Friday, December 26, 2008

Dollar shift: While Americans spent, Chinese saved

" ..... but Americans did not use the lower-cost money afforded by Chinese investment to build a 21st-century equivalent of the railroads".

Another primer on Econ 101 for all IB Economics 2009 candidates. It brings together most of what we've learned throughout these (almost) 2 years.

Read it here.

PS: Free Exchange, also makes a reference (today, the 26th) to the article. It considers it a finger pointing argument:
EVERYONE is a victim; everyone is to blame. "The reckoning" continues as the New York Times singles out another scapegoat for the financial crisis. China gets added to the running list of actors without whom this economic snafu would not have been possible, joining the ranks of Wall Street executives, mortgage brokers, credit-rating agencies, homeowners, the White House, Senator Charles Schumer, former Senator Phil Gramm, the rest of Congress, and possibly you.
Read the comment by Yves Smith (his full post is here)for the 'other side'. If you feel a bit uneasy (you shouldn't by now after our class discussions) on how there are such different viewpoints, read this one by Greg Mankiw ('A Question about Learning Economics' a letter to Greg M. by a confused Econ major and Greg's answer)

Thursday, December 25, 2008

Data Response Question: May08; HP3; Q1

This data question was different, interesting, a bit problematic (subquestion c) and had a rather demanding subquestion (d). As such I think that some thoughts on it could prove useful to you guys. If you haven't done it, try doing at least (d) in 20 minutes or less (since you will have already read these thoughts). You'll realize that it is still challenging. Bear in mind that what follows is not the expected 'answer'. There is no such thing (especially in d) as 'the' correct answer. Very many approaches can be considered fine by IB examiners. These are just some thoughts. Please refer to my 'how to' deal with data questions post . Lastly, standard level candidates should be aware that (a1), (c) and (d) could feature in a standard level exam.

May 2008 HP3 Q1 on vines and grapes:
a(i) equilibrium price is that price at which quantity demanded is equal to quantity supplied per period of time

a(ii) allocative efficiency exists if just the right amount of a good is produced from society’s point of view and thus scarce resources are allocated in the best possible way; this occurs if, for the last unit produced, P = MC.

b. Removing an indirect ad valorem tax implies that production costs will be lower so supply will increase, shifting and swiveling to the right from St to S. (i.e. not a parallel shift)

As a result the market price will decrease from P1 to P2 and quantity demanded will in-crease from Q1 to Q2 per period.

c. Since the resources (land, labor, capital and entrepreneurship) available to the Australian economy have not decreased and neither has the available technology changed, potential output (the combinations of goods that the economy can produce if all resources are fully employed given technology) has remained unchanged and thus the PPF has not shifted. Assuming that the economy was originally operating on its PPF (some point A), now that vines are pulled out fewer grapes can be produced in the short run moving to a point inside with fewer grapes (g2) and the same amount of apples produced (point B). When the land is ready for some other good to grow (apples) then there will be a movement to point C with more apples (a2) fewer (g2) grapes than originally. In other words, there has been a reallocation of resources (e.g. land) away from one good (grapes) towards the production of another good (e.g. apples)
Alternatively, if vines are considered a ‘factor’ of production, then a PPF with grapes on one axis and other goods on the other could pivot inward on the side of the grape axis.

d. You are asked to evaluate the role of falling (grape) prices in the reallocation of resources. First, think of the theoretical model: In free, competitive markets, which goods are produced, in what amounts and consequently how resources are allocated is dictated by demand and supply conditions. When market conditions change it is the changes in relative prices that that has ‘signaling power’ and thus leads to changes in the behavior of producers and consumers.

In the specific setup, the market price for grapes is falling as ‘large crops’ coupled with ‘a slower than expected export market for Australian wine’ (paragraph 1). A fall in price signals that too much of the good is available in the market and implies a decrease in profits (‘producers are suffering with falling profit levels’ (paragraph 4); you could visualize here a perfect competitor with his AR (MR, dd) curve falling). Incentives have changed as a result o the price change. Some growers will be making losses and thus exit the industry. Others will be forced to become more efficient: ‘there is a need for grape growers to find substitute products to grow, and for a vine retirement program where unwanted varieties are pulled out and other varieties planted’ (paragraph 3).
Up to this point you are describing the role of a relative price change. Now you should evaluate this role. Can, or do, falling prices on their own do the trick of resource reallocation?
Well, in paragraph 3 the existence of an ‘industry spokesman’ is revealed who is providing information to industry members. This implies a first weakness of relative price changes as a means of reallocating resources. Market participants (farmers) do not possess the ‘perfect information’ the model assumes. They may not be aware of the severity of the problem and of what other market opportunities exist for them to move resources into. Moreover, resources may be geographically or occupationally immobile which would further complicate the process.

Then, in paragraph 5 another issue is revealed: ‘It is estimated that it will take at least another two years to clear the oversupply of wine, with exports, hopefully, growing significantly to achieve a balance between supply and demand’. This information implies that maybe some of the growers should try to survive the current crisis as in 'two years’ the oversupply will clear. Price movements typically reflect current market conditions and often fail to account for future conditions. As a result, perhaps too many vines will be pulled out – more than the situation warrants.

Lastly, the situation now is exacerbated by ‘ appreciating Australian dollar’ which ‘is making it difficult to export more wine’ (paragraph 5). Since the exchange rate system is flexible (as the AUD is ‘appreciating’) and we know that foreign exchange markets exhibit significant volatility the appreciation described may be reversed sooner than expected.

It thus seems that despite the fact that relative price changes are a very powerful and efficient mechanism to allocate and reallocate scarce resources, there are imperfections that relate to scarce information concerning present and future market conditions as well as immobilities that perhaps necessitate the existence of industry and government assistance in the decision making process of the individual producers.

Not a very easy (d) but bear in mind that this question (how are resources allocated in a market economy) shows up very often as a short for the higher level and as a long for the standard level!

Wednesday, December 24, 2008

Who benefits from ipods?

If you have one, you obviously do benefit, but that's the consumption side of the story. What about the production side? Your ipod was not manufactured in the US so, in terms of employment numbers, does the US benefit?
Greg Linden, Jason Dedrick and Kenneth Kraemer ... tally the number of jobs and wages associated with the production, development and distribution of all Apple iPods in 2006. Apple (an American company) invented the iPod, but they, and the intermediate goods they require, are mainly manufactured abroad. So other than enjoying more music, have Americans benefited from the creation of iPods?

The answer is yes. The authors found iPods employed 41,170 people worldwide. About 27,000 of those jobs went overseas, but most of those were the low-wage and low-skill jobs involved in production. Only 30 Americans had jobs involved in iPod production. But 13,890 jobs were created in the engineering or retail sector. These Americans earned $753m from iPods, while overeases employees earned $318m. Americans earned more because Apple kept the high-skill jobs (the R&D side) at home and sent its manufacturing abroad. But America's lower-skill workers also benefited, mainly in the retail, non-professional sector. These jobs earned American workers more than $220m.
This interesting discussion was found at "Free exchange", the blog maintained by the Economist magazine. Check it out here.

Economists missed the brewing crisis

This article was brought to my attention by my colleague John L. Tomkinson (History and TOK) and I thank him as it is very interesting for all of us doing IB Economics and even more so for those planning to major in Economics somewhere in the UK or the US.

The full title of the article is: Paradigm lost: Economists missed the brewing crisis. Now many are asking: How can we do better? It starts by noticing that everyone is baffled by how the current crisis started and was transmitted throughout markets and economies:
The vast majority of us, after all, are not experts. But academic economists are. And with very few exceptions, they did not predict the crisis, either. Some warned of a housing bubble, but almost none foresaw the resulting cataclysm. An entire field of experts dedicated to studying the behavior of markets failed to anticipate what may prove to be the biggest economic collapse of our lifetime. And, now that we're in the middle of it, many frankly admit that they're not sure how to prevent things from getting worse.
The whole article is thought provoking but, if you aren't about to read the whole thing here then, at least read this, as it should sound familiar:
Already, the crisis is reshaping long-running debates. It has chastened believers in the self-correcting abilities of the free market - Alan Greenspan said as much before Congress in October - and emboldened those who see the need for more active government intervention.

In a sense, it's a debate that has been seesawing back and forth from crisis to crisis over the past century. Classical economics was devastated by the Great Depression, and in the years afterward gave way to the ideas of the British economist John Maynard Keynes: that individually rational economic decisions could add up to collectively disastrous consequences, that the "stickiness" of prices and wages could lead to long-term unemployment and stagnation, and that the government, as a result, has to step in to kick-start the economy.

The stagflation of the 1970s, while mild compared with the Depression, swung the pendulum back. It was Milton Friedman, a sharp critic of Keynesianism and a fervent advocate of unfettered free markets, who solved the seeming paradox of simultaneous inflation and high unemployment by realizing the deadening power of people's expectation of future inflation, and it was Friedman's proposed solution - sharply restricting the money supply - that eventually, albeit painfully, solved the problem.

Today's crisis has brought Keynes back to the center of the discussion, but some economists also see it driving the field into new territory. Up until very recently, the study of market bubbles was marginalized - there was no widely accepted definition of what a bubble was, and some economists, believers in the complete rationality of markets, argued that bubbles didn't even exist. Today, however, there is a growing sense that understanding bubbles is vital to understanding markets - among those making the case is Federal Reserve chairman Ben Bernanke, who, as head of the Princeton economics department, made a point of hiring young economists interested in the topic.

Over the same time period, the field of so-called behavioral economics has risen to prominence, led by, among others, Thaler, Laibson, and Robert Shiller, a Yale economist who warned of both the housing bubble and, in 2000, the dot-com bubble. By borrowing the insights and methods of psychology, behavioral economics focuses on all the ways in which humans fail to act as the rational, self-interested beings that economic models call for - we aren't good at thinking about the future, we're susceptible to peer pressure, we overestimate our abilities and underrate the odds of bad things happening. It's a set of traits that describes perfectly the behavior of many of the people who, in a cascade of self-defeating decisions, helped create the subprime crisis.
Thanks, John.

Monday, December 22, 2008

OPEC is turning into an increasingly irrelevant organization!

That's what an oil analyst recently said!

If you want a primer on cartels, OPEC, the incentive to cheat, stability etc please read this (easy) Business Week article: OPEC Loses Its Muscle.

Also, read (again?) our October 21 post on OPEC: 'Between a rock and a hard place'.

Development related reading

I promised in class to point out to you interesting, short and easy for you to understand articles written by the very best in the world on development related issues.

Please save, print and read these articles trying perhaps to make short summaries of their most important points.

We'll discuss some of these in class. Try using incorporating them into your essays.

This one is by Dani Rodrik: Let Developing Nations Rule

He claims that the current crisis may weaken the US and the EU to such an extent that the weight of the bigger developing countries will increase permitting them to influence the 'rules of the game'.
To make the best of this outcome, developing nations will have to have a good sense of their interests and priorities. So, what should they seek?

First, they should push for new rules that make financial crises less likely and their consequences less severe. Left to their own devices, global financial markets provide too much credit at too cheap a price in good times, and too little credit in bad times. The only effective response is counter-cyclical capital-account management: discouraging foreign borrowing during economic upswings and preventing capital flight during downswings.

So, instead of frowning on capital controls and pushing for financial openness, the International Monetary Fund should be in the business of actively helping countries implement such policies. It should also enlarge its emergency credit lines to act more as a lender of last resort to developing nations hit by financial whiplash.

The crisis is an opportunity to achieve greater transparency on all fronts, including banking practices in rich countries that facilitate tax evasion in developing nations. Wealthy citizens in the developing world evade more than $100 billion worth of taxes in their home countries each year, thanks to bank accounts in Zurich, Miami, London, and elsewhere. Developing countries’ governments should request and be given information about their nationals’ accounts.

Developing nations should also push for a Tobin tax – a tax on global foreign currency transactions. Set at a low enough level – say, 0.25% – such a tax would have little adverse effect on the global economy while raising considerable revenue. At worst, the efficiency costs would be minor; at best, the tax would discourage excessive short-term speculation.

The revenues collected – easily hundreds of billions of dollars annually – could be spent on global public goods such as development assistance, vaccines for tropical diseases, and the greening of technologies in use in the developing world. The administrative difficulties in implementing a Tobin tax are not insurmountable, as long as all major advanced countries go along. It would then be possible to get offshore financial centers to cooperate by threatening to isolate them.

Developing nations also need to enshrine the notion of “policy space” in the World Trade Organization. The goal would be to ensure that developing countries can employ the kind of trade and industrial policies needed to restructure and diversify their economies and set the stage for economic growth. All countries that have successfully globalized have used such policies, many of which (e.g., subsidies, domestic-content rules, reverse engineering of patented products) are currently not allowed under WTO rules.

Not a very easy article for the IB economics level but I'm sure you can benefit by reading it. We'll talk about it in class.

Internal Assessment

I expected to collect commentary #4 from 30 students today but I only collected 14. A bit disappointing. Two things:

1. A big thank you to those who have learned to respect a deadline
2. I do expect the rest to hand it in by Monday, the 29th. Please drop it off at the front desk (Ms. Eleni's desk).

Sunday, December 21, 2008

Has Global Stag-Deflation Arrived?

This is the title of an article by Nouriel Roubini, Professor of Economics at the Stern School of Business, NYU, I just read at Project Syndicate.

A must for IB Economics candidates as it presents the problems and policy options available to Governments and Central Banks at these difficult times.

'With a global recession a near certainty, deflation – rather than inflation – will become the main concern for policymakers. The fall in aggregate demand while potential aggregate supply has been rising because of overinvestment by China and other emerging markets will sharply reduce inflation. Slack labor markets with rising unemployment rates will cap wage and labor costs. Further falls in commodity prices – already down 30% from their summer peak – will add to these deflationary pressures.

Policymakers will have to worry about a strange beast called “stag-deflation” (a combination of economic stagnation/recession and deflation); about liquidity traps (when official interest rates become so close to zero that traditional monetary policy loses effectiveness); and about debt deflation (the rise in the real value of nominal debts, increasing the risk of bankruptcy for distressed households, firms, financial institutions, and governments).

With traditional monetary policy becoming less effective, non-traditional policy tools aimed at generating greater liquidity and credit (via quantitative easing and direct central bank purchases of private illiquid assets) will become necessary. And, while traditional fiscal policy (government spending and tax cuts) will be pursued aggressively, non- traditional fiscal policy (expenditures to bail out financial institutions, lenders, and borrowers) will also become increasingly important.

In the process, the role of states and governments in economic activity will be vastly expanded. Traditionally, central banks have been the lenders of last resort, but now they are becoming the lenders of first and only resort. As banks curtail lending to each other, to other financial institutions, and to the corporate sector, central banks are becoming the only lenders around.

Likewise, with household consumption and business investment collapsing, governments will soon become the spenders of first and only resort, stimulating demand and rescuing banks, firms, and households. The long-term consequences of the resulting surge in fiscal deficits are serious. If the deficits are monetized by central banks, inflation will follow the short-term deflationary pressures; if they are financed by debt, the long-term solvency of some governments may be at stake unless medium-term fiscal discipline is restored.'

The full article is here.

Xmas Assignment Candidates 2009

These are the Long and Short Essays I'd like you to complete over Xmas break.

Remember you should first read the section on development and then read the list of long essays. Choose one. Then research the key issue by checking out the net. Use advanced google. Remember also the World Bank, the UNDP site, the OECD development pages, the UN Millennium goals page, the WTO trade and development page, the Center for International Development at Harvard as well as specific pages/ posts that I recommend such as many of the Jeff Sachs articles found at the Project Syndicate site.

In any case, here they are:

Long Essays

1. Either May 2008 on (a) measuring development and (b) evaluating whether faster growth is the most effective way to pursue development or Nov 2007 on explaining 3 institutional factors that may contribute to growth and (b) evaluating whether growth leads to development.
2. Either #24 on (a) describing main barriers to development and (b) evaluating whether a more equitable income (and wealth) distribution promotes development or, Nov 2005 on (a) explaining 2 barriers to growth and (b) evaluating strategies to overcome the barriers mentioned in (a)
3. Either #27 on (a) explaining the different forms of aid and (b) evaluate whether aid is effective or May 2007 (very similar)
4. Either Nov 2006 on (a) why firms turn multinational and (b) evaluating whether FDI is effective in promoting growth and development

Short Essays
1. #39 on why indebtedness may hinder growth and development (or, #32)
2. #38 on explaining the difference between inward and outward oriented growth (or, #8)
3. #36 on why overdependence on primary products may be a dead end
4. #24 on sustainable development (or, #20 or, #37)
5. #23 on the gender specific benefits of educating girls
6. #28 on the types of growth to avoid
7. #34 on the difference between growth and development (or, #12, or#35)
8. #29 on the importance of human capital in the development process

This is the newest list of long essays and this is the list of short essays.


HP3 (and SP2): A 'how to' short manual

Note: This list is intended for my kids at the Moraitis School IB Program. If you are not an IB2 candidate at The Moraitis School please bear in mind that your teacher's advice is what you should follow. Many colleagues may disagree with what I say below. Constructive criticism is much appreciated so feel free to comment.

IB Economics: On HP3 (and SP2)

1.Do (a), (b) and (c) in 15 minutes without having read the extract. Only very few (b) or (c) questions require that you read a paragraph or two from the extract. If that is the case, the question usually directs you to the relevant paragraph(s).

2.For question (a): each definition should not be more than 2-4 lines long. Never explain more than is necessary. Be succinct. Also remember that a 'vague' explanation accompanied by a relevant and correctly drawn diagram may earn 2 points.

3.For (b) and (c) questions that explicitly ask for an ‘appropriate diagram’ remember that you earn 2 points for the diagram and 2 points for the explanation.

4.Thus, explanations must be brief and to the point, referring to the specifics of the diagram you have drawn (explanations should not be more than 5 - 10 lines maximum). The diagram must be large enough, clear, well labelled and drawn using a pencil and a ruler. You could read from my 'Economics Study Guide' p. 147 on how to effectively construct diagrams.

5.If a diagram is not required, you could still employ one if you consider it directly relevant, as diagrams are in general rewarded. In such (b) or (c) questions (that do not require a diagram) you may need to write anywhere between 8 - 15 lines maximum.

6.Once done with (a), (b) and (c), devote the remaining 25 minutes on (d)

7.First, carefully read, making sure you clearly understand, what you are asked to evaluate (rephrase the question if necessary)

8.Brainstorm for a couple of minutes, thinking of the different stakeholders, the different perspectives and the economic theory relevant to the specific issue

9.Then, go to extract and start reading it, noting with a pencil the phrases / sentences that you could use in (d).

10.Make sure you write at least 2.5 to 3 (I.B.) pages on question (d)

11. Make sure you use quotations and data from the extract to support what you write. Use quotation marks and in a paranthesis the paragraph from which the qute is drawn. You need not refer to the text for all the points you make. Make sure though that your evaluation is 'not in a vat' but that it is directly relevant to the specifics of the extract. An excellent evaluation without references can not earn more than 5 points. You could read from my 'Economics Study Guide' pp. 145-146 on how to evaluate.

12.Make sure you separate each point you explain in your evaluation with a blank line as it greatly helps the examiner in his/her assessment.

13.Use a 3B pencil (and a ruler) for your diagrams (also have a colored pencil with you – not red or green)

14.Have a watch and place it on your desk: HP3 (and SP2) are all about time management.

15. Copy and paste the above onto a word file and print

16. Do as many past papers you can under test conditions: do several in 40 minutes and also groups of 3 in 2 hours. You should also try doing separately (a),(b) and (c) in 15 and only (d)'s in 25. Practice is the key to success in this exam.

Thursday, December 4, 2008

Evaluating the crowding-out argument

When in a macro question you are asked to evaluate expansionary fiscal policy (deficit spending) it is expected that you include in your discussion the 'crowding-out' effect argument: the increased government spending is ineffective because private investment will decrease (will be crowded out) as higher borrowing by the government to finance these additional expenditures will increase interests rates.

Paul Krugman has an absolutely excellent piece on why the validity of this argument depends a lot on the specifics of the overall macroeconomic picture in which a government decides to use the Keynesian recipe to jump start the economy:
Right now there’s intense debate about how aggressive the United States government should be in its attempts to turn the economy around. Many economists, myself included, are calling for a very large fiscal expansion to keep the economy from going into free fall. Others, however, worry about the burden that large budget deficits will place on future generations.

But the deficit worriers have it all wrong. Under current conditions, there’s no trade-off between what’s good in the short run and what’s good for the long run; strong fiscal expansion would actually enhance the economy’s long-run prospects.

The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates, which makes businesses unwilling to spend on new plant and equipment, and that this in turn reduces the economy’s long-run rate of growth. Under normal circumstances there’s a lot to this argument.

But circumstances right now are anything but normal. Consider what would happen next year if the Obama administration gave in to the deficit hawks and scaled back its fiscal plans.

Would this lead to lower interest rates? It certainly wouldn’t lead to a reduction in short-term interest rates, which are more or less controlled by the Federal Reserve. The Fed is already keeping those rates as low as it can — virtually at zero — and won’t change that policy unless it sees signs that the economy is threatening to overheat. And that doesn’t seem like a realistic prospect any time soon.

What about longer-term rates? These rates, which are already at a half-century low, mainly reflect expected future short-term rates. Fiscal austerity could push them even lower — but only by creating expectations that the economy would remain deeply depressed for a long time, which would reduce, not increase, private investment.

One more thing: Fiscal expansion will be even better for America’s future if a large part of the expansion takes the form of public investment — of building roads, repairing bridges and developing new technologies, all of which make the nation richer in the long run.
(check out on this the 'tip' on page 78 of my econ guide)

The full article is here.

Wednesday, December 3, 2008

Morals and the Meltdown

There are quite a few of you in my class who are philosophically inclined, so to speak. I was just checking out Project-Syndicate (which you should bookmark and check out on your own from time to time) and I stumbled on a very interesting article by Robert Skidelsky.

Quoting from the article:
After World War I, H.G. Wells wrote that a race was on between morality and destruction. Humanity had to abandon its warlike ways, Wells said, or technology would decimate it.

Economic writing, however, conveyed a completely different world. Here technology was deservedly king. Prometheus was a benevolent monarch who scattered the fruits of progress among his people. In the economists’ world, morality should not seek to control technology, but should adapt to its demands. Only by doing so could economic growth be assured and poverty eliminated. Traditional morality faded away as technology multiplied productive power.

We have clung to this faith in technological salvation as the old faiths waned and technology became ever more inventive. Our faith in the market – for the market is the midwife of technological invention – was a result of this. In the name of this faith, we have embraced globalization, the widest possible extension of the market economy.

For the sake of globalization, communities are de-natured, jobs off-shored, and skills continually re-configured. We are told by its apostles that the wholesale impairment of most of what gave meaning to life is necessary to achieve an “efficient allocation of capital” and a “reduction in transaction costs.” Moralities that resist this logic are branded “obstacles to progress.” Protection – the duty the strong owe to the weak – becomes Protectionism, an evil thing that breeds war and corruption.

As long as we rely on technical fixes to plug moral gaps and governments rush in with rescue packages that enable the merry-go-round to start up again, we are bound to keep lurching from frenzy to frenzy, punctuated by intervals of collapse. But, at some point, we will confront some limit to growth.

Worth your time.

Winners and losers of a recession...

From the New York Times:

Tuesday, December 2, 2008

Silence in Class, Tuesday April 4 2006

….These issues are not confined to university campuses: it is also happening in schools. Since February, the normally sleepy, wealthy district of Upper St Clair in Pennsylvania has been riven with arguments over its curriculum after the local school board banned the International Baccalaureate (IB), the global educational programme, for being an "un-American" marxist and anti-Christian. During their election campaign, the Republicans of Upper St Clair referred to the IB, which is offered in 122 countries and whose student intake has risen by 73% worldwide in the past five years, as though it was part of an international communist conspiracy, suspicious of a curriculum that had been "developed in a foreign country" (Switzerland). "Our country was founded on Judeo-Christian values and we have to be careful about what values our children are taught," said one Republican board member. Similar campaigns have also sprung up recently at school boards in Minnesota and Virginia.

Monday, December 1, 2008

Interesting side-effects...!

The ongoing (pretty much, global) financial and economic crisis may be good for IB economics!

This article, "Economics teachers see a boon in the bust" describes the increased enthousiasm registered at both the college and HS level:
The financial crisis has made "the dismal science" more relevant and immediate to many high school and college students, and they are suddenly paying closer attention in class.

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!

Thursday, October 30, 2008

On export - led growth and the risks of large trade surpluses

Today in class we discussed whether a trade surplus is 'good' and the discussion drifted into the idea of export - led growth that many sucessful developing countries have followed during the past few decades.

"For five decades, developing countries that managed to develop competitive export industries have been rewarded with astonishing growth rates: Taiwan and South Korea in the 1960’s, Southeast Asian countries like Malaysia, Thailand, and Singapore in the 1970’s, China in the 1980’s, and eventually India in the 1990’s."
The above quote is from an article by Dani Rodrik titled "Is Export Led Growth Passé?".
"Nevertheless, developing countries have been falling over each other to establish export zones and subsidize assembly operations of multinational enterprises. The lesson is clear: export-led growth is the way to go.

But for how long? While reading the economic tea leaves is always risky, there are signs that we are at the cusp of a transition to a new regime in which the rules of the game will not be nearly as accommodating for export-led strategies."
The question is why? Rodrik goes on to explain:
"The most immediate threat is the slowdown in the advanced economies. Europe and the United States are both entering recession, and fears are mounting that the financial meltdown accompanying the sub-prime mortgage debacle has not worked itself out. All this is happening at a time when inflationary pressures hamper the usual monetary and fiscal remedies. The European Central Bank, tightly focused on price stability, has been raising interest rates, and the US Federal Reserve may soon follow suit. So the advanced economies will suffer for a while, with obvious implications for the demand for exports from emerging markets."
So, a slow down in the US and Europe implies a decrease in the import absorbing ability of these countries and thus slower export growth for the developing nations group. In addition,
"On top of this is the almost certain unwinding of global current-account imbalances. Emerging markets and developing countries ran a surplus of $631 billion in 2007, split roughly equally between Asian countries and the oil-exporting states. This amounts to 4.2% of their collective GDP. The US alone ran a current-account deficit of $739 billion (5.3% of its GDP). Neither the economics nor the politics of this pattern of current-account balances is sustainable, especially in a recessionary environment.

The politics is clear to see. Nothing works as potently to inflame protectionist sentiment as large trade deficits. According to a December 2007 NBC/Wall Street Journal poll, almost 60% of Americans think globalization is bad because it has subjected US firms and workers to unfair competition.

If globalization has acquired a lousy reputation in the US, the external deficit deserves much of the blame. US trade policy has been remarkably resistant to protectionist pressure in recent years. But, regardless of who wins America’s presidency, the world should expect closer scrutiny of imports from China and other low-cost countries as well as of outsourcing of services to places like India."
Notice the sentences in italics. This is exactly what we said in class this morning.

All IB economics students (higher and standard level) should read the whole article carefully and it can be found here.

Dani Rodrik's homepage at Harvard is here. Click on the Commentary link on the left hand side of the page to read interesting and (to some extent) accessible stuff for our IB course.

Wednesday, October 22, 2008

The new job market

Well, this is an upper for all of you budding MBA's! (courtesy of my friend George M.)

Or, maybe this:
"So long, suckers. Millionaire hedge fund boss thanks 'idiot' traders and retires at 37" (courtesy, once again, of my dearest Elly Vintiadis)

It's the end of the world as we know it...!

Well, this is a great REM song I first heard driving out of my driveway back in 1988 while listening to 104.1, WBCN, the rock of Boston. I thought of the song after reading this Nouriel Roubini article.
The delusion that economic contraction in the US and other advanced economies would be short and shallow – a V-shaped six-month recession – has been replaced by certainty that this will be a long and protracted U-shaped recession, possibly lasting at least two years in the US and close to two years in most of the rest of the world. And, given the rising risk of a global systemic financial meltdown, the prospect of a decade-long L-shaped recession – like the one experienced by Japan after the collapse of its real estate and equity bubble – cannot be ruled out.

Indeed, the growing disconnect between increasingly aggressive policy actions and strains in the financial market is scary. When Bear Stearns’ creditors were bailed out to the tune of $30 billion in March, the rally in equity, money, and credit markets lasted eight weeks. When the US Treasury announced a bailout of mortgage giants Fannie Mae and Freddie Mac in July, the rally lasted just four weeks. When the $200 billion rescue of these firms was undertaken and their $6 trillion in liabilities taken over by the US government, the rally lasted one day.

BTW, the guy is more often right than wrong! (check this from another IB econ blog as well as this on Roubini and his home page here)

Here is the video of the song and here are the lyrics:

OPEC: between a rock and a hard place

An interesting article on the current OPEC situation. It seems that members are between a rock and a hard place lately. The price of oil, as you probably are aware, is falling and this spells big problems for countries that rely on oil revenues for much of their growth. Check out the following from the article of today's Herald Tribune:
As the global economy continues to weaken, the Organization of the Petroleum Exporting Countries faces its toughest test in years. The problem for the oil exporters, who meet for an emergency session in Vienna on Friday, is to find a way to stop the price drop at a time when oil consumption is falling markedly in industrialized countries. Even the Chinese economy, long the biggest engine of growth for oil demand, seems to be cooling.

History suggests that OPEC will face a tough time propping up prices as oil consumption slows and the world teeters on the edge of a global recession, analysts said. Some experts warn that if the cartel took too much oil off the market, it could push prices up so much as to worsen the global economic crisis.

"OPEC's problem is they don't know how much demand is falling," said Jan Stuart, an energy economist at UBS. "So the risk they run is either they don't do enough, or they do too much. That's a tough choice."

And here, you find the classic problem facing cartel members:
The cartel, which controls 40 percent of the world's oil exports, has found it difficult in the past to get all its members to abide by production cuts. When prices fall, producers have an incentive to increase their output to maximize revenue, not stick with OPEC quotas.
Read the article here to find out more about the problems facing members and non-members as well as the possiblity of a commodity agreement (an export cartel a la OPEC) for natural gas producers!

Another must for all year 1 IB Economics students! Enjoy.

Monday, October 20, 2008

Well, what do you know!
"During a recession, laxatives go up, because people are under tremendous stress, and holding themselves back," said Shapiro, now chief executive of SAGE, a Chicago-based consulting firm. "During a boom, deodorant sales go up, because people are out dancing around. When people have less money, they buy more of the things that have less water in them, things that are not so perishable. Instead of lettuce and steak and fruit, it's rice and beans and grain and pasta. Except this time the price of pasta's so high that it's beans and rice."

A recent Nielsen report listed tobacco, carbonated drinks and eggs as especially vulnerable to recession, and candy, beer and pasta sauce as recession-proof. On Thursday, Hershey's announced third-quarter sales and income higher than last year's. ("We offer a tremendous variety of affordable indulgences, and people love chocolate, even in hard times." said Kirk Saville, a company spokesman.)

And here is another reason why an increase in GDP does not imply greater happiness!
A downturn, then, could result in benefits unmeasured by the market. "If people eat out less, the GDP goes down," Conley said, "but nothing in the GDP captures what you gain if you cook and eat in a leisurely way with your kids."

The full article can be found here.

A very interesting article on budget deficits

This article is from today's issue of the International Herald Tribune. I think it is a must read for any serious student if IB Higher Level Economics (but also for the interested Standard Level student who wants to go beyong textbooks).

Reading this article carefully may provide the IB Econ student with ideas on how to evaluate theory or a statement. There may be arguments against large budget deficits and expansionary fiscal policy but the seriousness of these arguments must be weighed against the specific circumstances.

The article can be found here.

Chinese economy growth rate slows

Globalization has ensured that the crisis that started in the US subprime market was not contained in the US but has spread all over. China announced the 3rd quarter growth which was once again lower than the previous one:

China's economic growth rate has fallen for the third quarter in succession, amid fears that the economy could be heading for a severe downturn.

The National Bureau of Statistics said the economy had grown at a rate of 9% in the three months to September.

...(This) marked a significant fall from the 10.4% growth of the first half of 2008, and the 12.2% growth seen in the first three quarters of 2007.
One could wonder how could a 9% growth rate be an issue! Well, it sure can. Dani Rodrik wrote this two weeks ago:

When other countries experiences financial crises, they lose a few percentage points of GDP and they get it over with. A lot more is at stake in China. China's precarious social balance and political stability hinge on continued high growth. Derail that growth engine, and you could have some really scary consequences that will affect 1.3 billion people and their neighbors.
What are the indicators that point to the slowdown and what are the Chinese authorities doing?

Correspondents say indicators from steel prices to housing sales suggest a severe economic slowdown could be in prospect.

Chinese factories are reporting that export orders are down sharply. Last week, the government said that half the country's toymakers had gone out of business.

Mr Li said the government had initiated timely measures to deal with the economic slowdown and cushion the impact from the global credit crisis, including falling exports and a restricted credit supply.

These included changing its focus from preventing the overheating of the economy and preventing structural inflation to the "preserving growth" and "controlling" inflation, he added.

Officials said over the weekend that the government was preparing to announce tax cuts and increased infrastructure investment. Curbs on the housing market in certain areas may also be relaxed. The People's Bank of China has cut interest rates twice and reduced banks' required reserves since mid-September. A third interest rate cut is expected later this year.
Read the BBC article about the new growth data here and read Rodrik's 'The other shoe drops' post here.

Monday, October 13, 2008

Paul Krugman rules!

I'm very happy!

This year's winner of the Nobel prize in Economics is Princeton economist and NYT columnist Paul Krugman.

Unfortunately guys, I never did bet and I thus didn't win any money, but I was right in predicting that he would win the Nobel prize this year! Check out my October 7 post 'This one is for you, Alex'!

Quoting from the New York Times article announcing the prize:
The prize committee lauded Mr. Krugman for “having shown the effects of economies of scale on trade patterns and on the location of economic activity.” Mr. Krugman is probably more widely known as a perpetual thorn in George Bush’s side from his perch as an Op-Ed page columnist for nearly a decade. His columns have won him both strong supporters and ardent critics. The Nobel, however, was awarded for academic — and less political — research that he conducted primarily before he began regularly writing for The Times.

He has developed models that explain observed patterns of trade between countries, as well as what goods are produced where and why. Traditional trade theory assumes that countries are different and will exchange only the different kinds of goods that they are comparatively better at producing; this model, however, was not reflected in flow of goods and services Mr. Krugman saw in the world around him. He set out to explain why worldwide trade was dominated by a few countries that were similar to each other, and why a country might import the same kinds of goods that it exported.

In his model, companies get more efficient at producing their goods as they sell more. Consumers like variety, so they pick and choose goods from among these producers in different countries. He developed this work further to explain what effect transport costs, which obstruct trade, should have on migration patterns. He helped explain under what conditions trade would lead to concentration or decentralization of populations.

Mr. Krugman’s models have been praised for their simplicity and practicality — features economists are often criticized for ignoring.

“Krugman’s trade models became the standard in the economics profession both because they fit the world a bit better and because they were masterpieces of mathematical modeling,” said Edward L. Glaeser, a professor at Harvard University who also studies economic geography. “His models’ combination of realism, elegance and tractability meant that they could provide the underpinnings for thousands of subsequent papers on trade, economic growth, political economy and especially economic geography.”

Mr. Krugman has been writing his Op-Ed page columns for The Times since 1999. In recent years, in his column and a related blog on, he has frequently and unrelentingly criticized Bush administration policies.

It's great that right now we are discussing trade theory in class. I hope that at least my ambitious group will take some time to check out a few things on the net about his ideas and contributions to orthodox economic theory. Even if you just bookmark the stuff for later!

I feel now even better adopting these past few years his introductory textbook for my IB economics classes!

Here is the Unofficial Paul Krugman site. Here you can find summaries of his NYT articles. And this is on his latest book "The Conscience of a Liberal".