In the wake of the credit crunch, the Federal Reserve Bank (the Fed) reduced interest rates to virtually zero in December 2008 and embarked on a huge round of quantitative easing over the following 15 months, ending in March 2010. This involved the purchase of some $1.7 trillion of assets, mainly government bonds and mortgage-backed securities. There was also a large planned fiscal stimulus, with President Obama announcing a package of government expenditure increases and tax cuts worth $787 billion in January 2009.
By late 2009, the US economy was recovering and real GDP growth in the final quarter of 2009 was 5.0% (at an annual rate). However, the fiscal stimulus turned out not to be as much as was planned (see and also) and the increased money supply from quantitative easing was not having sufficient effect on aggregate demand. By the second quarter of 2010 annual growth had slowed to 1.7% and there were growing fears of a double-dip recession. What was to be done?
The solution adopted by the Fed was to embark on a second round of quantitative easing – or “QE2”, as it has been dubbed. This will involve purchasing an additional $600 billion of US government bonds by the end of quarter 2 2011, at a rate of around $75 billion per month.
But will it work to stimulate the US economy? What will be the knock-on effects on exchange rates and on other countries? And what will be the effects on prices: commodity prices, stock market prices and prices generally? The following articles look at the issues. They also look at reactions around the world. So far it looks as if other countries will not follow with their own quantitative easing. For example, the Bank of England announced on 4 November that it would not engage in any further quantitative easing. It seems, then, that the USA is the only one on board the QE2.
Articles
QE2 – What is the Fed Doing? Will it Work? Kansas City Star, William B. Greiner (5/11/10)
The ‘Wall Of Money’: A guide to QE2 BBC News blogs: Idle Scrawl, Paul Mason (2/11/10)
Federal Reserve to pump $600bn into US economy BBC News (4/11/10)
Beggar my neighbour – or merely browbeat him? BBC News blogs: Stephanomics, Stephanie Flanders (4/11/10)
Too much cash, bubbles and hot potatoes Financial Times (5/11/10)
Bernanke Invokes Friedman’s Inflation-Fighting Legacy to Defend Stimulus Bloomberg, Scott Lanman and Steve Matthews (7/11/10)
The QE backlash The Economist (5/11/10)
Former Fed Chairman Volcker says bond buying plan won’t do much to boost US economy Chicago Tribune, Kelly Olsen (5/11/10)
Ben Bernanke’s QE2 is misguided Guardian, Chris Payne (6/11/10)
Effects on commodity prices and stock markets
Gold hits record high, oil rallies on Fed stimulus Taipei Times (7/11/10)
Analysis: Fed’s QE2 raises alarm of commodity bubble Reuters, Barbara Lewis and Nick Trevethan (5/11/10)
Fed’s Bernanke defends new economic recovery plan BBC News (7/11/10)
Sit back and enjoy the ride that QE2 has set in motion Financial Times, Neil Hume (5/11/10)
US accused of forcing up world food prices Guardian, Phillip Inman (5/11/10)
Effects on other countries
The rest of the world goes West when America prints more money Telegraph, Liam Halligan (6/11/10)
Backlash against Fed’s $600bn easing Financial Times, Alan Beattie, Kevin Brown and Jennifer Hughes (4/11/10)
China, Germany and South Africa criticise US stimulus BBC News (5/11/10)
G20 beset with fresh crisis over currency International Business Times, Nagesh Narayana (5/11/10)
European Central Bank Keeps Rates at Record Lows New York Times, Julia Werdigier and Jack Ewing (4/11/10)
Official statements by central banks
FOMC press release Board of Governors of the Federal Reserve System (3/11/10)
News release: Bank of England Maintains Bank Rate at 0.5% and the Size of the Asset Purchase Programme at £200 Billion Bank of England (4/11/10)
ECB Press Conference ECB, Jean-Claude Trichet, President of the ECB, Vítor Constâncio, Vice-President of the ECB (4/11/10)
Questions
- How has the Fed justified the additional $600 billion of quantitative easing?
- What will determine the size of the effect of this quantitative easing on US aggregate demand?
- How will QE2 influence the exchange rate of the dollar?
- Why have other countries been critical of the effects of the US policy?
- What will be the effect of the policy on commodity prices?
Competition authorities across the world are in a constant battle against the abuse of monopoly power and the collusion of oligopolists to gang up against the consumer. They are also concerned with mergers where these result in a reduction in competition. The following articles look at market power in Australia and at some high profile cases of oligopolist collusion. Examples include the big four banks in Australia and the two supermarket giants, Coles and Woolworths, which dominate the sector.
The articles also examine the role of the Australian Competition and Consumer Commission, Australia’s equivalent to the UK’s Competition Commission and Office of Fair Trading (soon to be merged).
Articles
Get out of monopoly free cards can’t be left to the roll of the dice Sydney Morning Herald, Jessica Irvine (27/10/10)
Australia watchdog adds voice to criticism of banks Reuters (22/10/10)
Major banks to beat wage rise The Australian, Blair Speedy (6/10/10)
Analysis: Australian firms forced into deals abroad Reuters, Michael Smith and Sonali Paul (21/10/10)
Hockey outlines plan for banking reform Business Spectator (25/10/10)
Banks are laughing all the way to… the bank Sydney Morning Herald, Josh Gordon (24/10/10)
Xenophon: ACCC Allows Woolworths & Lowes to Hurt Consumers & Competition Mathaba (27/10/10)
Woolies still the target of Coles firepower Sydney Morning Herald, Michael Baker (27/10/10)
Competition authority in Australia
Australian Competition and Consumer Commission
Questions
- In what ways can competition authorities bring about greater competition in oligopolistic industries?
- Explain the distinction between a demand-side and a supply-side approach to competition policy.
- Why do Australian airlines find it more difficult than Australian banks to pass on cost increases to consumers?
- Are highly competitive markets always better for consumers than oligopolistic ones? Explain.
As part of its drive to reduce the number of ‘quangos’ (quasi-autonomous, non-governmental organisations), the government has decided to merger the two main competition authorities: the Competition Commission and the Office of Fair Trading. The aim is to streamline the investigation of mergers, restrictive practices and the abuse of monopoly power, thereby saving costs and reducing the time taken before a decision is made. At present an initial OFT investigation can take many months before a reference is then made to the Competition Commission, which then starts the process of investigation from the beginning again.
Business leaders have welcomed the announcement, seeing the merger as a means of simplifying and speeding up investigations. But will the proposal be more effective in preventing the abuse of market power and encouraging competition? The following articles look at some of the issues.
OFT merger to shake up competition regime in UK Belfast Telegraph (15/10/10)
Competition lawyers gear up for merger of OFT and Competition Commission Legal Week, Friederike Heine (14/10/10)
Labour’s antitrust system dismantled Financial Times, Michael Peel (13/10/10)
Watchdog merger that merits review Financial Times (14/10/10)
Merged competition agency divides opinion Financial Times, Michael Peel (14/10/10)
Office of Fair Trading and Competition Commission to merge Guardian, Julia Kollewe (14/10/10)
Concerns at merger of OFT and Competition Commission Telegraph, Alistair Osborne (15/10/10)
Questions
- What are the current roles and responsibilities of the OFT and the Competition Commission?
- What types of market abuse are the two agencies designed to reduce or prevent? What instruments do they have at their disposal for enforcing their findings?
- What are the arguments in favour of the merger of the two agencies?
- What are the dangers of the merger?
- How will consumer protection be provided under the new regime?
Now the details of the Comprehensive Spending Review (CSR) are known, the comments are coming thick and fast. As we saw in the last news blog, Taking sides in the war of the cuts, economists are divided over whether the cuts will be compensated by a rise in private expenditure or whether overall aggregate demand will fall, driving the economy back into recession. As you will see in the articles below, they are still as divided as ever.
At least we know the details of the cuts. The plan is for an average cut across government departments of some 19 per cent over four years, although the size will vary enormously from department to department. The government is predicting that the effect will be about 490,000 fewer jobs in the public sector. In addition to the cuts, the retirement age is to rise to 66 for both men and women by 2020 and regulated rail fares will rise by 3% above RPI inflation for three years from 2012.
Examine the details of the measures in the articles below and consider what the effects are likely to be, both on the macro economy and on income distribution.
Articles
Spending Review: Osborne wields axe BBC News (20/10/10)
Spending Review: Q&A – what does it mean? BBC News (20/10/10)
Main points from the Comprehensive Spending Review Independent (20/10/10)
Osborne swings the welfare axe Independent, Oliver Wright (20/10/10)
Chancellor spells out austerity gamble Financial Times (20/10/10)
Easier said than done The Economist (20/10/10)
Julian Callow Sees Consolidation in Europe Bloomberg Podcasts, Tom Keene interviews Julian Callow, chief European economist at Barclays Capital (21/10/10)
Spending Review 2010: Business leaders urge clearer strategy for growth Telegraph, Louise Armitstead (20/10/10)
Spending Review 2010: George Osborne leaves markets unmoved Telegraph (20/10/10)
Spending review: Osborne gambles with the economy Guardian, Larry Elliott (20/10/10)
Larry Elliott on George Osborne’s spending review Guardian video (20/10/10)
Spending review: What the economists think Guardian (20/10/10)
Spending review: The work of a gambler Guardian editorial (20/10/10)
Spending review: economists and other experts respond Guardian, various economists (20/10/10)
Comprehensive spending review: We deserve an explanation. This wasn’t it Guardian, Aditya Chakrabortty (20/10/10)
Spending review: the winners and losers Guardian, Sam Jones (20/10/10)
All in it together? BBC News blogs, Stephanomics, Stephanie Flanders (20/10/10)
The sack: Lessons for government BBC News blogs, Peston’s Picks, Robert Peston (20/10/10)
A gamble on the economics Financial Times, Philip Stephens (20/10/10)
Q&A: the devil in the details Financial Times, Chris Giles (20/10/10)
Spending Review: Poorest Take Biggest Hit Sky News, Miranda Richardson (20/10/10)
Spending Review 2010: ‘More cuts could be needed’ Telegraph, Andy Bloxham (21/10/10)
Cuts ‘will push UK close to recession’ BBC Today Programme, Martin Wolf and Ken Rogoff (21/10/10)
Spending review cuts ‘are regressive’ BBC Today Programme, Tim Harford (21/10/10)
Spending review is a full stop but history lesson is vital in economics Guardian, Larry Elliott (25/10/10)
The Spending Review document
Spending Review 2010 HM Treasury (20/10/10)
Link to HM Treasury Spending Review site
Briefing and analysis from the Institute for Fiscal Studies
Opening remarks IFS, Carl Emmerson (21/10/10)
Link to briefing presentations (PowerPoint) IFS (21/10/10)
Analysis of fiscal consolidation by the IMF
Will It Hurt? Macroeconomic Effects of Fiscal Consolidation World Economic Outlook, Chapter 3, IMF (Oct 2010)
Questions
- What is the distribution of cuts between government departments?
- To what extent can it be said that there will be a real increase in health expenditure?
- What will be the effect of the cuts and tax increases on the distribution of income?
- What will determine whether the effect of the cuts will be to stimulate or dampen economic growth (or even drive the economy back into recession)? Which do you think is most likely and on what do you base your judgement?
- Trace through the multiplier effects of the measures.
- If the effect of the cuts is to drive the economy back into recession, what should the government’s ‘Plan B’ be?
In the run-up to the Comprehensive Spending Review a battle is raging. On one side are those who argue that cuts are necessary to secure long-term growth and to maintain confidence on the UK economy. These people include leaders of 35 major companies in the UK who wrote a letter to the Telegraph (see below) suppporting George Osborne’s policy of cuts.
On the other side are those who maintain that the cuts will drive the economy back into recession or, at least, will hamper economic recovery. The Federation of Small Businesses warns that “Some small firms rely on public-sector contracts for 50 or 60 per cent of their turnover. If the cuts are swingeing and overnight, these companies will be lost to the UK economy forever.”
Read the following articles to get a clear understanding of the arguments on both sides. Hopefully this will then put you in a better position to assess the cuts and their impact.
Articles
Osborne’s cuts will strengthen Britain’s economy by allowing the private sector to generate more jobs Telegraph, letter from 35 business leaders (18/10/10)
Spending Review 2010: cut now or pay later, say business leaders Telegraph, Andrew Porter, and Robert Winnett (17/10/10)
35 business leaders back Osborne’s cuts BBC News blogs: Peston’s Picks, Robert Peston (17/10/10)
Prominent Tory donors among business leaders who backed Osborne’s cuts Independent, Andrew Grice (19/10/10)
On the tight side The Economist (30/9/10)
History will see these cuts as one of the great acts of political folly Observer, Will Hutton (17/10/10)
Osborne has taken the coward’s route Guardian, David Blanchflower (18/10/10)
Osborne reading Christian Andersen, claims economist The Herald, Ian McConnell (19/10/10)
Time to broaden the debate on spending cuts Guardian, Ha-Joon Chang (19/10/10)
Slugging it out over spending cuts Independent, Sean O’Grady (19/10/10)
Spending Review 2010: We should all fear the darkness, David Cameron included Telegraph, Mary Riddell (18/10/10)
Spending cuts: Molehill and mountain BBC News blogs: Stephanomics, Stephanie Flanders (19/10/10)
Does fiscal austerity boost short-term growth? A new IMF paper thinks not The Economist (30/9/10)
Spending Review: Forecasts rely on ‘heroic assumptions’ BBC News (20/10/10)
Spending cuts: City divided on whether cuts are good for recovery Yorkshire Evening Post (20/10/10)
Spending Review 2010: Spending cuts will hit small businesses hardest Telegraph, James Hurley (20/10/10)
Speech
Rebalancing the Economy Speech by Mervyn King, Bank of England Governor (30/9/10)
Mervyn King warns of 1930s-style collapse (Extract from above speech) BBC News, Mervyn King (19/10/10)
Questions
- What are the main arguments for making large-scale cuts to government spending at the present time?
- What are the main arguments against making large-scale cuts to government spending at the present time?
- To what extent should the government’s poplicy on the size and timing of the cuts be influenced by international economic relations?
- What role might the ‘inventory cycle’ play in the economic recovery?
- Why may the government “pay heavily unless it learns to temper its bloody cuts with humanity”?
- How will large-scale spending cuts impact on (a) consumer confidence; (b) business confidence; (c) the confidence of international financiers?
- Will monetary policy allow fiscal policy to be tightened without causing a recession? Explain the effectiveness of monetary policy in these circumstances.