BP has just published its latest projection of energy trends – its Energy Outlook 2030. According to the press release:
World energy growth over the next twenty years is expected to be dominated by emerging economies such as China, India, Russia and Brazil while improvements in energy efficiency measures are set to accelerate.
The following podcast from the Financial Times features a discussion of the report and the factors affecting oil prices and their relationship to economic growth
Webcast
Emerging economies seen driving energy demand Financial Times videos, John Authers and Vincent Boland (19/1/11)
Articles
Energy outlook Financial Times, Lex column (19/1/11)
BP energy outlook: main points The Telegraph (20/1/11)
High energy prices need not mean doom Sydney Morning Herald, Jeremy Warner (21/1/11)
Report
BP Energy Outlook 2030 (January 2011)
Data
Power slide The Economist: Daily Chart (19/1/11)
Questions
- What are the most powerful driving forces behind the demand for energy?
- Why does the report forecast virtually no increase in energy demand in developed countries? What assumptions are made about growth rates in OECD and non-OECD countries?
- What factors would lead to a substitution of sustainable energy sources for fossil fuels? What would detrmine the size of such substitution?
- What is the role of the price elasticity of demand for and supply of oil and the income elasticity of demand for oil in determining oil consumption in different parts of the world?
- Why may high energy prices not necessarily mean ‘doom’?
Two reports on business confidence in the UK have just been published. The first, by Lloyds TSB Commercial, is its twice-yearly Business in Britain Report. The second is the Quarterly Economic Survey by the British Chambers of Commerce. Both reports paint a mixed picture about business confidence.
First the good news: the export sector is booming. Demand for exports is being boosted by (a) the depreciation of the pound, with the sterling exchange rate index some 20% lower now compared with the start of 2008 and (b) rapid economic growth in China, India and many other developing countries. Not surprisingly many exporting companies are looking to a bright future and are willing to invest.
Now the bad news. Domestic demand for many products is declining, especially services. This is not surprising given the rise in VAT, cuts in public spending and consumers cautious about their employment and income prospects in the coming year. With rapid cost-push inflation from higher oil and commodity prices, real incomes are set to fall and with it the level of real consumer demand (see Bosses gain – workers’ pain).
So where is the economy heading? The mixed picture painted by the two reports mean that the economy is likely to remain on the cusp. But with the export sector being much smaller than the domestic market, worries are likely to persist that economic growth may well slow significantly and the economy might return to recession. The main hope is that the restocking and replacement investment that follow a recession may be enough to provide just enough extra demand to avoid the ‘double dip’.
Articles
UK Business Confidence Hit By Domestic Demand Fears-Survey NASDAQ, Emma Haslett (4/1/11)
More doom and gloom as business confidence falls? Management Today, Nicholas Winning (5/1/11)
Smaller businesses do not share optimism Financial Times, Brian Groom (5/1/11)
New Year business confidence hit by domestic demand fears The Telegraph, James Hurley (5/1/11)
UK’s fragile services sector risks undermining recovery, BCC warns The Telegraph, Philip Aldrick (11/1/11)
Companies fear double-dip recession Oxford Mail, Andrew Smith (10/1/11)
Firms ‘planning investment freezes’ Press Association (4/1/11)
Surveys paint bleak picture for British economy Reuters, David Milliken (11/1/11)
Kern Says U.K. Services Industry Growth Is `Mediocre’ Bloomberg, Watch Video, David Kern (11/1/11)
UK economic growth rate slowing, BCC says BBC News (11/1/11)
Reports
Business in Britain, December 2010 Lloyds TSB Commercial (January 2011)
Quarterly Economic Survey, Q4 2010: Summary British Chambers of Commerce (January 2011)
Quarterly Economic Survey, Q4 2010: Tables British Chambers of Commerce (January 2011)
Data
Interest Rates and Exchange Rates Bank of England (for sterling effective exchange rates)
Economic and Labour Market Review Office for National Statistics (see Tables Chapter 1, worksheets in Table 1.03 for components of aggregate demand)
Business and Consumer Surveys European Commission, Economic and Financial Affairs (see latest ESI – Economic Sentiment Indicator, Table 1)
Questions
- Summarise the findings of the two reports.
- Using the data in Table 1.03 of the Economic and Labour Market Review, calculate the percentage of UK GDP accounted for by each of the main elements of aggregate expenditure.
- Why is the manufacturing sector as a whole experiencing relatively strong economic growth?
- If the service sector shrank by x% and the manufacturing sector grew by x%, what would be likely to happen to the rate of economic growth in the economy? What else would you need to know to establish the precise rate of economic growth?
- The BCC said both the government and the Bank of England must “act forcefully to support growth”. What measures would this include?
- If real wages fall, what could cause real aggregate demand to rise in these circumstances?
- What is likely to drive the level of investment in the coming months?
The government’s plan for the UK economy is well known. Reduce the public-sector deficit to restore confidence and get the economy going again. The deficit will be reduced mainly by government spending cuts but also by tax increases, including a rise in VAT from 17.5% to 20% on 1 January 2011. Reductions in public-sector demand will be more than offset by a rise in private-sector demand.
But what if private-sector demand does not increase sufficiently? With a fall in government expenditure, reduced public-sector employment and higher taxes, the danger is that demand for private-sector output may actually fall. And this is not helped by a decline in both consumer and business confidence (see, for example, Nationwide Consumer Confidence Index). What is more, consumer borrowing has been falling (see Consumer borrowing falls again) as people seek to reduce their debt, fearing an uncertain future.
So does the government have a ‘Plan B’ to stimulate the economy if it seems to be moving back into recession? Or will it be ‘cuts, come what may’? The Financial Times (see link below) has revealed that senior civil servants have indeed been considering possible stimulus measures if a return to recession seems likely.
Over in Threadneedle Street, there has been a debate in the Bank of England’s Monetary Policy Committee over whether an additional round of quantitative easing may be necessary. So far, the MPC has rejected this approach, but one member, Adam Posen, has strongly advocated stimulating demand (see The UK inflation outlook if this time isn’t different, arguing that the current high inflation is the result of temporary cost-push factors and is not indicative of excessively strong demand.
So should there be a Plan B? And if so, what should it look like?
Articles
Gus O’Donnell’s economic ‘Plan B’ emerges BBC News, Nick Robinson (14/12/10)
Sir Gus O’Donnell asks ministers to consider possible stimulus measures Financial Times, Jim Pickard (14/12/10) (includes link to article by Philip Stephens)
Gus O’Donnell urges Treasury to prepare ‘Plan B’ for economy Guardian, Patrick Wintour and Nicholas Watt (14/12/10)
Unemployment, and that ‘Plan B’ BBC News blogs, Stephanomics, Stephanie Flanders (15/12/10)
Inflation wars (cont’d) BBC News blogs, Stephanomics, Stephanie Flanders (16/12/10)
Don’t overreact to UK inflation – Bank’s Posen Reuters, Patrick Graham (16/12/10)
Bank of England’s Adam Posen calls for more quantitative easing The Telegraph, Philip Aldrick and Emma Rowley (29/9/10)
Don’t overreact to above-target UK inflation rate, cautions Posen Herald Scotland, Ian McConnell (17/12/10)
Posen calls for calm as inflation fears rise Independent, Sean O’Grady (17/12/10)
Data
OECD Economic Outlook OECD (see, in particular, Tables 1, 18, 27, 28 and 32)
Forecasts for the UK economy HM Treasury
UK Economic Outlook PricewaterhouseCoopers
Employment and Unemployment ONS
Inflation Report Bank of England
Questions
- What are likely to be the most important factors in determining the level of aggregate demand in the coming months?
- What are the dangers of (a) not having a Plan B and (b) having and publishing a Plan B?
- Why is inflation currently above target? What is likely to happen to inflation over the coming months?
- What are the arguments for and against having another round of quantitative easing?
- What else could the Bank of England do to stimulate a flagging economy?
What will happen to interest rates over the next two or three years? There is considerable disagreement between economists on this question at the moment.
There are those who argue that recovery in the UK, the USA and Europe is faltering. With much tighter fiscal policy being adopted as countries attempt to claw down their deficits, there is a growing fear of a double-dip recession. In these circumstances central banks are likely to keep interest rates at their historically low levels for the foreseeable future and could well embark on a further round of quantitative easing (see Easy money from the Fed?). But what about inflation? With demand still expanding in developing countries and commodity prices rising, won’t cost pressures on inflation continue? Those who forecast that interest rates will stay low, argue that the pressure on commodity prices will ease as global demand slows. Also, in the UK, now that sterling is no longer depreciating, this will remove a key ingredient of higher inflation.
These views are not shared by other economists. They argue that interest rates could soar over the next two years. In fact, one economist, Andrew Lilico, the Chief Economist at Policy Exchange argues that interest rates in the UK will reach 8% by 2012. Central to their argument is the role of the money supply. The monetary base has been expanded enormously through programmes of quantitative easing. And yet, consumer credit has fallen. When the economy does eventually start to recover strongly, Lilico and others argue that there is a danger that consumer credit and broad money will expand rapidly, thereby fuelling inflation. But won’t the spare capacity that has built up during the recession allow the increase in aggregate demand to be met by a corresponding increase in output, thereby keeping inflation low. No, say these economists. A lot of capacity has been lost and output cannot easily expand to meet a rise in demand.
It’s not uncommon for economists to disagree! See, by reading the articles below, if you can unpick the arguments and establish where the disagreements lie and whose case is the strongest.
Articles
America’s century is over, but it will fight on Guardian, Larry Elliott (23/8/10)
Rates to remain low for foreseeable future Interactive Investor, Rhian Nicholson (18/8/10)
BoE gets benefit of doubt on inflation – for now Reuters, Christina Fincher (19/8/10)
BGilts reflect continued uncertainty AXA Elevate, Tomas Hirst (23/8/10)
A bull market in pessimism The Economist (19/8/10)
Interest rates ‘may hit 8%’ by 2012 says think tank BBC News (22/8/10)
Interest rates ‘may hit 8pc’ in two years Telegraph, Philip Aldrick (21/8/10)
Bernanke Must Raise Benchmark Rate 2 Points, Rajan Says Bloomberg, Scott Lanman and Simon Kennedy (23/8/10)
Inflation, not deflation, Mr. Bernanke Market Watch, Andy Xie (22/8/10)
Inflation comes through the door and wisdom flies out of the window Telegraph, Liam Halligan (21/8/10)
Data
British Government Securities, Yields Bank of England
Bankstats: Data on UK money and lending Bank of England
Questions
- Summarise the arguments of those who believe that interest rates will stay low for the foreseeable future.
- Summarise the arguments of those who believe that interest rates will be significantly higher by 2010.
- What factors will be the most significant in determining which of the two positions is correct?
- Why are the yields on long-term bonds a good indicator of people’s expectations about future inflation and monetary policy?
- Why has consumer credit fallen? Why might it rise again?
- Why may unemployment not fall rapidly as the economy recovers? Is this an example of hysteresis?
Every three months, the Bank of England produces its Inflation Report. This includes forecasts for inflation and economic growth for the next three years. The forecasts are presented as fan charts. These depict the probability of various outcomes for inflation or growth in the future. “In any particular quarter of the forecast period, GDP is expected to lie somewhere within the fan on 90 out of 100 occasions.” Each coloured band represents a 10% probability of occurrence. “Although not every member will agree with every assumption on which our projections are based, the fan charts represent the MPC’s best collective judgement about the most likely paths for inflation and output, and the uncertainties surrounding those central projections.” The broader the fan the less confident are the forecasts. The fans have tended to get broader in recent Reports, reflecting the greater uncertainties in the UK and global economies since the credit crunch.
Since the last Report, the forecast for economic growth in 2011 has been adjusted downwards from 3.4% to 2.5%. Inflation, while still being forecast to be below the target of 2% in two years’ time, is forecast to rise in the short term, thanks to higher commodity prices and the rise in VAT from 17.5% to 20% in January 2011.
So what impact, according to the Report, will various factors such as the Coalition’s emergency Budget in June, rising commodity prices, falling consumer confidence and improving export performance have on the economy? And how much credence should be put on the forecasts? The following articles address these questions
Articles
Bank chief warns of ‘choppy recovery’ Independent, Russell Lynch (11/8/10)
King warns of ‘choppy recovery’ for economy Channel 4 News, Faisal Islam (11/8/10)
Bank of England warns UK recovery will be weaker than hoped Telegraph (11/8/10)
Bank of England lowers UK growth forecast Telegraph, Angela Monaghan (11/8/10)
Bank of England cuts UK economic growth forecasts Guardian, Katie Allen (11/8/10)
Bank of England forecasts ‘choppy’ economic recovery BBC News, Katie Allen (11/8/10)
Bank of England Cuts Outlook for Economic Growth Bloomberg, Jennifer Ryan (11/8/10)
Why is the UK heading into choppy waters? BBC News Analysis, Hugh Pym (11/8/10)
Bank of England overhauls forecast model after errors Telegraph, Philip Aldrick (11/8/10)
The Bank’s impossible balancing act Independent, David Prosser (11/8/10)
How uncertain exactly is the uncertain BoE? Reuters Blogs, MacroScope (11/8/10)
‘Slowflation’ – the combination the Bank of England fears most Independent, Sean O’Grady (11/8/10)
The Bank is right to paint a mixed picture Independent, Hamish McRae (11/8/10)
Sterling falls, gilts rally after Bank of England cuts growth forecasts Guardian Blogs, Elena Moya (11/8/10)
Report
Inflation Report
Inflation Report Press Conference
Questions
- Do the Bank of England’s forecasts suggest that the UK economy is on track for meeting the inflation target in 24 months’ time?
- How much reliance should be put on Bank of England inflation and growth forecasts? You might want to check out the forecasts made one and two years ago for current (2010) rates of inflation and growth (see Inflation Reports (by date)).
- What are the factors that have persuaded the Bank of England to reduce its forecast for the rate of economic growth in 2011? Are these factors all on the demand side?
- According to the fan chart for economic growth, what is the probability that the UK economy will move back into recession in 2011?
- Will the rise in VAT in January 2011 cause inflation to be higher in 2012 than in 2010 (other things being equal)? Explain.
- Why did the FTSE fall by 2.4% on the day the Report was released?
- If commodity price inflation increases (see Food prices: a question of supply and demand), what impact is this likely to have (a) on the rate of economic growth; (b) on the rate of interest chosen by the MPC?
- What policy should the Bank of England adopt to tackle ‘slowflation’?