Markets have made a tremendous rally the past months.
We’ve had a very long rally and people are getting suspicious, we know insiders like Jim Rogers, George Soros and Warren Buffet are either selling stocks or at least not buying them.
According to this table investors withdrawed around 5 billion from the stock market last week.
If we cumulate all withdrawals from the last 8 weeks it comes to more than 25 billion USD in around two months!!
How come the markets have not declined because of this?
Some say the governments do big market-intervention nowadays, everyone – banks, the government, pension funds – is benefitting in higher market prices. Some say everything is done to achieve this.
Robert Kiyosaki, author of the book Rick Dad, Poor Dad, also thinks the markets are being “manipulated”.
It’s not that the government didn’t do this before… Governments certainly do have experience in intervening on financial markets.
In 1989 already the Robert Heller, by then the governor of the FED, said in an interview in the wall street journal that the FED was very interested in the possibilities of supporting the stock-market by buying futures.
Also from summaries of meeting of the FED in 1994 may be concluded that the FED has experience in intervening in financial markets. Under the heading ‘Central bankers eye unusual steps’ in a article on Reuters (29th of june 2003) Greenspan stated that measures once not acceptable – like the regulations in Financial assets – might become normal.
I think they may have become normal by now…
Saturday 31 October 2009
Friday 30 October 2009
“Quantitative easing has set off another Sharp, and so far containable asset bubble.”
Andrew Smither, head of the research-firm Smithers&Co, said the S&P is 40% overvalued basing on his predictions of the Q-ratio and the adjusted price-to-earnings ratio by Robert Shiller.
Declines are becoming more and more likely because banks will need to sell more shares to raise vapital. Smithers said “Markets are very vulnerable for the end of quantitative easing.”
This is exactly what I’ve been posting about the last couple of days. The governments around the world have been busy inflating the economy and keeping the system alive using heavy drugs. Now Smithers says we might have become addicted to those drugs.
What we blame the FED for is for keeping the interest rates too low for a too long time and creating the bubble of which we are now facing the burst. According to Smithers “Quantitative easing has set off another sharp, and so far containable asset bubble.”, the problems are being solved by creating the next.
Smithers: “If it [the bubble] gets too high and starts come down then we’ll head straight back [into recession] “
The drug we’re addicted to, however, is almost fully used. “Central banks, they’ve got to stop some time and if that happens everything will come down.“
Declines are becoming more and more likely because banks will need to sell more shares to raise vapital. Smithers said “Markets are very vulnerable for the end of quantitative easing.”
This is exactly what I’ve been posting about the last couple of days. The governments around the world have been busy inflating the economy and keeping the system alive using heavy drugs. Now Smithers says we might have become addicted to those drugs.
What we blame the FED for is for keeping the interest rates too low for a too long time and creating the bubble of which we are now facing the burst. According to Smithers “Quantitative easing has set off another sharp, and so far containable asset bubble.”, the problems are being solved by creating the next.
Smithers: “If it [the bubble] gets too high and starts come down then we’ll head straight back [into recession] “
The drug we’re addicted to, however, is almost fully used. “Central banks, they’ve got to stop some time and if that happens everything will come down.“
Thursday 29 October 2009
Speculations…
There are huge speculations in gold lately, and the gold price is soaring. What is the reason for this speculation?
The last couple of days I’ve been talking about the very heavy drug the FED is using inflating the economy with US dollars. This was not money the FED owned, this was simply printed.
Taking the effects of the money multiplier into account, every dollar brought into the system will result in 10 dollars extra in the system. (assuming a 10% ratio, the actual amount banks keep risk-free is normally around 8 or 9 per cent)
Ever since the start of the credit crunch the monetary base increased by 1100 billion USD.
It shows the inflation-adjusted gold price throughout history, showing we are around 50% away from the all-time high!
Gold is taking a more and more important role within investors portfolios and I think this is good: there is more than enough space left for gold to climb in price, way more than the space for the S&P to climb.
But more about that tomorrow…
The last couple of days I’ve been talking about the very heavy drug the FED is using inflating the economy with US dollars. This was not money the FED owned, this was simply printed.
Taking the effects of the money multiplier into account, every dollar brought into the system will result in 10 dollars extra in the system. (assuming a 10% ratio, the actual amount banks keep risk-free is normally around 8 or 9 per cent)
Ever since the start of the credit crunch the monetary base increased by 1100 billion USD.
According to our money multiplier this will result in an increase of the M3 by 11,000 billion USD. An increase of 11,000 billion within an economy whose GDP is around 14,000 billion… You don’t have to study economics to understand this will lead to inflation on the long term.
Normally it takes about three years before the results are seen in the real economy, since the FED started printing (extra) money in the summer of 2007 the effects will probably reveal itself somewhere within next year. (possibly a bit later since the banks have been very careful with new loans)
I suspect the rise in the gold price is caused by anticipation of the inflationary pressures.
There are a lot of people stating that gold now is overbought since the price has increased and increased in the last few months. ‘New records’ have been set for the gold price and according to some people a very heavy correction is highly probable. However: those analysts are looking at the nominal price instead of the inflation adjusted prices.
I would like them to take a look at this graph:
It shows the inflation-adjusted gold price throughout history, showing we are around 50% away from the all-time high!
Gold is taking a more and more important role within investors portfolios and I think this is good: there is more than enough space left for gold to climb in price, way more than the space for the S&P to climb.
But more about that tomorrow…
Wednesday 28 October 2009
It's magic
Goldman sachs Q3 earnings were close to quadrupling.
Reuters reports “its shares fell on disappointment that so much of the profit came from trading gains that might not be sustainable.”
I’ve come across a funny but very interesting video which explains what is meant by these unsustainable trading gains and why they won’t be sustainable.
Reuters reports “its shares fell on disappointment that so much of the profit came from trading gains that might not be sustainable.”
I’ve come across a funny but very interesting video which explains what is meant by these unsustainable trading gains and why they won’t be sustainable.
Visit msnbc.com for Breaking News, World News, and News about the Economy
Tuesday 27 October 2009
"We are living in a dream, and we started to believe it."
Willem Middelkoop, a Dutch economist famous for its book on the weaknesses of the dollar and peak oil, stated in an interview on Dutch television a second crisis is coming.
He clearly states that the consumer, this time, IS NOT able to buy us out of the crisis. The American consumer counts for more than 25% of the world’s consumption and they simply have to watch their debts and cut spending.
’This is a structural problem which causes that structural recovery for the economy is not possible.’
Governments are now keeping the system alive, but it’s not natural. The American government pumped nearly 24 trillion dollar into the US economy for it to revive. How much of the rally we see today is unsustainable? How much is natural economic recovery?
The governments are using a drug for the economy: But it’s a very heavy drug causing very heavy side-effects. The drug might longer the life, but might not save the life of the economy. The heart of the system – capitalism and the free markets – already died since in America the biggest insurance company now is nationalized, 60% of the mortgage market is nationalized, the biggest car manufacturer is nationalized and the biggest banks are nationalized or need government funding.
According to Willem Middelkoop the next crisis will be in a few years where governments are not able to pay for their deficits anymore. The only way out of this would be to create extra money, this will result in worthless currencies.
The fact that the USA were already heading for a deficit problem in early 2007 is shown in this video:
Note that this is made in early 2007; in 2008 and in the beginning of 2009 there has been approx. 30 trillion dollars of additional spending... As part one stated that a 45,4 trillion on total fiscal exposure is like having a 750,000 dollar mortgage and no house. How bad is it right now?
If we keep on going like this...
"By year 2040 we can do little more than pay interest on the massive and growing federal debt. "
A change in the economic system is needed.
A possible new set-up would be to shift the banks to the public sector. Why did we give the ability to create money to private companies?Private – profit based – companies have the ability to create money and divide the profits made by doing this. Is this a fair system?
Currently we are creating something out of nothing.(read money out of air) That’s not possible, we should go back: make banks government owned again and link currencies to gold again.
He clearly states that the consumer, this time, IS NOT able to buy us out of the crisis. The American consumer counts for more than 25% of the world’s consumption and they simply have to watch their debts and cut spending.
’This is a structural problem which causes that structural recovery for the economy is not possible.’
Governments are now keeping the system alive, but it’s not natural. The American government pumped nearly 24 trillion dollar into the US economy for it to revive. How much of the rally we see today is unsustainable? How much is natural economic recovery?
The governments are using a drug for the economy: But it’s a very heavy drug causing very heavy side-effects. The drug might longer the life, but might not save the life of the economy. The heart of the system – capitalism and the free markets – already died since in America the biggest insurance company now is nationalized, 60% of the mortgage market is nationalized, the biggest car manufacturer is nationalized and the biggest banks are nationalized or need government funding.
According to Willem Middelkoop the next crisis will be in a few years where governments are not able to pay for their deficits anymore. The only way out of this would be to create extra money, this will result in worthless currencies.
The fact that the USA were already heading for a deficit problem in early 2007 is shown in this video:
Note that this is made in early 2007; in 2008 and in the beginning of 2009 there has been approx. 30 trillion dollars of additional spending... As part one stated that a 45,4 trillion on total fiscal exposure is like having a 750,000 dollar mortgage and no house. How bad is it right now?
If we keep on going like this...
"By year 2040 we can do little more than pay interest on the massive and growing federal debt. "
A change in the economic system is needed.
A possible new set-up would be to shift the banks to the public sector. Why did we give the ability to create money to private companies?Private – profit based – companies have the ability to create money and divide the profits made by doing this. Is this a fair system?
Currently we are creating something out of nothing.(read money out of air) That’s not possible, we should go back: make banks government owned again and link currencies to gold again.
Monday 26 October 2009
The diminishing scarcity power of malls
During the glory days of the economy malls were full of shops; paying (almost) all their abnormal profit to the landowner who was able to demand a very high price and 10 to 20 year contracts because of his scarcity power – everyone wanted to buy a place for their shop in malls.
However, since the beginning of the recession the demand for commercial estate - especially in the USA- has plummeted and the landlords are not in a very powerful position anymore. The scarcity power they once had seems to be diminished:
“"It used to be that the landlord was in the driver's seat -- you used to beg to get into a mall," Cohen [ Marshal Cohen, chief industry analyst at market research for NPD group] said. Now, "the landlord is just happy to get anybody into a space."”
This gave to opportunity for this new phenomenon to enroll: ‘Pop-up’ stores.
Pop-up stores, also known as ‘quickie retail operations’, are stores that fill the gaps at recession-battered shopping centers for a fraction of the regular rents.
Surprisingly enough this is not something that only utilized by small companies trying out a new product or business model; it is also utilized by the bigger well known companies. Toy’s R Us Inc is setting up 80 of those pop-up shops and Gap Inc. recently opened a pop-up shop on trendy Robertson Boulevard to promote its new premium denim line.
According to the LA times this is a trend that could reshape USA’s landscape if it continues, diminishing the power of commercial landlords and making it easier for merchants to test new locations and products with little commitment.
However, since the beginning of the recession the demand for commercial estate - especially in the USA- has plummeted and the landlords are not in a very powerful position anymore. The scarcity power they once had seems to be diminished:
“"It used to be that the landlord was in the driver's seat -- you used to beg to get into a mall," Cohen [ Marshal Cohen, chief industry analyst at market research for NPD group] said. Now, "the landlord is just happy to get anybody into a space."”
This gave to opportunity for this new phenomenon to enroll: ‘Pop-up’ stores.
Pop-up stores, also known as ‘quickie retail operations’, are stores that fill the gaps at recession-battered shopping centers for a fraction of the regular rents.
Surprisingly enough this is not something that only utilized by small companies trying out a new product or business model; it is also utilized by the bigger well known companies. Toy’s R Us Inc is setting up 80 of those pop-up shops and Gap Inc. recently opened a pop-up shop on trendy Robertson Boulevard to promote its new premium denim line.
According to the LA times this is a trend that could reshape USA’s landscape if it continues, diminishing the power of commercial landlords and making it easier for merchants to test new locations and products with little commitment.
Sunday 25 October 2009
Zombie banks...
Visit msnbc.com for Breaking News, World News, and News about the Economy
This video has been posted just a couple of days ago. It features David Epstein, he is one a political science professor at Columbia University in New York.
In the video David starts straight away: The housing prices are going to plummet for maybe even 5 per cent! Keeping in mind the video I posted yesterday about Elisabeth Warren stating that the housing market is already going from bad to worse and that 10 to 12 million houses might have to be sold in foreclosure, I just do not want to think about how bad it could get!
According to David – who is an expert on bubbles in financial markets – we are creating another bubble.
Without the 24 billion of government money the markets would not have been where they are right now meaning the 60% rally we are on right now for the DJI has been bought and possibly is very unstable.
When the government started to bail out banks this was done from the idea that the bail-out would save the economy; however: the big banks are simply absorbing the money and are not continuing to lend.
“We’re not being saved”
Saturday 24 October 2009
Very interesting video...
The video I post about today features Elisabeth Warren, head of the TARP control oversight panel. She states that she thinks the housing market is getting worse. She points out that there is an increasing amount of people who can't pay their mortgages anymore and she also points out that 10 to 12 million houses might have to be sold in foreclosures.
Friday 23 October 2009
Homework AS
Homework AS economics
The article (http://www.economicshelp.org/2009/10/inflation-and-optimal-interest-rates.html) is looking for the optimal interest rates to keep the inflation between 1 and 3% and also to ensure economic growth.
CPI fell to 1,1% last month, we should note this is annualised. This means that the CPI fell to around 0,1% in the month stated.
I think the article correctly states that an inflation rate of above those boundaries (1 to 3 per cent) are less dangerous and risky for the economy than inflation rates below those boundaries. Especially if the citizens have large debts.
The article states the UK has the biggest output gap in entire Europe. So what is the optimal interest level and what are possibilities to solve this problem?
The inflation is low – 1,1% - and there is a huge large negative output gap. Probably the best to do is to increase AD, but how?
AD= C+I+G+(X-M)
This shows there are several options for increasing taxes:
- Stimulating C- C=c(Y-T) +Co – This might therefore be done by a cut in taxes. (T=Taxes)
- Stimulating I, EG by cutting corporation tax.
- Increasing G, EG by starting new projects to make schools/roads/hospitals or improve education and training.
- Stimulating(X-M), EG by lowering exchange rate.
The problem is: All these options cost money, and the government debt is no joke. The most ‘cheap’ one would be the last option; by lowering the value of the GBP against other currencies to stimulate the exports. But there might be some troubles: The value of currencies is primarily determined by the market and the daily volume for those currencies are huge.
Therefore – to do serious interventions – the intervention itself must be Huge.
Another problem is that all those options will have time lags, some might take a few years to fully give its effect and the recession might be over by then…
So what will the optimal interest rate be?
I think the interest rate should be kept on the same level, a decrease would tend towards ZIRP of which I am not a proposer.
The article (http://www.economicshelp.org/2009/10/inflation-and-optimal-interest-rates.html) is looking for the optimal interest rates to keep the inflation between 1 and 3% and also to ensure economic growth.
CPI fell to 1,1% last month, we should note this is annualised. This means that the CPI fell to around 0,1% in the month stated.
I think the article correctly states that an inflation rate of above those boundaries (1 to 3 per cent) are less dangerous and risky for the economy than inflation rates below those boundaries. Especially if the citizens have large debts.
The article states the UK has the biggest output gap in entire Europe. So what is the optimal interest level and what are possibilities to solve this problem?
The inflation is low – 1,1% - and there is a huge large negative output gap. Probably the best to do is to increase AD, but how?
AD= C+I+G+(X-M)
This shows there are several options for increasing taxes:
- Stimulating C- C=c(Y-T) +Co – This might therefore be done by a cut in taxes. (T=Taxes)
- Stimulating I, EG by cutting corporation tax.
- Increasing G, EG by starting new projects to make schools/roads/hospitals or improve education and training.
- Stimulating(X-M), EG by lowering exchange rate.
The problem is: All these options cost money, and the government debt is no joke. The most ‘cheap’ one would be the last option; by lowering the value of the GBP against other currencies to stimulate the exports. But there might be some troubles: The value of currencies is primarily determined by the market and the daily volume for those currencies are huge.
Therefore – to do serious interventions – the intervention itself must be Huge.
Another problem is that all those options will have time lags, some might take a few years to fully give its effect and the recession might be over by then…
So what will the optimal interest rate be?
I think the interest rate should be kept on the same level, a decrease would tend towards ZIRP of which I am not a proposer.
Thursday 22 October 2009
The beginning of banking…
Banking is actually a very old phenomenon, it started hundreds of years ago with the goldsmiths. People in the village could ‘deposit’ their gold at the smith, at he would take care of it. The people would get a ticket in return that said they had the right to pick up their gold.
Soon enough people started paying with these tickets – why not? It is a perfect alternative for gold and it’s a lot less heavy =D Paper money was born.
The goldsmith came up with this amazing idea: He could sell more tickets than he had in gold. That would increase his profit enormously! He figured it would be good enough to keep a certain amount of gold as a ‘reserve’. The rest was available to lean to other people and to gain interest.
People started leaning more and more, and more and more tickets got into the village. However: Critical citizens saw this happening and noticed there suddenly was an overwhelming increase of tickets and they started to convert their tickets to gold.
The goldsmith wasn’t prepared for this: a lot of people tried to convert their tickets into gold and he started to run out of ‘reserves’. This would have been the first bank-run ever. But certainly not the last one.
De goldsmith had to admit he handed out more tickets than there was in gold: people who had those tickets suddenly realised they didn’t own gold but just an illusion.
The banking system nowadays works exactly the same way. Let’s have a look at a – very much simplified - example. (We are assuming banks keep 10% as ‘reserves’)
You are in a country with 110 people and everyone has 1,000 pounds worth of paperbacks. 100 of those 110 people bring their money to the bank on the island. The bank now owes 100,000 pounds. The bank keeps 10% and has therefore 90,000 available for leaning out to the people on the country.
This 90,000 pounds will be leant to 10 people in the country ; they are agriculturally active and they but equipment to work the land. The 90,000 goes to other citizens who produce the equipment. They bring this to the bank again.
The bank now has 190,000 worth of deposits. The amount of money in the country surged to 210,000 pounds. This consist of: 10,000 as a reserve from the bank, 10,000 of own value and 190,000 of deposits.
The citizens were very happy; they became way more wealthy! They suddenly owned 190,000 pounds!
Again, the bank got 90,000 pounds and will keep 10% as a reserve. Being 81,000 available for leaning to people on the island.
This cycle continues and continues until there is for every 1 pound of ‘base-money’(the money we started with) 10 pounds of credit.
Banks have created an additional 9 pounds for every 1 pound.
The question is: are the savings of the people on the country still money? Or are they just a loan to the bank?
Nowadays there is a very thin line between money…. and debt.
Soon enough people started paying with these tickets – why not? It is a perfect alternative for gold and it’s a lot less heavy =D Paper money was born.
The goldsmith came up with this amazing idea: He could sell more tickets than he had in gold. That would increase his profit enormously! He figured it would be good enough to keep a certain amount of gold as a ‘reserve’. The rest was available to lean to other people and to gain interest.
People started leaning more and more, and more and more tickets got into the village. However: Critical citizens saw this happening and noticed there suddenly was an overwhelming increase of tickets and they started to convert their tickets to gold.
The goldsmith wasn’t prepared for this: a lot of people tried to convert their tickets into gold and he started to run out of ‘reserves’. This would have been the first bank-run ever. But certainly not the last one.
De goldsmith had to admit he handed out more tickets than there was in gold: people who had those tickets suddenly realised they didn’t own gold but just an illusion.
The banking system nowadays works exactly the same way. Let’s have a look at a – very much simplified - example. (We are assuming banks keep 10% as ‘reserves’)
You are in a country with 110 people and everyone has 1,000 pounds worth of paperbacks. 100 of those 110 people bring their money to the bank on the island. The bank now owes 100,000 pounds. The bank keeps 10% and has therefore 90,000 available for leaning out to the people on the country.
This 90,000 pounds will be leant to 10 people in the country ; they are agriculturally active and they but equipment to work the land. The 90,000 goes to other citizens who produce the equipment. They bring this to the bank again.
The bank now has 190,000 worth of deposits. The amount of money in the country surged to 210,000 pounds. This consist of: 10,000 as a reserve from the bank, 10,000 of own value and 190,000 of deposits.
The citizens were very happy; they became way more wealthy! They suddenly owned 190,000 pounds!
Again, the bank got 90,000 pounds and will keep 10% as a reserve. Being 81,000 available for leaning to people on the island.
This cycle continues and continues until there is for every 1 pound of ‘base-money’(the money we started with) 10 pounds of credit.
Banks have created an additional 9 pounds for every 1 pound.
The question is: are the savings of the people on the country still money? Or are they just a loan to the bank?
Nowadays there is a very thin line between money…. and debt.
Wednesday 21 October 2009
Summary Chapter 6 AS
Government policies are primarily divided into two kinds of policies:
1) Demand side policies, which include:
1.1) Fiscal policies, and
1.2) Monetary policies
2) Supply side polices.
1.1 Fiscal Policies: The nature of fiscal policies is to influence the AD. There are two main types of fiscal policies: Discretionary fiscal policies and Automatic stabilisers.
The Discretionary fiscal policies include:
1) A change in government spending, which includes:
1.1) Capital Expenditure (EG hospitals; roads; schools etc), this is influenced by government policies and for example changes in the composition of the population
1.2) Current Spending: all expenditures for running public services. (EG teachers, drugs for NHS or police officers) This is primarily effected by the level of wages.
1.3) Transfer payments: This is for transferring money from taxpayers to recipients. (EG money from working people to unemployed or pensioned)
1.4) Debt interest payments, this is primarily affected by the rate of interest.
2) A change in taxes, which includes:
2.1) Progressive tax, also: direct tax. (EG Income tax) Progressive means that the rich pay more on the taxes than the poor do.
2.2) Regressive tax, also: indirect tax. (EG VAT) Regressive means that the rich pay relatively less than the poor do. (Nominally the same)
The automatic stabilisers are a change in government spending by EG the social protection. (Paying to people who don’t have jobs) The more unemployed there are, the more the payments will be. (G up, ceteris paribus, AD up)
The fiscal policies do have some advantages and disadvantages.
The main advantages include:
- Offset fluctuations in GDP.
- Potential to increase both AS and AD (EG corporation tax cuts)
The main disadvantages include:
- Tax cuts have take some time to have an effect; because of this time lag the policies might work against the economy. (EG when economy is heading into a boom and AD is being stimulated this might lead to inflationary pressure)
- Might not work because firms and household might react in unexpected ways( Cut in income tax leading to more savings instead of consumption and investments; primarily because of a lack of confidence)
- Might not work because the size of the multiplier was estimated wrongly
-Might not work because other countries might have different fiscal policies resulting in less efficient fiscal policies in this country)
- Might clash with other macro-economic objectives. (EG a rise in income tax might discourage people from working or a rise in tax which was meant to reduce inflation might result in a too big cut of AD causing real GDP to fall causing unemployment. En visa versa: While stimulating AD to reduce unemployment price levels may go up as well increasing inflationary pressures.)
1.2 Monetary policies, there are three main monetary ‘tools’ for the government:
1) Rate of interest
When the government increases the rate of interest:
-The exchange rate will go up (because other people start putting their money on British banks and therefore the demand for the GBP will increase), this will result in cheap imports and dear exports. Therefore the Net exports will be reduced.
-The investments will fall because corporations will have to pay more interest on debts.
- Consumption will fall because consumers will borrow less.
- Since in AD=C+I+G+(X-M); C falls, I falls and (X-M) falls.. AD will fall.
2) Money supply.
When the government increases the money supply:
- Banks will lean more money; causing an increasing in consumption and a decrease in the rate of interest. (The supply for the pound has increased so the price will fall)
- A falling rate of interest and an increasing consumption will cause the AD to increase.
3) Exchange rate.
When the government lowers the exchange rate:
- It will increase the balance of trade ( (X-M) will increase)
-Increases economic activity. (More cheap for foreign investors to come and start businesses)
There are however some disadvantages to applying monetary policy:
- The market fluctuations have a big influence in the exchange rate; making it hard for governments to intervene in this market.
- Time lags ( Changes in the ‘tools’ take time to get to work; the rate of interest is estimated to take 2 years before the full effects are experienced)
- It’s hard to estimate in what extend AD will change when applying those tools.
- Ability to change interest rates isn’t that big because they have to stay within a certain boundary from other countries interest rates to prevent massive money flows.
- The use of these tools might have side effects. (EG the increase of the ex. Rate meant to reduce inflation might also worsen the balance of payments.
2) Supply side policies: policies primarily focused on influencing the AS.
Usually this is done by lowering the costs of production and/or Increasing productive capacity by increasing efficiency. The supply side policy increases performance on particular markets instead of entire economy. (Sometimes referred as microeconomic policies)
The supply side policies do have some advantages and disadvantages.
The main advantages include:
- Increase of productive potential
- May reduce structural and frictional unemployment
- May help prevent inflation.
- Improve country’s trade position.
- Increasing AS enables AD to grow over time without inflationary pressures building up. (AS curve shifts to the right enabling AD to move to AD1)
The main disadvantages include:
- Might not work because the results of certain policies are debatable. (EG the reduction in unemployment benefit will only rise AS for structural unemployment issues. )
- Might not work because of time lags.
- Won’t work if there’s a lack of AD: the extra capacity won’t be used.
Examples of supply-side policies:
1) Education and training. This will result in a more efficient economy and therefore in a rise of AS.
2) Government assistance to new firms. (New firms create employment and new ideas)
3) Reduction in direct taxes. This raises Investments raising both AS and AD.
4) Reduction in unemployment benefit. Reduction in jobs seeker allowance results in unemployed being forced to seek work and accept work at lower wages. This will however only work if the unemployment is of structural uses. When there are no jobs the consumption will fall as real disposable income falls and AD will – ceteris paribus- fall, causing firms to reduce output and make workers redundant.
5) Reduction in other benefits. Reducing benefits for economically inactive people will make more people go to work increasing productive capacity.
6) Reduction in trade union power. Wages will be lower; lowering costs of production. This will cause firms to employ more people which will raise output. This is also debatable because trade unions may also help labour markets work efficiently. They may act as a counterbalance to the market imperfection of very powerful employers. They may also reduce firms’ costs by acting as a channel for communication between employers and workers on issues, since it is cheaper to negotiate with one body than with individual workers.
7) Privatisation.
8) Deregulation: removal of barriers of entry.
The policies discussed above are used to deal with macro-economic objectives, they seek to:
1) Reduce unemployment
This can either be done by demand-side policies or by supply side policies.
Using the demand side policy the government will try to – by using fiscal policies- increase AD by cutting taxes or increasing government spending. Increasing G will work more effectively because this has a multiplier bigger than 1 and the cutting of taxes tend to have a multiplier lower than 1. (10 billion tax cut will result in 6 billion stimulus because 3 billion is saved and 1 billion is imported)
Also the government will try to – by using monetary policies- lower interest rates or increase the money supply.
However, those ‘expansionary’ fiscal and monetary policies may have undesirable side-effects. One consequence of a rise in AD may be a rise in the price level if the economy moves close to full employment. The higher level of spending may also increase any existing deficit on the current account of the balance of payments as UK residents buy more imported products.
Using the supply side policies unemployment can exist even where there is not a shortage of AD if there are supply-side problems. This is the structural unemployment. Things causing structural unemployment are: lacking appropriate skills, geographically or occupationally immobile or family circumstances etc.
Those problems cannot be solved by simply stimulating the AD; things that do help are better education, better infrastructure, greater provision of low-cost-child-care may enable more lone parents to work.
Also increasing the economic incentive to work by increasing the gap between income received from working and income received from benefits might help out.
Of course; most of the time unemployment is built up by a combination of both cyclical unemployment and structural unemployment. Therefore a combination of supply-side and demand-side policies is required.
2) Control inflation
There are two kinds of inflation to be controlled: Cost-push inflation and Demand-pull inflation.
To control the Cost-push inflation in the short run there are a few options:
- If a government thinks that the inflation is caused by excessive increases in wage rates, it may try to restrict wages. The government can do this by limit wage increases to for example 3%. In the public sector it’s more easy because the government itself employs those people.
- A government may try to lower the costs of production by reducing corporation tax. This will also have the advantage of stimulating investments (and therefore AD and AS). Governments may also give subsidies to stimulate investments. This all has the result that firms can cover rising costs without putting up prices.
To control Demand-pull inflation demand-side policies are used. The AD is being lowered by for example raising income tax. The main short-run-anit-inflationary policy instrument being employed in the UK is the interest rate.
In the long run the aim is that AS and AD will grow at the same rate so that people can enjoy a higher GDP without inflationary pressures.
3) Promote economic growth
In the short run the government basically tries to increase AD, the best policies for economic growth are policies like a interest rates because a lower interest rates increases both AS and AD. (As everything does that increases Investments; other examples of both an AD and AS increase might be the improvement of infrastructure or education) Since the AS is growing the long-term economic growth will be enabled.
Governments try to make the AD rise in line with the trend growth to ensure stable growth.
4) Improve balance of payments.
Policies to improve the balance of payments usually focus on instruments to influence the current account position.
In the short run there are three main ways a government may try to increase export revenue and/or decrease import revenue:
- Causing a fall in exchange rate; central banks can do this by selling their currency and/or lowering interest rates. This also increases AD and reduces unemployment. The only thing is that it might cause inflationary pressures.
- Reducing demand for all products: lowering imports by higher taxation and/or higher interest rates. This may cause AD to fall and unemployment to rise.
- Import restrictions; reducing imports using tariffs and quotas
In the long run a deficit arises from lack of quality competitiveness, low labour productivity or high inflation, then reducing the value of the currency, deflationary demand-side policy instruments and import restrictions will not provide long-term solutions. What may be long-term solutions is giving subsidies to small companies in the belief that they have potential to grow and become internationally competitive.
There might, however, be some conflicts between several policy objectives. For example:
1) Economic growth and low unemployment may benefit from expansionary demand-side policy measures, but these measures may make it more difficult for a government to achieve low inflation and a satisfactory balance of payments position.
2) Raising the interest rate will reduce inflationary pressure but these moves also have an effect on the exchange rate and so on the balance of payments and employment.
Governments try not to make policies clash and try to ensure that the growth in AD is in line with the growth in AS and the economy is working at its full capacity.
THE ADVANTAGES OF INTERNATIONAL TRADE
International trade has a lot advantages: the consumer gets more choice since there are more firms on the markets. Also the consumer probably ending up paying a lower price for the products since there is more competition.
For firms it works both ways: domestically they have more competition but they also have acces to way larger markets to sell their products to.
Despite those advantages some countries still restrict the international trade using a few protectionistic tools to protect the domestic industries from foreign competition:
- Tariffs: these are basically taxes on imported goods.
- Quotas: These are a maximum on the amount of imported goods.
- Voluntary export restraint (VER) : a limit placed on imports from a country with the agreement of that country’s government. (most of the time this is a two-way export quota)
- Foreign exchange restrictions: A government may seek to reduce imports by limiting the amount of foreign exchange made available to those wishing to buy imported goods and services or to invest or travel abroad.
- Embargoes: the ban on export or import of a product and/or ban on trade with a particular country. EG: A country may ban the export of arms to a country that has a low human rights standard.
- Red tape: Time-delaying customs procedures to encourage imports.
- Requesting certain quality standards, seeking to raise costs for companies that would like to export to the country.
- Government may reduce imports by buying from domestic firms rather than foreign firms even when the price is higher.
Note: Entire AS book summaries are now to be found on this blog; I will include a written version of chapter 5 later
1) Demand side policies, which include:
1.1) Fiscal policies, and
1.2) Monetary policies
2) Supply side polices.
1.1 Fiscal Policies: The nature of fiscal policies is to influence the AD. There are two main types of fiscal policies: Discretionary fiscal policies and Automatic stabilisers.
The Discretionary fiscal policies include:
1) A change in government spending, which includes:
1.1) Capital Expenditure (EG hospitals; roads; schools etc), this is influenced by government policies and for example changes in the composition of the population
1.2) Current Spending: all expenditures for running public services. (EG teachers, drugs for NHS or police officers) This is primarily effected by the level of wages.
1.3) Transfer payments: This is for transferring money from taxpayers to recipients. (EG money from working people to unemployed or pensioned)
1.4) Debt interest payments, this is primarily affected by the rate of interest.
2) A change in taxes, which includes:
2.1) Progressive tax, also: direct tax. (EG Income tax) Progressive means that the rich pay more on the taxes than the poor do.
2.2) Regressive tax, also: indirect tax. (EG VAT) Regressive means that the rich pay relatively less than the poor do. (Nominally the same)
The automatic stabilisers are a change in government spending by EG the social protection. (Paying to people who don’t have jobs) The more unemployed there are, the more the payments will be. (G up, ceteris paribus, AD up)
The fiscal policies do have some advantages and disadvantages.
The main advantages include:
- Offset fluctuations in GDP.
- Potential to increase both AS and AD (EG corporation tax cuts)
The main disadvantages include:
- Tax cuts have take some time to have an effect; because of this time lag the policies might work against the economy. (EG when economy is heading into a boom and AD is being stimulated this might lead to inflationary pressure)
- Might not work because firms and household might react in unexpected ways( Cut in income tax leading to more savings instead of consumption and investments; primarily because of a lack of confidence)
- Might not work because the size of the multiplier was estimated wrongly
-Might not work because other countries might have different fiscal policies resulting in less efficient fiscal policies in this country)
- Might clash with other macro-economic objectives. (EG a rise in income tax might discourage people from working or a rise in tax which was meant to reduce inflation might result in a too big cut of AD causing real GDP to fall causing unemployment. En visa versa: While stimulating AD to reduce unemployment price levels may go up as well increasing inflationary pressures.)
1.2 Monetary policies, there are three main monetary ‘tools’ for the government:
1) Rate of interest
When the government increases the rate of interest:
-The exchange rate will go up (because other people start putting their money on British banks and therefore the demand for the GBP will increase), this will result in cheap imports and dear exports. Therefore the Net exports will be reduced.
-The investments will fall because corporations will have to pay more interest on debts.
- Consumption will fall because consumers will borrow less.
- Since in AD=C+I+G+(X-M); C falls, I falls and (X-M) falls.. AD will fall.
2) Money supply.
When the government increases the money supply:
- Banks will lean more money; causing an increasing in consumption and a decrease in the rate of interest. (The supply for the pound has increased so the price will fall)
- A falling rate of interest and an increasing consumption will cause the AD to increase.
3) Exchange rate.
When the government lowers the exchange rate:
- It will increase the balance of trade ( (X-M) will increase)
-Increases economic activity. (More cheap for foreign investors to come and start businesses)
There are however some disadvantages to applying monetary policy:
- The market fluctuations have a big influence in the exchange rate; making it hard for governments to intervene in this market.
- Time lags ( Changes in the ‘tools’ take time to get to work; the rate of interest is estimated to take 2 years before the full effects are experienced)
- It’s hard to estimate in what extend AD will change when applying those tools.
- Ability to change interest rates isn’t that big because they have to stay within a certain boundary from other countries interest rates to prevent massive money flows.
- The use of these tools might have side effects. (EG the increase of the ex. Rate meant to reduce inflation might also worsen the balance of payments.
2) Supply side policies: policies primarily focused on influencing the AS.
Usually this is done by lowering the costs of production and/or Increasing productive capacity by increasing efficiency. The supply side policy increases performance on particular markets instead of entire economy. (Sometimes referred as microeconomic policies)
The supply side policies do have some advantages and disadvantages.
The main advantages include:
- Increase of productive potential
- May reduce structural and frictional unemployment
- May help prevent inflation.
- Improve country’s trade position.
- Increasing AS enables AD to grow over time without inflationary pressures building up. (AS curve shifts to the right enabling AD to move to AD1)
The main disadvantages include:
- Might not work because the results of certain policies are debatable. (EG the reduction in unemployment benefit will only rise AS for structural unemployment issues. )
- Might not work because of time lags.
- Won’t work if there’s a lack of AD: the extra capacity won’t be used.
Examples of supply-side policies:
1) Education and training. This will result in a more efficient economy and therefore in a rise of AS.
2) Government assistance to new firms. (New firms create employment and new ideas)
3) Reduction in direct taxes. This raises Investments raising both AS and AD.
4) Reduction in unemployment benefit. Reduction in jobs seeker allowance results in unemployed being forced to seek work and accept work at lower wages. This will however only work if the unemployment is of structural uses. When there are no jobs the consumption will fall as real disposable income falls and AD will – ceteris paribus- fall, causing firms to reduce output and make workers redundant.
5) Reduction in other benefits. Reducing benefits for economically inactive people will make more people go to work increasing productive capacity.
6) Reduction in trade union power. Wages will be lower; lowering costs of production. This will cause firms to employ more people which will raise output. This is also debatable because trade unions may also help labour markets work efficiently. They may act as a counterbalance to the market imperfection of very powerful employers. They may also reduce firms’ costs by acting as a channel for communication between employers and workers on issues, since it is cheaper to negotiate with one body than with individual workers.
7) Privatisation.
8) Deregulation: removal of barriers of entry.
The policies discussed above are used to deal with macro-economic objectives, they seek to:
1) Reduce unemployment
This can either be done by demand-side policies or by supply side policies.
Using the demand side policy the government will try to – by using fiscal policies- increase AD by cutting taxes or increasing government spending. Increasing G will work more effectively because this has a multiplier bigger than 1 and the cutting of taxes tend to have a multiplier lower than 1. (10 billion tax cut will result in 6 billion stimulus because 3 billion is saved and 1 billion is imported)
Also the government will try to – by using monetary policies- lower interest rates or increase the money supply.
However, those ‘expansionary’ fiscal and monetary policies may have undesirable side-effects. One consequence of a rise in AD may be a rise in the price level if the economy moves close to full employment. The higher level of spending may also increase any existing deficit on the current account of the balance of payments as UK residents buy more imported products.
Using the supply side policies unemployment can exist even where there is not a shortage of AD if there are supply-side problems. This is the structural unemployment. Things causing structural unemployment are: lacking appropriate skills, geographically or occupationally immobile or family circumstances etc.
Those problems cannot be solved by simply stimulating the AD; things that do help are better education, better infrastructure, greater provision of low-cost-child-care may enable more lone parents to work.
Also increasing the economic incentive to work by increasing the gap between income received from working and income received from benefits might help out.
Of course; most of the time unemployment is built up by a combination of both cyclical unemployment and structural unemployment. Therefore a combination of supply-side and demand-side policies is required.
2) Control inflation
There are two kinds of inflation to be controlled: Cost-push inflation and Demand-pull inflation.
To control the Cost-push inflation in the short run there are a few options:
- If a government thinks that the inflation is caused by excessive increases in wage rates, it may try to restrict wages. The government can do this by limit wage increases to for example 3%. In the public sector it’s more easy because the government itself employs those people.
- A government may try to lower the costs of production by reducing corporation tax. This will also have the advantage of stimulating investments (and therefore AD and AS). Governments may also give subsidies to stimulate investments. This all has the result that firms can cover rising costs without putting up prices.
To control Demand-pull inflation demand-side policies are used. The AD is being lowered by for example raising income tax. The main short-run-anit-inflationary policy instrument being employed in the UK is the interest rate.
In the long run the aim is that AS and AD will grow at the same rate so that people can enjoy a higher GDP without inflationary pressures.
3) Promote economic growth
In the short run the government basically tries to increase AD, the best policies for economic growth are policies like a interest rates because a lower interest rates increases both AS and AD. (As everything does that increases Investments; other examples of both an AD and AS increase might be the improvement of infrastructure or education) Since the AS is growing the long-term economic growth will be enabled.
Governments try to make the AD rise in line with the trend growth to ensure stable growth.
4) Improve balance of payments.
Policies to improve the balance of payments usually focus on instruments to influence the current account position.
In the short run there are three main ways a government may try to increase export revenue and/or decrease import revenue:
- Causing a fall in exchange rate; central banks can do this by selling their currency and/or lowering interest rates. This also increases AD and reduces unemployment. The only thing is that it might cause inflationary pressures.
- Reducing demand for all products: lowering imports by higher taxation and/or higher interest rates. This may cause AD to fall and unemployment to rise.
- Import restrictions; reducing imports using tariffs and quotas
In the long run a deficit arises from lack of quality competitiveness, low labour productivity or high inflation, then reducing the value of the currency, deflationary demand-side policy instruments and import restrictions will not provide long-term solutions. What may be long-term solutions is giving subsidies to small companies in the belief that they have potential to grow and become internationally competitive.
There might, however, be some conflicts between several policy objectives. For example:
1) Economic growth and low unemployment may benefit from expansionary demand-side policy measures, but these measures may make it more difficult for a government to achieve low inflation and a satisfactory balance of payments position.
2) Raising the interest rate will reduce inflationary pressure but these moves also have an effect on the exchange rate and so on the balance of payments and employment.
Governments try not to make policies clash and try to ensure that the growth in AD is in line with the growth in AS and the economy is working at its full capacity.
THE ADVANTAGES OF INTERNATIONAL TRADE
International trade has a lot advantages: the consumer gets more choice since there are more firms on the markets. Also the consumer probably ending up paying a lower price for the products since there is more competition.
For firms it works both ways: domestically they have more competition but they also have acces to way larger markets to sell their products to.
Despite those advantages some countries still restrict the international trade using a few protectionistic tools to protect the domestic industries from foreign competition:
- Tariffs: these are basically taxes on imported goods.
- Quotas: These are a maximum on the amount of imported goods.
- Voluntary export restraint (VER) : a limit placed on imports from a country with the agreement of that country’s government. (most of the time this is a two-way export quota)
- Foreign exchange restrictions: A government may seek to reduce imports by limiting the amount of foreign exchange made available to those wishing to buy imported goods and services or to invest or travel abroad.
- Embargoes: the ban on export or import of a product and/or ban on trade with a particular country. EG: A country may ban the export of arms to a country that has a low human rights standard.
- Red tape: Time-delaying customs procedures to encourage imports.
- Requesting certain quality standards, seeking to raise costs for companies that would like to export to the country.
- Government may reduce imports by buying from domestic firms rather than foreign firms even when the price is higher.
Note: Entire AS book summaries are now to be found on this blog; I will include a written version of chapter 5 later
Article on Zerohedge
Hi all,
Came across a very interesting article on the internet on Zerohedge. (http://www.zerohedge.com/article/how-federal-reserve-bailed-out-world)
This article states that last year there were even more severe problems for the world economy than thought before. According to the article the entire European Banking system was about to collapse, but the FED saved us.
What happened?
In the period between 2000 and 2007 European banks took more foreign assets on their sheets en those were primarily based on the USD. Those assets were financed by short-term credit in Dollars.
But when Lehman Brothers collapsed there was a shortage of dollars. There was a gigantic need for dollars but nobody wanted to sell it. This caused some problems and according to the article there was a budget deficit of up to 6,500 Billion USD!
De extraordinary demand for dollars resulted in the forces liquidation of assets. Shares and money market funds were sold to whatever price they could get to get the dollars.
Without the FED financing the entire banking system was about to collapse.
However: the FED did finance for 582 Billion USD (over half a trillion) for foreign central banks. These central banks divided the dollars over the banks.
Problem solved? No, today the carry trade in of the dollar is very volatile causing the threatening budget deficit to be way bigger at new problems than the 6,500 billion.
Zerohedge states that this ‘liquidity crisis’ may cause a “potential massive and historic short squeeze”.
Came across a very interesting article on the internet on Zerohedge. (http://www.zerohedge.com/article/how-federal-reserve-bailed-out-world)
This article states that last year there were even more severe problems for the world economy than thought before. According to the article the entire European Banking system was about to collapse, but the FED saved us.
What happened?
In the period between 2000 and 2007 European banks took more foreign assets on their sheets en those were primarily based on the USD. Those assets were financed by short-term credit in Dollars.
But when Lehman Brothers collapsed there was a shortage of dollars. There was a gigantic need for dollars but nobody wanted to sell it. This caused some problems and according to the article there was a budget deficit of up to 6,500 Billion USD!
De extraordinary demand for dollars resulted in the forces liquidation of assets. Shares and money market funds were sold to whatever price they could get to get the dollars.
Without the FED financing the entire banking system was about to collapse.
However: the FED did finance for 582 Billion USD (over half a trillion) for foreign central banks. These central banks divided the dollars over the banks.
Problem solved? No, today the carry trade in of the dollar is very volatile causing the threatening budget deficit to be way bigger at new problems than the 6,500 billion.
Zerohedge states that this ‘liquidity crisis’ may cause a “potential massive and historic short squeeze”.
Saturday 10 October 2009
What are Keynesian economics?
What is Keynes?
Keynes was born in 1883 in Cambridge, as a son of John Nevilla and Florence Ada Keynes. His father was a famous economist and linked to the university of Cambridge. One thing Keynes had in common with a lot of big economists before him – like Stuart Mill and Léon Walras – was that the economic principle was taught to him a very young age. Keynes’ mother was even more famous than his father was since she was the major of Cambridge in 1932.
On a very young age Keynes already had some sort of trade, on elementary school Keynes had someone who carried his books for him in exchange for help with homework.
Keynes went to high school in Windsor, where he was taught at Eton college. He stood out because of his talents in Maths and History. One remarkable thing was that his marks for economics have always been pretty low. Years later he explained this by saying: “I evidently knew more than my examiners.”
At the age of 15 he applied to a mathematics course at Kings College in Cambridge, but he replaced this mathematical study pretty fast by an economic one. When Keynes was 21 he was allowed to call himself ‘master’ in economics.
At first Keynes wanted to follow his father and he tried to become a fellow at the university of Cambridge. However, he really stood out and got a job at a government-based employer. The India office.
His courage and gift to solve practical problems with economic theory opened his way to a high position at the British ministry of Finance. In 1911 he became redactor at the economic journal.
Keynes was one of the main advisors for the Versailles treaty where he was one of the British Expert advisors.
Keynes resigned because he didn’t agree with the outcome of the treaty, Keynes mostly disagreed with the penalties for Germany(mostly pushed by the French, led by Clemanceau). According to Keynes the Versailles treaty wouldn’t give recovery to Germany but would rather cause a revenge-action from Germany causing another war. He wrote about this in his book: “The economic consequences of peace.”
He wrote about Clemanceau:“he was a foremost believer in the view of German psychology that the German understands and can understand nothing but intimidation (…) Therefore you must never negotiate with a German or conciliate him; you must dictate to him. On no other terms will he respect you, or will you prevent him from cheating you. (…) The European civil war is to end with France and Italy abusing their monetary victorious power to destroy Germany and Austria-Hungary now prostrate, they invite their own destruction also.”
Keynes foresaw that the recovery-payments or penalties for Germany would have a great impact on the German economy. And he was right:
In 1920 you could buy one bread for 1,20, in 1923 you had to pay 80,000,000,000 for the same bread.
After the Versailles treaty Keynes was mainly occupied doing public debates and he wrote a lot. One of the most famous works was “The end of laissez-faire” in which he writes about the free-market principle.
In 1936 Keynes gives out his highly anticipated book “The General Theory of Employment, Interest and Money”. His book was brought to the market relatively cheap and the timing of the book couldn’t be better. The world was in the middle of “The great depression”.
In this book he describes his economic theory and he knew he came up with something very important which might change the way of economic thinking; he wrote:
““ I believe myself to be writing a book on economic theory which will largely revolutionize—not, I suppose, at once but in the course of the next ten years— the way the world thinks about economic problems.” –
John Maynard Keynes
The main idea of this theory (I will talk about the theory itself in different posts) is that Keynes says that the ‘laissez-faire’ assumption is not valid. The classical economists are wrong, governments should intervene(using the multiplier effect) to make recessions less heavy. (Anti-cyclical government policy)
When the second world war breaks out he writes “How to pay for the war” in 1940. This states that governments should pay for the war by raising taxes and not by accepting debts. The British government agrees with this and does what Keynes advised them to do in 1941.
Also Keynes was involved in the set-up of the Bretton Woods system. During these talks also the IMF was founded. The Bretton Woods system stated that every country had to keep themselves to a certain value of their coin for which this coin would be transferrable to gold. This system has proven to be a success, but in the begin of the ’70s the USA couldn’t guarantee the transfer to gold anymore for their dollar.
Keynes died in 1946.
Before Keynes
Keynes made a difference by going against the most common thoughts of the ‘classical’ economists. The classical assumption – as described by Say’s law – is that the free market will work for itself (laissez-faire) and that there is no need for any government interventions.
Keynes model states that governments should intervene in the markets with an anti-cyclical government policy to make recessions less deep and booms less high. (To reduce booms and bursts. Note: Marco-economic objective is nearly always stated as ‘STABLE economic growth’)
Another difference between Keynes’ model and the classical model is that Keynes is mostly looking at the short run of the economy and the classical model is mostly looking at the long-run. This means that the production cannot change in the Keynesian model making the firms reaching market equilibrium by changing the price only.
The Keynesian economics acknowledges three different stages within the economy:
- Overdemanding; this is where the AD is bigger than the production capacity. During these periods inflation regulation is becoming more important since the AD being higher than the production capacity will lead to more demand for (skilled) workers (raising wages and cost-based inflation) and it will lead to more demand-based inflation. The ‘overdemanding period’ may be cut into two parts. The part where the AD is going up within this period is called a hausse and the part where AD is going down is called recession(officialy it is only called a recession if there is a negative growth for two executive quarters).
- Balance of demand; this is where the AD equals production capacity.
- Underdemanding; this is where the AD is smaller than the production capacity. You may also divide this in two parts. When the AD is going down within the ‘Underdemanding period’ it is called a depression and when the AD is going up within this period it is called recovery.
Normally we look at two kinds of Keynesian models before going to the most difficult version, but that’s not what we are doing now. Keynesian model describes a certain amount of money flows.
Note: The X and M flow might seem to be in the wrong way but this graph describes money flows and not the flow of goods.
The Keynesian model is modeled by a few formula’s; to keep it quite simple:
1) AD=Y
2) AD= C+I+G+X-M
3) C=c*Yd +Co
4) Yd= Y-T
5) T=tY
6) I=Io
7) G=Go
8) X=Xo
9) M=mY
Note: The small letters show ‘quotes’, they represent the amount of the income that is being used to – for example – consume.
Note: Yd = Disposable income
If we substitute the formula’s we will get to a resulting complete formula :
AD=Y= c(Y-tY)+Co+Io+Go+Xo-mY
Let’s take some numbers to show the workings. c = 0,5 ; t= 0,2 ; m=0,2; Co = 50; Io = 10 ; Oo = 25 ; Xo= 15
Y=0,5(Y-0,2Y)+50+10+25+15-0,2Y
Y=0,5(0,8Y)+100-0,2Y
Y=0,4Y+100-0,2Y
Y=0,2Y+100
0,8Y=100
Y=(10/8)*100
Y=125 billion (Point where the green line cuts the blue line in coming picture)
Now there is this very important idea within the Keynesian theory of the multiplier effect, the only thing this actually states is that when I invest 10 million the AD will –ceteris paribus – go up for 10 million in the first place.
But the company receiving the order will also invest some of this money itself because the company is making extra profits. Let’s say it invests 1million extra because of this order. This on itself will raise the AD again with 1 million.
The AD has risen with 11 million already as a result of a basic investment of 10 million, this is describes as the multiplier.
Just imagine that the company that received the 1 million order does not reinvest anything extra, so that the total increase in AD will equal 11 million. Now to calculate the multiplier the only thing we have to do is fill in this formula:
Multiplier= Change in AD/ Change in variable.
Our variable in this story has been I(investments), this has changed 10 million. The AD has changed 11 million making the multiplier 11/10 = 1,1
There is a way in modeling the multiplier effect, and of course with a certain formula.
Lets go back to our previous example(The one with the Y=125 billion outcome) and change the Investments by 15 billion to 25 billion.
This would give us:
AD=Y= c(Y-tY)+Co+Io+Go+Xo-mY
Y=0,5(Y-0,2Y)+50+25+25+15-0,2Y
Y=0,5(0,8Y)+115-0,2Y
Y=0,4Y+115-0,2Y
Y=0,2Y+115
0,8Y=115
Y=(10/8)*115
Y=143,75 billion. (the point where the black line crosses the blue line in the coming picture)
The result is an increase of 18,75 billion as a result of an increase of investments of 15 billion. In our formula for the multiplier this would lead to a multiplier of 1,25
However, there are more sophisticated ways in calculating the multiplier. I won’t go through the mathematical prove of it. But you might also want to use this formula for the multiplier.
1/((1-c)+tc+m) = 1/((1-0,5)+0,2*0,5+0,2 = 1/(0,8) = 1,25
Note: This may not be used for changes in all variables! A change in the Import variable has the formula -1/((1-c)+tc+m and a change in the Taxes uses even another formula.
So what is understood with the Keynesian economics? Keynesian economics use an economic model that is mainly influenced by the idea that ‘laissez-faire’ does not work. The government interventions are more strong than originally thought because of the multiplier effect. This still is very actual, on what basis are countries currently pumping a lot of money into the economy…?
Keynes was born in 1883 in Cambridge, as a son of John Nevilla and Florence Ada Keynes. His father was a famous economist and linked to the university of Cambridge. One thing Keynes had in common with a lot of big economists before him – like Stuart Mill and Léon Walras – was that the economic principle was taught to him a very young age. Keynes’ mother was even more famous than his father was since she was the major of Cambridge in 1932.
On a very young age Keynes already had some sort of trade, on elementary school Keynes had someone who carried his books for him in exchange for help with homework.
Keynes went to high school in Windsor, where he was taught at Eton college. He stood out because of his talents in Maths and History. One remarkable thing was that his marks for economics have always been pretty low. Years later he explained this by saying: “I evidently knew more than my examiners.”
At the age of 15 he applied to a mathematics course at Kings College in Cambridge, but he replaced this mathematical study pretty fast by an economic one. When Keynes was 21 he was allowed to call himself ‘master’ in economics.
At first Keynes wanted to follow his father and he tried to become a fellow at the university of Cambridge. However, he really stood out and got a job at a government-based employer. The India office.
His courage and gift to solve practical problems with economic theory opened his way to a high position at the British ministry of Finance. In 1911 he became redactor at the economic journal.
Keynes was one of the main advisors for the Versailles treaty where he was one of the British Expert advisors.
Keynes resigned because he didn’t agree with the outcome of the treaty, Keynes mostly disagreed with the penalties for Germany(mostly pushed by the French, led by Clemanceau). According to Keynes the Versailles treaty wouldn’t give recovery to Germany but would rather cause a revenge-action from Germany causing another war. He wrote about this in his book: “The economic consequences of peace.”
He wrote about Clemanceau:“he was a foremost believer in the view of German psychology that the German understands and can understand nothing but intimidation (…) Therefore you must never negotiate with a German or conciliate him; you must dictate to him. On no other terms will he respect you, or will you prevent him from cheating you. (…) The European civil war is to end with France and Italy abusing their monetary victorious power to destroy Germany and Austria-Hungary now prostrate, they invite their own destruction also.”
Keynes foresaw that the recovery-payments or penalties for Germany would have a great impact on the German economy. And he was right:
In 1920 you could buy one bread for 1,20, in 1923 you had to pay 80,000,000,000 for the same bread.
After the Versailles treaty Keynes was mainly occupied doing public debates and he wrote a lot. One of the most famous works was “The end of laissez-faire” in which he writes about the free-market principle.
In 1936 Keynes gives out his highly anticipated book “The General Theory of Employment, Interest and Money”. His book was brought to the market relatively cheap and the timing of the book couldn’t be better. The world was in the middle of “The great depression”.
In this book he describes his economic theory and he knew he came up with something very important which might change the way of economic thinking; he wrote:
““ I believe myself to be writing a book on economic theory which will largely revolutionize—not, I suppose, at once but in the course of the next ten years— the way the world thinks about economic problems.” –
John Maynard Keynes
The main idea of this theory (I will talk about the theory itself in different posts) is that Keynes says that the ‘laissez-faire’ assumption is not valid. The classical economists are wrong, governments should intervene(using the multiplier effect) to make recessions less heavy. (Anti-cyclical government policy)
When the second world war breaks out he writes “How to pay for the war” in 1940. This states that governments should pay for the war by raising taxes and not by accepting debts. The British government agrees with this and does what Keynes advised them to do in 1941.
Also Keynes was involved in the set-up of the Bretton Woods system. During these talks also the IMF was founded. The Bretton Woods system stated that every country had to keep themselves to a certain value of their coin for which this coin would be transferrable to gold. This system has proven to be a success, but in the begin of the ’70s the USA couldn’t guarantee the transfer to gold anymore for their dollar.
Keynes died in 1946.
Before Keynes
Keynes made a difference by going against the most common thoughts of the ‘classical’ economists. The classical assumption – as described by Say’s law – is that the free market will work for itself (laissez-faire) and that there is no need for any government interventions.
Keynes model states that governments should intervene in the markets with an anti-cyclical government policy to make recessions less deep and booms less high. (To reduce booms and bursts. Note: Marco-economic objective is nearly always stated as ‘STABLE economic growth’)
Another difference between Keynes’ model and the classical model is that Keynes is mostly looking at the short run of the economy and the classical model is mostly looking at the long-run. This means that the production cannot change in the Keynesian model making the firms reaching market equilibrium by changing the price only.
The Keynesian economics acknowledges three different stages within the economy:
- Overdemanding; this is where the AD is bigger than the production capacity. During these periods inflation regulation is becoming more important since the AD being higher than the production capacity will lead to more demand for (skilled) workers (raising wages and cost-based inflation) and it will lead to more demand-based inflation. The ‘overdemanding period’ may be cut into two parts. The part where the AD is going up within this period is called a hausse and the part where AD is going down is called recession(officialy it is only called a recession if there is a negative growth for two executive quarters).
- Balance of demand; this is where the AD equals production capacity.
- Underdemanding; this is where the AD is smaller than the production capacity. You may also divide this in two parts. When the AD is going down within the ‘Underdemanding period’ it is called a depression and when the AD is going up within this period it is called recovery.
Normally we look at two kinds of Keynesian models before going to the most difficult version, but that’s not what we are doing now. Keynesian model describes a certain amount of money flows.
Note: The X and M flow might seem to be in the wrong way but this graph describes money flows and not the flow of goods.
The Keynesian model is modeled by a few formula’s; to keep it quite simple:
1) AD=Y
2) AD= C+I+G+X-M
3) C=c*Yd +Co
4) Yd= Y-T
5) T=tY
6) I=Io
7) G=Go
8) X=Xo
9) M=mY
Note: The small letters show ‘quotes’, they represent the amount of the income that is being used to – for example – consume.
Note: Yd = Disposable income
If we substitute the formula’s we will get to a resulting complete formula :
AD=Y= c(Y-tY)+Co+Io+Go+Xo-mY
Let’s take some numbers to show the workings. c = 0,5 ; t= 0,2 ; m=0,2; Co = 50; Io = 10 ; Oo = 25 ; Xo= 15
Y=0,5(Y-0,2Y)+50+10+25+15-0,2Y
Y=0,5(0,8Y)+100-0,2Y
Y=0,4Y+100-0,2Y
Y=0,2Y+100
0,8Y=100
Y=(10/8)*100
Y=125 billion (Point where the green line cuts the blue line in coming picture)
Now there is this very important idea within the Keynesian theory of the multiplier effect, the only thing this actually states is that when I invest 10 million the AD will –ceteris paribus – go up for 10 million in the first place.
But the company receiving the order will also invest some of this money itself because the company is making extra profits. Let’s say it invests 1million extra because of this order. This on itself will raise the AD again with 1 million.
The AD has risen with 11 million already as a result of a basic investment of 10 million, this is describes as the multiplier.
Just imagine that the company that received the 1 million order does not reinvest anything extra, so that the total increase in AD will equal 11 million. Now to calculate the multiplier the only thing we have to do is fill in this formula:
Multiplier= Change in AD/ Change in variable.
Our variable in this story has been I(investments), this has changed 10 million. The AD has changed 11 million making the multiplier 11/10 = 1,1
There is a way in modeling the multiplier effect, and of course with a certain formula.
Lets go back to our previous example(The one with the Y=125 billion outcome) and change the Investments by 15 billion to 25 billion.
This would give us:
AD=Y= c(Y-tY)+Co+Io+Go+Xo-mY
Y=0,5(Y-0,2Y)+50+25+25+15-0,2Y
Y=0,5(0,8Y)+115-0,2Y
Y=0,4Y+115-0,2Y
Y=0,2Y+115
0,8Y=115
Y=(10/8)*115
Y=143,75 billion. (the point where the black line crosses the blue line in the coming picture)
The result is an increase of 18,75 billion as a result of an increase of investments of 15 billion. In our formula for the multiplier this would lead to a multiplier of 1,25
However, there are more sophisticated ways in calculating the multiplier. I won’t go through the mathematical prove of it. But you might also want to use this formula for the multiplier.
1/((1-c)+tc+m) = 1/((1-0,5)+0,2*0,5+0,2 = 1/(0,8) = 1,25
Note: This may not be used for changes in all variables! A change in the Import variable has the formula -1/((1-c)+tc+m and a change in the Taxes uses even another formula.
So what is understood with the Keynesian economics? Keynesian economics use an economic model that is mainly influenced by the idea that ‘laissez-faire’ does not work. The government interventions are more strong than originally thought because of the multiplier effect. This still is very actual, on what basis are countries currently pumping a lot of money into the economy…?
Monday 5 October 2009
Did you have a bad weekend?
And he's right!!
'Now you can give me all the propaganda'!
Very nice... '366, interesting number'
'Now you can give me all the propaganda'!
Very nice... '366, interesting number'
Thursday 1 October 2009
Run, Flee, Hide, SELL
US Markets down ±3% today.
In my opinion this might be the turning point, 4%-indicator gives a sell as from today.
This decline today was thanks to dissapointing manufacturing data and another ominous unemployment report. The Institute for Supply Management's (ISM) index of manufacturing actitvity was the primary reason for today's drop. (It dropped from 52.9 to 52.6 - analists estimates were that it would surge to around 54.)
It's now just waiting for the highly anticipated nonfarm payrolls report tomorrow, this is - in my opinion - the only thing on the very short term to keep the confidence in the market. And we do need this confidence.
When it is disappointing too the market might take a nosedive down.
Why?
Investors are eager to take profits on their positions and the major decline of Oktober last year has not been forgotten.
Also: big funds (E.G. hedgefunds, government funds, pension funds etc.) are more in stocks than they normally should be because they wanted to take some profit in this rally. When the funds go back to the normal (obligation + gold)/shares ratio this will simply lead to sell-offs.
What to do?
In my opinion it is best to lay some stops under your stocks. Close stops of about 2-2,5% (for volatile stocks I'd suggest stop of max 4-5%) are good, if the market corrects tomorrow because of the nonfarm payrolls data you'll probably still be in.
I would dare to buy some puts of about 10% out of the money on November 2009. The risk is high, but when you invest like 0,5-1,0% in these things and you have your stops on the stocks, there might be a nice profit =D
If you want to take it slower(but still believe in the market going down), look at this. Very nice product nowadays, less risk, and they might even pay some dividends. =D
Also: Watch VIX coming days; today VIX up 5,89%!!
In my opinion this might be the turning point, 4%-indicator gives a sell as from today.
This decline today was thanks to dissapointing manufacturing data and another ominous unemployment report. The Institute for Supply Management's (ISM) index of manufacturing actitvity was the primary reason for today's drop. (It dropped from 52.9 to 52.6 - analists estimates were that it would surge to around 54.)
It's now just waiting for the highly anticipated nonfarm payrolls report tomorrow, this is - in my opinion - the only thing on the very short term to keep the confidence in the market. And we do need this confidence.
When it is disappointing too the market might take a nosedive down.
Why?
Investors are eager to take profits on their positions and the major decline of Oktober last year has not been forgotten.
Also: big funds (E.G. hedgefunds, government funds, pension funds etc.) are more in stocks than they normally should be because they wanted to take some profit in this rally. When the funds go back to the normal (obligation + gold)/shares ratio this will simply lead to sell-offs.
What to do?
In my opinion it is best to lay some stops under your stocks. Close stops of about 2-2,5% (for volatile stocks I'd suggest stop of max 4-5%) are good, if the market corrects tomorrow because of the nonfarm payrolls data you'll probably still be in.
I would dare to buy some puts of about 10% out of the money on November 2009. The risk is high, but when you invest like 0,5-1,0% in these things and you have your stops on the stocks, there might be a nice profit =D
If you want to take it slower(but still believe in the market going down), look at this. Very nice product nowadays, less risk, and they might even pay some dividends. =D
Also: Watch VIX coming days; today VIX up 5,89%!!
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