all individual incentives are to restrict spending.
Naked Capitalism have an excellent pdf up (from the NY Fed0 giving a timeline of the crisis.
Hopi ties up various threads of the ‘cuts debate’.
Those interested in money,credit and quantative easing should have a look at Alphaville on China today.
Finally Adam at the TUC’s Touchstone Blog asks an important question.
It is perfectly right and proper, and indeed necessary, to have a rational discussion on fiscal policy. Government debt, the size of both public spending and the tax burden are the matters that should be discussed by rival politicians of the left and right.
However it is simply not acceptable for the Governor of an independent Central Bank to wade into this area.
It’s not his job. The quid pro quo of the Government not interfering in monetary policy is that central bankers stay out of fiscal policy. The issue is not the rights or wrongs of what the Governor has said. The issue is that he has spoken on this issue at all.
This is the second time in a year that Mervyn King has strayed from this basic principle.
The charitable interpretation of his last entry into the fiscal debate was that it represented not an attack on Alistair darling but an attack on Danny Blanchflower. Given Blanchflower is no longer on the MPC this excuse no longer holds any water.
The Governor has now firmly placed himself in the political area and is acting as a political figure. This is very similar to Alan Greenspan’s last years in office, especially his vocal support of Bush’s tax cuts. As Harry Reid, then Senate Minority Leader, said in 2005 Greenspan had become “one of the biggest political hacks we have here in Washington.”
The Governor is now a political hack. I honestly hope that there is no connection between his attacks on the Chancellor and the Tory plans to expand the Bank’s role. I also hope that the fact that George Osborne’s chief economics advisor (Matt Hancock) is a former Bank economist who used to be Paul Tucker’s (the current Deputy Governor) private secretary is not relevant.
But these questions have to be asked. When you behave like a political hack, you get treated like one.
On a side note I submitted the following FOI request to the Bank on the 26th May and am still awaiting a response:
I am writing to make a Freedom of Information request.
Could I please details of any meetings between Bank staff (especially the Governor, Deputy Governors and other executive level staff) and representatives of the Conservative Party (MPs, Peers, MPs’ and Peers’ staff and other employees of the Conservative Party) over the past 12 months?
Could I please have the dates of such meetings, any minutes or papers prepared for them and a list of attendees (from both the Bank and the Conservative Party)?
As may have become apparent, I’m becoming rather annoyed at German policy makers.
They seem, as Paul has noted, intend on free riding of the stimulus packages of others.
What’s more they then criticise those very same stimulus policies.
As Snowflake5 has noted their policies are not working especially well.
But what really annoys is what my friend Vino said this morning in an email:
The thing I find really sad about the German situation vis a vis the US is that – if Germany has high unemployment people will blame it on their labour market/welfare state/social-market economy rather than on sado-monetarism. Bad news for the European social model.
Paul notes that Yasmin Alibhai Brown is talking of ‘tough choices’ which should be read as ‘cuts in the welfare state’.
Don summarises the findings as:
1. Nearly all the participants in the discussion groups placed themselves in the ‘middle’ of the income spectrum, despite the fact that they came from the full range of socio-economic groups. They interpreted the income gap in terms of the gap between the ‘middle’ and the ‘super-rich’.
2. Most participants believed that ‘deserved’ inequalities are fair. They were therefore not opposed to high incomes in general because they tended to believe that these were deserved on the basis of ability, effort, performance or social contribution.
3. Despite a widespread belief in ‘fair inequality’, participants strongly supported a progressive tax and benefits system – although they complained that the system is not generous enough towards the ‘middle’ (that is, where participants placed themselves)
4. Participants’ attitudes towards those on low incomes were often more negative and condemning than their attitudes towards ‘the rich’. For example, they placed far greater blame and responsibility on the former for their situation than on the latter.
5. Most participants were strongly attracted to a social vision founded on improving quality of life for everyone (more so than one founded on explicitly egalitarian objectives, and far more so than one founded on economic growth).
In his second post he makes, to me at least, the key argument:
One criticism of the welfare state is that once you include tax credits, child benefit, housing and council tax benefit and so on, a lone parent who is not in paid employment and has two children has roughly the same income as a single person who works and gets the average wage.
One possible reaction to this is “that’s a disgrace, and it shows that benefits are too high.” This is the one which you will read a lot in the newspapers.
But another is “that’s a disgrace, and it shows that wages for the average worker are too low.”
Which of these – prioritising cutting benefits or raising wages for middle income workers – is more likely to help improve people’s quality of life and make sure that hard work is properly rewarded?
The people in the middle, seem to agree with him.
I think we are stumbling towards an agenda here.
If Cameron had been PM and Osborne Chancellor last year, would this article have appeared in the Times rather than the Irish Times?
Sometimes a government may decide to “let the deficit ride” and borrow money to bridge the gap. Our Government has decided not to do this, but to reduce the deficit as much as it can – by about €5 billion in 2009 and by about the same in each of the next two years. The target is to get the deficit below 3 per cent of GDP by 2013, in line with EU guidelines.
This means raising taxes and cutting expenditure over a long period, and runs the risk of deepening the recession. Higher taxes will hurt consumption, investment and work effort. Lower spending will mean less demand and perhaps less essential infrastructure.
The fact that the “stabilisation” will continue for three or more years means people may hoard. Household incomes – already reduced – will be budgeted carefully, not just to pay this year’s higher taxes and levies but also in anticipation of new carbon, property, and other taxes in the pipeline. People also have to allow for the fact that they may not have a job next year.
It is hard to overestimate the fear factor. It seems unlikely that non-essential consumer spending will pick up soon. It doesn’t matter much if our consumption of imported goods falls, but falling demand for domestically produced goods will mean more job losses and bankruptcies.
Instead of a stimulus package – which other countries have introduced – we have gone in the other direction. It could prove to be the worst own goal in our history. If the Government’s top priority of “stabilising the public finances” does extinguish the last spark in the economy, all bets are off. It might not even succeed in reducing the deficit. If economic activity falls further, so will revenue, and the Government will find itself chasing a target from which it is constantly moving away.
Sticking with alternative policies, Germany is on the verge of passing what I would describe as the most economically illiterate law ever conceived: a balanced budget amendment. As Wolfgang Munchau puts it:
From 2016, it will be illegal for the federal government to run a deficit of more than 0.35 per cent of gross domestic product. From 2020, the federal states will not be allowed to run any deficit at all. Unlike Europe’s stability and growth pact, which was first circumvented, later softened and then ignored, this unilateral constitutional law will stick. I would expect that for the next 20 or 30 years, deficit reduction will be the first, second and third priority of German economic policy.
To meet the interim deficit reduction goals, the new government will have to start cutting the structural deficits by 2011 at the latest. There is clear danger that the budget consolidation timetable might conflict with the need for further economic stimulus, should the economic crisis take another turn for the worse.
What is the rationale for such a decision? It cannot be economic, for there is no rule in economics to suggest that zero is the correct level of debt, which is what a balanced budget would effectively imply in the very long run.
I rerally like this blog. It simply gives news from 1930 from the corresponding day to today.
Yesterday for example:
Col. Ayres, VP Cleveland Trust, predicts an abrupt recovery in stock and commodity prices by Labor Day due to current consumption exceeding production. Distinguishes between two types of depression, “V”-shaped and “U”-shaped.
Hat tip: Alphaville.
I’ve written a fair bit about gilt yields over the past few months. I’m getting quite few hits from people searching for data/information/graphs on this issue.
Whilst I’m delighted to get their attention, I think they might be disappointed if what they are looking for is simple hard data. So, in the spirit of public service blogging, here’s a quick guide to where to get info on government bonds and how to read it.
The simple best resource, updated through the day, is this Bloomberg page.
How to read the table:
The first column is simple – the maturity of some government debt – so three months, 7 years, whatever. The key ones to look at tend to be 2 years, 10 years and 30 years.
The second column gives the ‘coupon’, i.e. the set payment from each maturity of debt. So, for example 5 year bonds have a set payment of 5.00.
The third column just gives the date on which the debt is to be settled. So the five years mature on 09/07/2015.
The fourth column is the interesting one. It gives to numbers separated by a slash. The first gives the current price of the debt (the debt is always issued at ‘100’). The second gives the current yield.
Think of it this way, if we issue a 10 year bond at ‘100’ with a annual coupon of 10.0% and the price of the bond goes to ‘200’, then the current yield will only be 5%, not 10%. As the coupon is fixed – you get ‘10’ annually from something you paid ‘200’ for.
Now actually it gets a little more complex than that, as the debt will always be repaid at a ‘par’ value of 100. So the second number gives the current yield accounting for this factor.
So to stick with the five years the current figures (at time of typing) are 111.23/2.67. So the price of a UK five year bond is ‘111.23’ and the annual yield is currently 2.67%.
The fifth column shows the change on the day. Again the first number (before the slash) is the price and the second number is the yield. This two numbers always move inversely – if the price rises the yield falls and vice versa. What we like, from a public finance point of view is to see the price going up and the yield coming down.
Today, on the five years, we can see that the price has risen by 0.081 and the yield has therefore fallen by 0.017. Five year debt today has an interest rate 0.017% lower than the day before.
If you start checking this page regularly, you’ll see that moves of more than 0.05% a day are comparatively rare. You can use the tabs at the top of this page to check out the debt of the US, Japan, Hong Kong, Germany, Brazil and Australia too.
Finally, if one scrolls down the page there is a graph. This shows the ‘yield curve’ of UK debt. This is a simple graph plotting the yield of different maturities. What matters with yield curves is the shape of the curve and the steepness.
For those really interested, I’d recommend following them links from Investopedia’s article on the curve.
To summarise though:
The shape of the yield curve is closely scrutinized because it helps to give an idea of future interest rate change and economic activity. There are three main types of yield curve shapes: normal, inverted and flat (or humped). A normal yield curve (pictured here) is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession. A flat (or humped) yield curve is one in which the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition. The slope of the yield curve is also seen as important: the greater the slope, the greater the gap between short- and long-term rates.