Archive | April 2016

Still dithering over monetary policy

Whether monetary policy should be expansionary or contractionary/neutral is still of great concern for the central banks in the USA and Japan.

The Federal Reserve (USA central bank) has given hints that it will raise interest rates (contractionary!)  in June because the USA economy seems to be moving higher on the upturn of the economic cycle and may soon exceed its potential GDP . Notice that, in particular, there has been plenty of job creation in the labor market and so maybe unemployment is now at its natural rate, as the labor market tightens.

Just a day later, however, the Bank of Japan announced that it would not, as expected, change its monetary policy, even though the economy would benefit from further stimulus.  The Japanese economy seems to be unable to get out of the deflationary spiral that is dragging down real GDP. The consumer price index dropped again by 0.3% in March and consumption remains weak. In addition, the earthquakes in Kyushu led to factory shutdowns in other parts of Japan (eg Toyota), which may pull down GDP growth further.

Nonetheless the Japanese central bank will keep its negative interest policy and will continue with its massive bond purchase scheme  (which is basically the same as “printing money”). It is probably hoping that the proposed interest rate rise in the USA will attract savers to put their funds there (an inflow on the financial account of the USA BOP). The flows of financial/portfolio “investment” would cause the dollar to appreciate and the yen to depreciate, lowering Japanese export prices and boosting the net exports component of aggregate demand. Thus Japan could benefit from foreign exchange movements without being accused of deliberately trying to depreciate or undervalue the yen.

 

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Asymmetry of information in the car market

Mitsubishi Motors Corp. (MMC)  has probably  sold over 2 million cars with false information about their fuel efficiency (in other words, overestimating the amount of kilometers that they can run per litre of gasoline). MMC has admitted that data had been manipulated to make four minicar models look 5 to 10 percent more fuel efficient than they actually are.

In addition to fooling their customers, MMC also for a while misled  Nissan Motor Corp, which sells two MMC-manufactured models under the brand- name of “Nissan”. It appears that Nissan double-checked the test  data with its own numbers and discovered discrepancies.

The revelations also have implications for the government’s taxation revenue.  Japan has lowered the taxes on “eco-friendly” cars, because their negative externalities of consumption are lower than for regular cars. But, if the fuel economy of the eK Wagon had not been boosted, the minicar would have been excluded from the list of green cars whose buyers are exempt from paying certain extra taxes when buying a car.

MMC knew more about the fuel efficiency of their minicars than their customers, Nissan, and the government for at least ten years. Thus there was a market failure, because more of their minicars were sold than the optimal amount.

 

OPEC dysfunctionality

Thank you to SungJae Lim who found this article and coined the term “OPEC dysfunctionality”

Oil price dives after producers fail to agree output cap – http://www.bbc.co.uk/news/business-36070255

Although Saudi Arabia, the world’s biggest exporter, had been prepared to freeze output if all Opec members had agreed, some countries, such as Iran, are continuing to increase output. The outcome is that oil prices continue to fall, reducing member countries’ export revenues and tax revenues. Poorer countries, such as Angola, Venezuala and Nigeria are now running large Balance of Trade deficits (Angola has gone to the IMF for a loan) and rising budget deficits. Even Saudi Arabia is  trying to diversify its economy away from oil.

Therefore, why can’t they agree to cut output and thus raise prices? This can be explained by a classic game theory model.  For example, assuming just two OPEC members and that the pay-off matrix shows revenues in dollar terms, with Saudi Arabia’s revenue listed first in each cell, the pay-offs might be as below. They are calculated on the assumption that the demand for oil is price-inelastic. Thus, cutting output (shifting the supply curve left) will raise revenues. However, if just one country cuts output, while the other increases output, the latter country will be able to sell a relatively large amount at its reduced price (capturing a large part of the other country’s customers) because oil is relatively homogeneous.

Try to work out each country’s dominant strategy and see where the equilibrium is.

    SAUDI ARABIA
  Decision Cut output Increase output
IRAN Cut output 1000, 500 2000, −700
Increase output −700, 2000 −600, −300

Light relief

1)

Thank you to Jason Keal who found the following. It shows two economists trying to advise a politician on how to get Britain out of recession. A policy suggestion is made that you should not repeat in an exam. (By the way, VAT is the European term for an indirect sales or consumption tax. “Shore up the pound” means trying to prevent the exchange rate from depreciating–perhaps by using foreign currency reserves to buy the British currency.)

2) Are you having difficulty understanding the Keynesian vs New Classical debate? Perhaps the following will help.  Hayek was an Austrian economist who argued that promoting free markets (rather than government intervention steering markets) was the better macroeconomic policy.

 

Listen to the lyrics, identifying key economic terms, and read them on the link below. Notice that “animal spirits” could be thought of as the CONFIDENCE of consumers/firms. Keynes considered that lower interest rates would NOT alone lead to higher investment by firms.

lyrics&questions for Fear the boom and the bust

Lessons from the “Panama Papers”

The unveiling of the contents of millions of documents from a legal firm based in Panama has revealed a degree of corruption, money laundering, tax evasion, and tax avoidance beyond most people’s expectations.

It also provides some interesting links for the economics syllabus:

  1. There is significant asymmetry of information in financial markets. In an article, Thomas Piketty (the author of the book on growing income and wealth inequality published last year) writes that “There is still a complete lack of transparency as far as private assets held in tax havens are concerned”. As in the run-up to the 2008 financial crisis, this is a cause of market failure because financial regulators and central banks do not know how much “money” there is in the financial system, who owns it, and how secure (safe) financial assets are.  According to Piketty, there could be another global financial crisis due to this lack of knowledge.
  2. The use of “tax havens” allows multinationals (MNCs) to avoid  paying almost any tax on profits in Europe.  They can do this by the technique of “transfer pricing” through their subsidiaries in Luxembourg and Ireland.  It is legal, but disclosure rules (plus new rules in the UK’s most recent budget) mean that governments can perhaps claim back at least some of the tax. But this is much more difficult when the tax haven is on a Caribbean island.
  3. Governments attempt to redistribute income through progressive income taxes. If the marginal tax rates are very high for very high income individuals, some people will try to avoid (legally) and/or evade (illegally) paying the tax by setting up complicated trusts or pretend companies employing, perhaps, a Panamanian law firm. While this is often legal, it does ultimately mean that the progressivity of the tax is lessened, that governments lose potential tax revenue, and that there is a waste of resources (opportunity cost) spent on accountants and lawyers who work out the complex avoidance schemes. Thus there is an argument for making taxes less progressive and, in particular, providing fewer “exemptions” which can be exploited as loop-holes.
  4. Different economies have very, very different tax rates and systems. Could there be an international tax on income and wealth (perhaps applied by the IMF or the UN or the World Bank) which applies the same set of rates to all economies?
  5. Free global financial markets  allow individuals, often including the ruling elite and even the government in a country, to take financial assets, change them into another currency, and send them overseas. This is not only an outflow on the financial sector of the BOP, which will tend to depreciate the exchange rate,  but also removes a significant portion of the economy’s wealth and income (a leakage) which could have been reinvested to increase future GDP.
  6. Corruption  (illegal behaviour that allows powerful people to gain financial benefits)  is also made much easier, because the funds obtained can be transferred secretly to other countries.           

The first foreign take-over of a major Japanese firm shows how markets are changing

Taiwanese manufacturer Foxconn is  taking over the  Japanese electronics company Sharp, which has been making losses for over four years but is still a leader in liquid display technology,.

Before the announcement of a deal, Sharp had been discussing a rival offer from a government-backed consortium of Japanese investors, but that fell through.

We have tended to say that the Japanese electronics market is oligopolistic, because there are just a few major firms. But the trends in the past few years and the fiercely competitive nature of the market (including price competition) have changed it. Maybe it fits the monopolistically competitive market structure better now, particularly once the global market is factored in.

Another part of economic analysis to consider is whether or not the Foxconn-Sharp tie-up will yield economies of scale. On the face of it there does not seem to be much potential for exploiting economies of scale because the two firms’ activities have a limited overlap. But Foxconn assembles most of the world’s iPhones and the merger will give it a more crucial position in the supply chain of Apple, which uses Sharp screens on its devices,

Mergers with foreign firms may enable Japanese firms to become more productive and less cosseted from competition. It could be a way to revitalise Japan’s economy, which is necessary as the domestic population and consumption shrink.