Topical Economic Issues

April 21st 2013  IMF discourages austerity policies!

The IMF has been infamous for imposing austerity (contractionary fiscal) policies on economies. However, this week, the head of the IMF suggested that Britain’s policies are too austere. There is concern that Britain might have slipped into an unprecedented “triple dip recession” . The first dip was caused by the 2008 financial crisis. Many other economies (such as the USA and, probably, Japan) are now achieving positive growth figures for GDP.  But in Britain unemployment is still rising and aggregate demand continues to be very weak. The government, nonetheless, has made it a priority to reduce the budget deficit. Large cuts in government spending (particularly on transfer payments) went into effect this month.

http://www.guardian.co.uk/politics/2013/apr/18/george-osborne-imf-austerity

March 28th, 2013   Cyprus bail-out has far-reaching implications

Although the banks are re-opening in Cyprus and it will be receiving funds from the EU and the IMF to alleviate its international debt crisis, the terms of the bail-out and other measures will change its economy radically. Other economies, with large debts that they cannot finance for themselves requiring them to seek extra loans or grants from overseas, will need to notice what happens. (But remember that Japan’s national debt is not a cause for concern in the same way because it can be financed by domestic savings).

Here is a list of some of the conditions and  implications:

1) Cyprus’s GDP will shrink dramatically as a result of the austerity measures (cuts in government expenditure, higher taxes and privatisation)  demanded in return for €10bn in aid.

2) The tax (of up to 40%) on large bank deposits  (over €100,000) reduces savings and may make people all over the world less willing to deposit their savings in banks anywhere. Because almost all “money” is in the form of bank deposits, the functions of money ( financing transactions and steering funds from savers to investors) may be impeded.

3) Currency controls (such as a prohibition on anyone leaving the island with more than €3,000 in banknotes) are being implemented to prevent “capital flight”.  Otherwise, Cyprus would experience a large outflow on the financial section of its Balance of Payments and banks would lose a huge amount of their funds, because many Europeans and others now have little trust that their financial assets will be “safe” in Cyprus. Also the previous relatively high interest rates that they earned on their assets in Cypriot banks will be reduced drastically.

4) It is possible that, due to the controls,  few foreign firms will invest in the country. If they make any profit, it will be difficult to get the money out. Also, foreign workers are discouraged for the same reason. It will be more difficult to change their income into other currencies.

5) There is concern in Spain and Italy that if they need bailout funds, the EU will  demand a similarly large tax on those who have deposited savings in banks. There are reports of banks in both countries suffering a “flight of funds” to safer banks and economies in the eurozone.  Italy’s banks, however, have been declared “healthy” by the IMF this week. Spain’s banks remain in difficulties, but, if a bail-out is required,  bondholders that have lent banks money will suffer losses before depositors do.

February 2nd, 2013 Japan’s Budget for fiscal year 2013 announced

The total size of the new budget is about the same size as last year’s and tax revenues are forecast (perhaps too optimistically, because the forecast assumes that GDP growth will recover) to rise by 1.8% to 43.1 trillion yen. Nonetheless, there will still be a wide, if slightly narrower, deficit because government spending will total 92.61 trillion yen. Of this, over 20 trillion yen will be spent on servicing the rising government (national) debt. The government’s policy spending–money spent for purposes other than repaying the principal and interest on government bonds–will be about 70.5 trillion yen.

For the first time in four years, total tax revenues will be more than the amount received by issuing bonds (i.e. borrowing)–but only slightly!

***

The new LDP government also emphasizes that more of the spending will be on infrastructure, which should push out the production possibility frontier, and that it is slowing the growth of spending on welfare payments. Sceptics will point out that much of the new infrastrucure will be for farming and fishing projects, rather than facilitating manufacturing, and is therefore mainly aimed at pleasing the LDP’s traditional supporters. There are also concerns that defense expenditure will rise. While this will still have a multiplier effect, such expenditure does not appear to do much to raise potential GDP.

January 26th Japan’s Trade Deficit widest since 1980

The widening deficit (which started in 2011 after many surplus years) is due to
a) falling exports to Europe and to China–each for different reasons
b) rising import payments, particularly for natural gas to generate electricity as a replacement for nuclear energy.

However it may start to narrow in 2013, because
a) the world may come out of recession leading to an increase in global demand
b) the yen’s depreciation should theoretically increase demand for exports and lower demand for imports.

But as the yen falls, the price of natural gas in yen terms will rise and the demand is probably inelastic. So although the volume of imports will fall, import payments will probably rise. If export demand is insufficiently elastic, the Marshall-learner condition may not be fulfilled and there may be J-curve effect with the deficit widening even further.

Notice that, despite the trade deficit, the current account surplus will probably continue due to large net earnings of interest and dividends (arising from previous investments made by Japanese overseas) on the income account.

January 18th Japan’s stimulus budget
The Japanese government has approved an EXTRA budget for this fiscal year (the first budget was implemented in April 2012). This new budget will increase government spending (mostly on infrastructure and old-age pensions) by up to Yen 13 trillion. It will be financed by issuing bonds (in other words, by borrowing), so the national debt will rise. However the government hope that the effect of the stimulus on the economy (when the multiplier effect is included) will raise incomes and thus, eventually, government tax revenues.

Economists’ responses are mixed. The nobel laureate Paul Krugman has written in the New York Times approving Prime Minister Abe’s boldness. He considers that this expansionary policy (and the targeting of inflation through increases in the money supply–refer to the post on December 17th), is the most appropriate policy in the present recession. He considers that the US and Europe would adopt similarly expansionary policies.

But others think that the stimulus package will not increase employment significantly and that the main purpose is just to force the yen to depreciate. There are fears that there may be a period now in which several economies strive to devalue their currencies (a currency “war”), which would be destabilizing and would ultimately have no benefits for Japan’s exports.

So is Prime Minister Abe pursuing the most appropriate economic policies for Japan? It is for you to decide.

January 3rd 2013 Has the fiscal cliff been averted?
An agreement has been reached in the US congress to avert the “fiscal cliff”. It raises the income tax on the wealthiest 2% of Americans (those who earn over $400,000 annually), while preventing the automatic tax hike for everyone that would have been implemented from January 1st. It also extends unemployment benefits for another year. (If unemployment benefits had been severed for the long-term unemployed and if income taxes had been raised for all households, the contractionary impact could have sent the US and global economies back into recession.)

Consequently, the income tax system will become more progressive from its present structure.
Federal_Income_Tax_Rates_in_the_US,_2009

It should, however, be remembered that over the last 25 years, the structure had steadily become less progressive. In the late 1970s, the top marginal tax rate in the U.S. was 70%.

Meanwhile, many consider that cuts in government spending are still essential in order to reduce the total size of the budget deficit further. These will be debated over the next few months.

December 28th 2012
Many are watching to see whether or not the USA economy will “fall over the fiscal cliff” on January 1st.
For an explanation of the Fiscal Cliff try watching this short video from The Economist

If no agreement is reached in the next few days, the automatic rises in income taxes and government expenditure cuts will operate as a highly contractionary fiscal tool. What will be the effects on:
a) US GDP and unemployment?
b) Imports to the US?
c) Other economies in the world, including Japan?
_____________________________________________________________________________________________________________________________________________________
December 17th 2012
The new prime minister of Japan is known to favor an increase in money supply in order to stimulate the economy and to aim for an annual inflation rate of about 2%.
The day after his election…… the yen depreciated against the dollar and the Nikkei stock index rose. What are the connections?
Why would a 2% inflation rate be good news for Japan?

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