Sunday, November 30, 2008

And, down under, interest rates are also being cut!
RECESSION fears have fuelled predictions interest rates will be slashed by a full percentage point when the Reserve Bank of Australia meets tomorrow.

Economists are unanimous there will be a rate cut as the RBA strives to insulate Australia from the worst financial crisis in decades.

Inflation Down, Unemployment Rises in Eurozone

This is an article that is good news for EU15 households with adjustable mortgages who still have their jobs or businesses (why?).
European economists expect the European Central Bank to cut interest rates again next week by at least half a percentage point. The new rate is expected to be two-and-a-quarter percent. The rates have already been slashed twice in the past two months

An article on the current crisis and the fiscal response of Spain

This one is also worth reading as it describes a genuine Keynesian recipe you should all be aware of. It's a 11.0 billion euro fiscal stimulus package that the Spanish government announced. Read about it here.

A great one on cartels and their instability

Definitely IB Economics!

We learn that cartels are unstable structures as each member has the incentive to 'cheat' and sell more than their quota (the agreed amount). That is why cartels can only be found in oligopolistic structures where 'fewness' makes monitoring possible and decreases the propbability that the cartel collapses. OPEC has historically been the most successful cartel. It was founded in 1960 (read here a few interesting historical facts on OPEC).

In this recent (Nov 28) IHT article we read that
For the first time in a decade, oil producers are facing a real test of their unity...
exporters are being pummeled by a triple whammy of lower prices, falling demand and declining revenue. The group, whose members account for more than 40 percent of global oil exports, is desperately seeking ways to stop the drop in prices, which have fallen from their summer peaks at a record pace.
We've seen that cartels are more likely to collapse when demand is falling (or, the other way around, that they are more stable if demand is buoyant - I always liked this use of the word!). Now...
...OPEC is increasingly torn between its moderate members, led by Saudi Arabia, which can afford a period of lower oil prices, and countries with high government spending, like Iran and Venezuela, which have become much more dependent on high prices.
...Instead of coasting on growing demand, producers are confronted with a significantly different environment and must adapt to a world of slowing consumption and overflowing oil supplies. They must also contend with losses of hundreds of billions of dollars in revenue.
The succcess of OPEC largely is the result of the role of Saudi Arabia.
...Even if OPEC agreed to a new cut in production, analysts doubt that all the countries would abide by their quotas, and it would fall to Saudi Arabia to shoulder the brunt of the cutbacks.
...member countries control a much less significant share of the world's total oil supplies than previously. Non-Opec countries such as Russia, Norway and Mexico have ramped up production while new flows of oil fields have been discovered in Africa and South America. While Opec still controls more than half of the world's crude oil exports, the world league of top-10 oil producers now contains just three Opec members. This means that Opec can easily be undermined by non members when it decides to shore up prices by cutting production. (verbatim from this BBC article) makes sense that OPEC members are considering to... consultations with producers outside the cartel, the Iranian envoy has indicated, and could set the contours for a coordinated response by OPEC and non-OPEC producers, including Mexico and Russia. In the late 1990s, Norway and Mexico trimmed their production to bolster oil prices after the Asian economic crisis.
This is an excellent article on cartels and you should all spend a few minutes to read it.

P.S.:I was just checking today's IHT when I saw a new article on the same issue. The weekend meeting ended without much progress.
Global growth, the biggest factor for oil demand, is under severe stress, new supplies are coming on the market, oil inventories are brimming, and investors are fleeing commodities.
Overall global oil consumption could drop for the first time in 25 years this year and may not recover before 2011, according to analysts. Some analysts say OPEC needs to cut output by at least 3 million barrels a day to make up for declining demand in industrialized nations.
Meanwhile the credit crisis is hurting the ability of producers to finance new developments, and crimping high-cost producers such as tar sands or deep water offshore, who need prices between $60 and $80 a barrel to be viable. This means supplies could be affected as oil companies cut back their investment spending. If prices keep falling, some existing fields could also become uneconomical, and might be forced to shut down.
(There was a little bit of micro here: marginal costs are obvoiusly notidentical across oil producers: exit would start with the least efficient...)

The newer article (Nov 30) can be read here.

Friday, November 28, 2008

Sachs on the need for direction

It's getting late and I need to get my kids ready for bed but I just read this one from Jeff Sachs and I advise my (serious) students (who are taking exams in a couple of weeks and THE exams in a few months...) to spend a few minutes reading it.

It's titled 'A Sustainable Recovery' and it can be found here.

Why didn't economists see it coming?

I've been getting plenty of questions from colleagues and students at school on why wasn't this crisis averted earlier. The "Subprime crisis" explanation by The Long Johns" was after all uploaded on youtube in January!

Well, Paul Krugman offers his view in a most elegant (as usual) way in today's NYT:
"Some people say that the current crisis is unprecedented, but the truth is that there were plenty of precedents, some of them of very recent vintage. Yet these precedents were ignored. And the story of how “we” failed to see this coming has a clear policy implication — namely, that financial market reform should be pressed quickly, that it shouldn’t wait until the crisis is resolved.

About those precedents: Why did so many observers dismiss the obvious signs of a housing bubble, even though the 1990s dot-com bubble was fresh in our memories?

Why did so many people insist that our financial system was “resilient,” as Alan Greenspan put it, when in 1998 the collapse of a single hedge fund, Long-Term Capital Management, temporarily paralyzed credit markets around the world?

Why did almost everyone believe in the omnipotence of the Federal Reserve when its counterpart, the Bank of Japan, spent a decade trying and failing to jump-start a stalled economy?

One answer to these questions is that nobody likes a party pooper. While the housing bubble was still inflating, lenders were making lots of money issuing mortgages to anyone who walked in the door; investment banks were making even more money repackaging those mortgages into shiny new securities; and money managers who booked big paper profits by buying those securities with borrowed funds looked like geniuses, and were paid accordingly. Who wanted to hear from dismal economists warning that the whole thing was, in effect, a giant Ponzi scheme?"

Read the whole article here.

Wednesday, November 26, 2008

China's industrial muscle weakened by slowdown

This one is from today's Herald Tribune and it relates to trade, macro and development economics.
It is happening faster than most anyone predicted: China's economy, long the world's fastest-growing major economy, is slowing down. Economists are forecasting that after growing nearly 12 percent last year, China's economy could slow to 5.5 percent in the fourth quarter of this year — a stunning retreat for a country accustomed to boom times.

Last week, banking regulators began warning about the risk of bad loans accumulating, and labor officials publicly worried about the possibility that mass layoffs would lead to unrest.

"It's the speed of the deceleration that scares people," says Liang Hong, a Goldman Sachs economist who said she recently surveyed companies in China.

The American recession is one big reason China's epic economic growth is imperiled: as Americans buy less, China sells less. And China's own efforts to keep its economy growing, through a stimulus package worth nearly $600 billion, may not replace a falloff in American demand as the United States' recession deepens.

The global downturn is already reaching deep into the heart of the country's once-rapid industrial transformation — its steel, cement and construction companies — stalling dozens of multibillion-dollar investment projects. Plunging housing prices at home combined with a virtual global investment freeze have led to steel orders softening, steel prices plummeting, and inventories and losses piling up.
In America, consumers have closed their wallets. Parts of Europe are already in recession. And in Asia, Japan and Hong Kong now say that they too have slid into recession.

The ripple effects are being felt everywhere in China. Hard-hit airlines and automakers have appealed for government aid. Local governments that raised millions of dollars auctioning off land rights are confronting lower bids and depressed sales, which essentially means lower tax revenue.
This is not getting any better. Remember the Roubini post a while ago?

Daniel Altman's post in his Managing Globalization blog 'Evaluating the $7 trillion bailout' is worth also reading.

Do multinationals promote better pay and working conditions?

This one is very IB economics!

It is the title of a recent OECD report and of a summary article found here. It is excellent reading as it provides the IB Economics student (both higher level and standard level) not only with information that is very relevant to the syllabus but also with a style of writing that candidates should try to emulate. To convince you that it is worth clicking on the link above, saving and reading the article, here are some quotes:
If ever there was a question to provoke impassioned debate between supporters and opponents of globalisation, the title of this article may be it. A harbinger of progress and higher standards of living, will say the yeas, a cause of underdevelopment and Western-style exploitation, will roar the nays. The protagonists rarely agree.

Who is right? Before attempting an answer, let’s start by looking at what the term “multinational” actually means. Crudely speaking, multinational enterprises (MNEs) are corporations with headquarters in one country and affiliates, subsidiaries or merged operations in one or several others. These firms expand abroad to gain market share, or to tap into local resources like raw materials and cheaper labour. Think major US brands, such as Coca-Cola, Nike and Microsoft, or the French energy company, EDF, the British-Australian mining firm, Rio Tinto, and Japan’s Toyota.


On the whole, the OECD report shows that MNEs do tend to pay more than local firms, though the difference lessens with local firms that compete in the same markets. In general, foreign multinationals pay 40% higher in average wages than local firms, and the differential is higher in low-income countries of Asia and Latin America. They may offer higher pay than their local counterparts because this helps to minimise worker turnover and reduce monitoring costs.

Comparing workers who stay on in firms that are taken over with their counterparts in domestic firms, shows that foreign takeovers had only a very slight or no effect at all on individual wages. This indicates that average wage gains due to foreign takeovers partly reflect changes in the skill composition of the workforce that tend to accompany such takeovers.

But wages are only one side of the coin: what about working conditions? One argument used by proponents of FDI is that multinationals promote socially responsible investment, and some of the literature backs this view. However, the analysis of foreign takeovers in the report suggests that FDI might not have much effect on working conditions.
Click, save, read, summarize: it's worth the hour you'll spend!

Tuesday, November 25, 2008

'...born between 1978 and 1994': is that you?

Well, it's not me!

The article is titled "The kids are alright", it is about the 'net generation' and I read it today in the Economist (Nov 15 issue). A couple of quotes that made me feel good about you (my students) and my own kids:
....the Net Geners are smarter, quicker and more tolerant of diversity than their predecessors,” Mr Tapscott argues. “These empowered young people are beginning to transform every institution of modern life.” They care strongly about justice, and are actively trying to improve society...

Contrary to the claims that video games, Facebook and constant text-messaging have robbed today’s young of the ability to think, ...the “Net Geners” are the “smartest generation ever”.
There is growing neuroscientific support for this claim. People who play video games, for example, have been found to process complex visual information more quickly. They may also be better at multi-tasking than earlier generations, which equips them better for the modern world.
So, just because 'we' didn't do it, it doesn't mean that it is bad / unacceptable / catastrophic!

PS: 'the kids are alright' is a reference to a song by the Who from their album 'My Generation'.

Sunday, November 23, 2008

Economics SL: November 2005; SP2; Q5: on the dollar and the euro

This was a question on a recent quiz we had. The best part of the question is the advice given by Lehman Brothers....

Anyway, here are some tips on this question:
a(i): exchange rate: the price os a currency expressed in terms of another currency (or, the number of units of a foreign currency required to buy a unit of the domestic currency)

a(ii): depreciation: refers to a decrease in the price of a currency withing a flexible (free floating) exchange rate system (eg from $1.00 = euro 0.80 to $1.00 = euro 0.70 --> the USD depreciated, it's now cheaper to buy; rem that a vague definition with an example or a diagram may push you to full points)

b. You are asked to 'explain (using a diagram) one reason for the fall in the value of the US dollar'. Remember that you earn two points for a (correct) diagram and 2 points for a (correct) explanation. Since the points awarded for the explanation are only 2 you need not spend too much time on it. The diagram here could have on the vertical axis 'Price of USD expressed in euros: euros/$' and on the horizontal 'USD traded per period'. You need a demand for USD (which expresses the value of exports of the US as well as capital inflows into the US) and a supply of USD (which reflects the value of US imports as well as outflows of capital from the US). Since the question asks for 'one reason' you need not refer to the text even though it would be better (but not necessarily more rational on your part on a test). Reasons you could quote that relate to the text include the rise in UK interest rates (paragraph 4), the low US interest rates (paragraph 3), the widening US current account deficit (paragraph 2) or the lack of confidence of foreign investors in the future performance of the US economy (paragraph 2).

For example, since US interest rates are low (and now relatively even lower to the UK interest rates which increased), there willbe an outflow of capital from the US. Investors will sell US assets like US bonds and US dollar deposits as they are not attractive (low - lower rate of return). Supply of US dollars in the forex markets will rise (shift to the right in you diagram) pushing the dollar down.

Or, since a widening current account deficit means that US import spending rises (faster than export revenues do) it follows that the supply of dollars is increasing (shifting to the right; faster than the demand is), pushing down the USD.

Or, since foreign investors do not feel confident about the performance of the US economy demand for USD will fall (pushing down the USD) as demand for US shares will weaken (and for FDI into the US).

Any of these would do and given the wording of the question there was no need to 'connect' to the extract.

c. You are asked in this one to explain (using an AD/AS diagram) why Japan 'fears a high-valued yen'. The key is to realize that the higher the value of a currency the more expensive and thus less competitive abroad are the country's exports. If a Toyota is priced at Yen 100 and the dollar-Yen exchange rate changes from Y100 = USD1.00 to Y100 = USD2.00 then an American who needed 1 dollar to buy the car would now need 2 dollars. The dollar price of the Japanese export increased. The second useful point to keep in mind is that AD (total spending on domestic goods and services per period) is equal to the sum of (C+I+G+X-M). Obviously, spending on domestic goods and services by foreigners is included (X). It follows that the high Yen implies pricier and thus less competitive Japanese exports and thus a decrease in X and thus Japan's AD. Drawing an AD/AS diagram for the Japanese economy with the average Japanese price level (P) on the vertical and Japanese real output/ income (Yr) on the horizontal you would need to shift left from say AD1 to AD2 the AD curve which would be responsible for a lower equilibrium level of (Japanese) real output/ income. It makes a lot of sense for Japan to fear a 'high-valued' Yen: it could lead to slower growth (or, recession) and higher unemployment.

d. This one asks you to evaluate "two methods that the US government might use to correct its 'exploding current account deficit'". Well, if you are asked to evaluate two methods, you should first come up with two methods and explain how each would in principle work to do the job! You are not asked to present these metods in broad terms but given that the syllabus does indeed present them with their 'names' (see section 4.7) you could organize your answer around the ideas of expenditure changing (reducing in this deficit case) and expenditure switching policies.

Expenditure changing policies refer to demand side policies that would affect AD and thus Y, banking on the fact that import spending (M) is positively related to the level of national income (Y). So, if you need to lower M (to treat a widening current account deficit) you might as well try to lower Y by applying the brakes on fiscal policy. But lowering Y implies slower growth (or, even inducing a recession) so the opportunity cost of such a policy could be a rise in (cyclical) unemployment. Economic activity will slow down, some firms will go under others will suffer lower sales and workers will be laid off. The short term cost may be significant (but necessary). As any inflation would also be contained, exports may benefit as well as import competing firms (so X rises and M falls - what we're after).

Expenditure switching policies (the second major choice) refer to policies that aim at switching expenditures away from imports (so, M decreases) towards domestic goods and services. The trick is to make imports pricier and thus less attractive! What about protectionism (tariffs, quotas etc) or a devaluation (rapid depreciation)? Tariffs (and quotas) increase the domestic price of foreign goods, so, voila! The problem is that the 'other side' (i.e. the country's trading partners) will probably get pretty upset. Also, within the WTO (and any RTBs), tariffs etc are not easy to get by with. Increased protectionism is bound to create trade frictions, especially if we're talking about a huge economy (an engine, or ex-engine, of world growth) as the US. Think of the current discussions on whether president-elect Obama will or will not pursue protectionist policies. Frictions and the possibility of retaliation diminish the attractiveness of such a policy choice.

What about a devaluation / depreciation of the currency? Well, exports get cheaper (more competitive) and imports pricier (and, less attractive). This may do the trick as X will tend to be boosted (thanks M.M. for the expression - I know you like it!) and imports will tend to decrease. But, there is a risk of inflationary pressures arising. If such a scenario remains unchecked then any benefits from the devaluation could be short lived.

Interestingly enough, the extract is not very helpful to use in this evaluation! One could note that in paragraph 4 it states that 'most of the burden of the dollar’s depreciation has fallen on the euro as the major Asian economies have defended their currencies against any appreciation. China’s renminbi is pegged to the dollar and the Chinese administration has rejected suggestions from the White House that the Chinese allow the currency to rise' This suggests that the US should insist that the Chinese revalue the yuan (the remnimbi) against the USD so that Chinese goods lose some of their attractiveness inside the US and so that US exports become more competitive in China. Given the huge bilateral US trade deficit with China this could help the most.

Also, the info in paragraph 2 that 'the US will not be able to attract enough investment' suggests that the US current account deficit is not temporary (and thus reversible) but of a rather fundamental (structural) nature. The US seems like a 'sick' economy (well, we are witnessing the outcome of these structural problems in a terrible way now - 5 years after this article was written). If private investors seem unwilling to buy US assets then their outlook for the future economy is obviously poor. What is the 'sickness'? Perhaps that 'too much spending' (public and private) was allowed for too long. Huge budget deficits and a massive spending spree by the private sector may be at the bottom of all this.

In any case, try to at least use quotes that refer to what is happenning to the USD, to the size of the current account deficit etc so that your answer is not in a 'vat' something which would prevent you from being awarded level 3 points

*** for higher level candidates only: remember you could use here the idea of the 'twin'deficits: Given that, in equilibrium, withrawals (W) must equal injections (J), or that (M + S + T) must equal (X + I + G), if there is a budget deficit (so that G > T) and assuming that the private sector is in equilibrium (so that S = I) then M will necessarily exceed X. Imagine if the private sector is also in deficit (perhaps because of ultra low interest rates - something for which now, Alan Greenspan is accused...!) then the current account deficit is even bigger. If G decreases and T rises (contractionary fiscal; an expenditure reducing policy ) then, the current account deficit will narrow (more so, as private spending will also shrink)

BTW, I owe a public thank you to Katerina D. for the email she sent me! What a girl!

Friday, November 21, 2008

With or without you - 21 years old...

No relationship to IB economics!

Was just watching this clip from a live U2 performance (been there, seen them) and thought of posting it. I just realized that some may not even be aware of the song (March 1987, the release date for the song, is a loooong time ago for you guys) and since I think that it's a great piece I decided to take the time to post it.

Come to think of it, there may be a connection to IB economics. Bono is also a well known political activist who has teamed up with Jeff Sachs and is the co-founder of the One campaign (do check out the issues on the link as they provide very short and decent introductions to major development economics themes).

More about him when discussing development issues - soon at a theater near you. For now, enjoy this (the vocals are really good):

Friday, November 14, 2008

New textbooks (and online practice material)

I have just received an email from the Global Development and Environment Institute (GDAE) at Tufts University announcing two new introductory textbooks, one micro and one macro. I am quoting from the email I received:

"Microeconomics in Context, Second Edition by Neva Goodwin, Julie A. Nelson, Frank Ackerman and Thomas Weisskopf, provides a thorough introduction to the principles of microeconomics, but also delves deeper, offering a fresh portrait of the economic, social, and environmental realities of the 21st century"


"Macroeconomics in Context, First Edition by Neva Goodwin, Julie A. Nelson, and Jonathan Harris, covers standard macro topics such as classical and Keynesian approaches, but also addresses issues such as ecological sustainability, non-marketed production, the quality of life, and the distribution of income."

I am posting this to bring to your attention these new textbooks and the free supplementary materials available online. You can find the exercises here (micro) and here (macro).

Thursday, November 13, 2008

Our November Quiz (and December trimester exam)

Well, today was the day we were all looking forward to. The format of today's exam will hopefully prove very useful. I like the idea of forcing you to focus only on the (d) question of paper 3 (paper 2 for standard level). It makes you realize that the time constraint you face is rather severe. It also (I hope) makes you realize that you need to practice a lot at home doing (d) in 25 or less. We will also begin practicing on doinf a, b and c in 15 or less so that by May you are as efficient as this Ferrari team:

Tuesday, November 11, 2008

Economics Higher Level Paper 3: May 2005: Q4(d)

A couple of days ago, I asked you to write in 25 minutes an answer to subquestion (d) of question 4 of the May 2005 Higher Level Economics Paper 3 exam. The goal was for you to realize that the time constraint you face in P3 (and in P2 for standard level candidates) is quite severe. To have a chance to move into the so called level 3 marks (6,7 or 8 of 8)for subquestion (d) you need to plan on spending about (but not more than) 25 minutes on it, which leaves you with around 15 minutes on subquestions a, b and c.

This specific question asks you to evaluate (using the text) the
"likely impact of the depreciation of the dollar on the domestic US economy."
Here are some ideas to organize your thoughts:

> explain what depreciation means
> effect on Px and Pm: exports become cheaper abroad and more competitive; imports pricier and less attractive
> effect on X (export revenues) and M (import bill) using price elasticities in your discussion and perhaps distinguishing between the short run and the long run; explanation of significance of M-L condition
> effect on export sector stakeholders: effect on labor (employment is expected to increase; could use text 'inside-out'); firm profits to rise and perhaps investment spending to pick up (could mention risk of excess capacity developing and associated long run dangers; could use text 'inside-out')
> expected effect on US import-competing firms: sales; employment
> could claim that a sharp depreciation may act as a subsidy on exports and a tax on imports (paraphrasing text)
> Assuming that NX (net exports) rise, AD will rise (as NX is a component); depending on how close to capacity the US is operating, there is a risk of inflationary pressures developing; but, by reading the first sentence of paragraph 1 where it states that the dolar decline 'will provide a much-needed stimulus to the US economy, it seems that this risk is rather low; on the other hand, since import prices will rise, the US cost of living automatically will go up and if US firms use a lot of imported inputs this too may prove inflationary; again, given the importance of services in the US, this risk is probably low
> whether the 'much needed' depreciation proves helpful for the US economy in succeeding to shrink its widening current account deficit (use info from text) also depends on whether the 'root cause' of this deficit is corrected; if, for example, the balloning deficit is a result of an excessive private and public deficits (eg interest rates maintained too low for too long leading to a household spending spree or tax cuts that have increased budget deficits) then the positive effect may be short lived.
> lastly, whether the 'much needed' depreciation proves helpful for US manufacturing also depends on whether it will focus and restructure in niches where it may still have a strong comparative (competitive) advantage (e.g.high tech areas), as it seems rather unlikely that in the long run it will be able to compete with very low wage countries such as China in washing machines or even (ordinary) steel products.

Rem: 25 minutes is tight so you need lots of practice.

Friday, November 7, 2008

On HP3 May 2008

This is the New Zealand data we did in class and as homework. I checked out what you handed in and I can't say that I was very impressed. Remember that our trimester exam in December will be a two hour paper 3 without choice (3 out of 3) so it may be a good idea to try to practice a bit more on this rather demanding paper. So:
a(i): you are asked to define 'nominal' (interest rates - in the extract). The term is in contrast to 'real' and it implies the value of a variable without adjusting for inflation. So, the nominal interest rate is the interest rate a bank quotes for a deposit or a loan while the real interest rate would be the nominal rate minus the (expected) rate of inflation.
a(ii): you are asked to define the term 'inflationary gap'. An inflationary gap arises if the equilibrium level of real income is above the full employment level (Ye>Yfe). This implies that unemployment is (temporarily) below the natural rate. Remember that you could always draw a diagram to illustrate your definition which makes sense to do only if you are unsure about the wording you employ as 'a vague definition accompanied by an appropriate diagram' permits examiners to award 2/2 points.

b: the question asks you to explain (using a diagram) why a widening current account deficit tends to depreciate a currency. The currncy is the NZ dollar so the vertical axis should read 'price of NZ$ expressed in US$ i.e. US$/NZ$' while the horizontal should read 'NZ$s traded per period'. There is a demand for NZ$ and a supply of NZ$. Remember that, assuming away capital flows, the demand for a currency in the forex market reflects the value of its exports of goods and services while the supply of its currency its imports. Given that the data reveal that the NZ current account deficit is becoming bigger one could argue that imports increased shifting the supply of NZ$ to the right and/or that exports shrunk shifting the demand for NZ$ to the left and thus leading to the depreciation of the NZ$ (in your answer you could also define a current account deficit - when the value of imports of goods and services exceeds the value of exports of goods and services; or, when the sum of net exports of goods and services, net income form investments and net transfers of money is negative)

c: the question asks you to explain the impact of a falling growth rate on the amout of goods and services produced i.e. on real income. The key is to remember that a lower growth rate means that output continues to rise but at a decreasing rate. So, more goods and services will still be produced (real output still rises / economic activity still increases) but not as fast as initially expected. Analysts expected real GDP to increase by about 4.5% but now they expect it to still rise but by less (by only 2.8%). You are not required to employ a diagram but you could, by drawing a standard AD/AS with two AD curves drawn to the right of an original AD curve (think - we do this stuff in class).

d: Think: what am I asked to evaluate here? You are asked to evaluate the consequences for New Zealand of increasing interest rates. Remember that to move into the top marks band (level 3: 6,7,8 out of 8) you must include explicit references / quotations from the extract. Your answer must not be in a vat. You are asked to evaluate a policy move within a very specific context.

Describing what the point of employing tight monetary policy in this specific setup is and how how tight monetary policy works may be a way to start. Your answer could include the expected consequences on households and consumption expenditures as well as on businesses and investment spending. Remember that not all households and firms are the same. Remember also that changes in interest rates affect the exchange rate (explain how) and thus the external sector (explain how; use text). There are short run and long run effects. Are there effects on the distribution of income or on efficiency? The policy is undertaken presumably because of the expected benefits. But there are also costs. Describe these. Are these benefits worth the costs? Why? (think of the benefits of price stability or the costs of runaway inflation).

Make sure you organize your thoughts. Make sure you leave a blank line between different points you make. You could use a diagram but do not feel obliged to do so.

Tuesday, November 4, 2008


Well, it's time to officially remind you about that Trade exam! It is approaching very fast, so better prepare than be sorry.


Commentary #3 is due the week before the November 17 break (i.e. next week).

Remember, we have agreed on these issues in class and if you doubt this, check out the post on October 5 (one month ago)

(The mug above has a Far Side cartoon on it. Since I think Gary Larson is great, well, here's another one:

I just found out that a complete Far Side cartoon collection exists, and, guess what, I think I'm getting it!)

Monday, November 3, 2008

Greece: Current Account Balance (as a % of GDP) = -14.0!

We have lately been discussing in class whether a current account deficit is a problem and we concluded that first of all, size does matter, and that it also matters whether the deficit is temporary or fundamental.

When discussing size we noticed that we should not focus on the dollar size of the variable but that we should 'scale it': Italy has a current account deficit equal to 71.1 billion dollars while Greece has a 50.8 billion dollars current account deficit. Italy's is bigger, but Italy is a much bigger economy than Greece is! If we try to isolate the effect of size by dividing each country's deficit by its GDP (expressing it thus as a % of GDP) then we get a different picture: a minus 14.0% for Greece (the minus reflects the deficit) and a minus 2.5% for Italy! It follows, that the situation is much more serious for Greece!

As a matter of fact, if Greece was still using the drachma (and not the Euro) then it would have sufferred a currency crisis long ago, as this size is incredibly high. So, what do we conclude? Well, it seems that the euro saves the day. Being such a small economy, the euro is not much affected by this current account deficit.

But: (quoting from Kathimerini)
Σε πρωτοφανή επίπεδα από την ένταξη της Ελλάδας στην Ευρωζώνη ανήλθε το spread (η διαφορά στην απόδοση) μεταξύ των γερμανικών και των ελληνικών δεκαετών ομολόγων την περασμένη εβδομάδα, καθώς παρατηρήθηκε μαζική φυγή κεφαλαίων από την ελληνική αγορά. Αναλυτές αποδίδουν την αύξηση του spread μέχρι και τις 172 μονάδες βάσης στη στροφή προς το «ασφαλές καταφύγιο» των γερμανικών ομολόγων, την οποία επιτείνει ο μειωμένος όγκος συναλλαγών που παρατηρείται στην αγορά ομολόγων.

Η στροφή στα γερμανικά Βunds μπορεί να γίνεται με στόχο την αποφυγή του κινδύνου σε περίοδο χρηματιστηριακής αστάθειας, ωστόσο, είναι μόνο η μία πλευρά του νομίσματος, καθώς συνοδεύεται από την επιστροφή της επιφυλακτικότητας των διεθνών επενδυτών απέναντι στα ελληνικά ομόλογα. Εν μέσω της κρίσης, προτιμούν να αποφύγουν τον αυξημένο κίνδυνο που υποδηλώνει το τεράστιο έλλειμμα τρεχουσών συναλλαγών της Ελλάδας, το υψηλό δημόσιο χρέος αλλά και την επιπλέον επιβάρυνση που σηματοδοτεί για τη δημοσιονομική κατάσταση της χώρας η εγγύηση των 28 δισ. ευρώ του Δημοσίου προς τις τράπεζες. Ξένοι αναλυτές επισημαίνουν τον κίνδυνο ενός φαύλου κύκλου που θα επιτείνει αυτά τα προβλήματα, καθώς όσο αυξάνεται η απόδοση των ομολόγων, τόσο πιο ακριβή γίνεται η χρηματοδότηση -δηλαδή ο δανεισμός!- για τη χώρα.
I know it's in Greek and I apologize! The basic idea is that this huge current account deficit (coupled with the sizable national debt) forces Greece to pay investors a premium (higher interest rates - 172 basis points above what equivalent German bonds pay). This implies increased interest payments and if a vicious cycle starts than the deficit will not be sustainable... Interestingly, not much discussion on this issue in the Greek media!