Pt1420 Unit 1 Assignment
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ASSIGNMENTS
You are required to complete both below. The word limit is 2,500 words for each assignment but this does not include the stimulus material given here, the questions that follow it, or the bibliography that you are required to include at the end of each assignment. Specific guidance will be given on how to approach each assignment in class but the style to be adopted is strongly analytical. This means that your points must be supported by reasoned argument. Wherever possible, appropriate data should be used to support your arguments and diagrams that support and illustrate your arguments are encouraged. Please note that although your submission will be judged in a holistic manner and credit will be awarded wherever the discussion …show more content…
merits it, you should try to answer each question fully within the appropriate section. Within this general guideline, allocate your time and effort as you think appropriate. Assignment 1
Retailers Are Slashing Prices Ahead of Holiday
By STEPHANIE CLIFFORD New York Times, Published: December 22, 2011 Half off at the entire store at Ann Taylor. Sixty per cent at Gap. Forty per cent off almost everything at Abercrombie & Fitch. Going into the holiday season, inventories had grown much faster than sales at several retailers including Urban Outfitters. Aggressive last-minute deals in the days before Christmas are good for procrastinators, but they could be an alarm bell for the retail industry. While scattered markdowns are standard every year, discounts across entire stores — which analysts say are more widespread than last year — suggest merchants are stuck with too much merchandise. “It’s really a game of chicken,” said David Bassuk, managing director and head of the retail practice at the consultant firm AlixPartners. Many retailers entered the season “with pretty optimistic plans” that shoppers would rush into stores and pay full price, Mr. Bassuk said. But that did not pan out, and the final days before Christmas have retailers being “much more aggressive in terms of promotions being offered,” he said. Shoppers are filling their holiday lists against the backdrop of an uncertain year, with stubbornly high unemployment, increased food prices, volatile gas prices and unpredictability for stocks and Europe’s debt crisis. The government on Thursday said that third-quarter economic growth had
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not been as brisk as it previously estimated, because of a drop in consumer spending on services like health care. Toys “R” Us announced on Thursday new deals on dozens of items for Friday and Saturday, including ‘buy one, get one half off” on popular toys like Legos. A sampling of other promotions: Up to 70 per cent off toys at Amazon; up to 50 per cent off gifts at Restoration Hardware; 40 per cent off almost everything at American Eagle Outfitters, Talbots, Limited and Wet Seal; and 30 per cent off everything at J. Crew. “There’s been kind of a waiting game with retailers,” Gerald L. Storch, the chief executive of Toys “R” Us, told CNBC last week. “And it looks like the consumer wins.” Paul Lejuez, an analyst at Nomura Equity Research, surveyed mall deals over the weekend and said he was concerned. “It looks like 40 per cent is the new level you have to be at, 40 per cent off, to drive traffic. Those that weren’t at that level weren’t getting their fair share,” he said. Going into the holiday season, inventories had grown more than three times as fast as sales at several retailers, including American Eagle Outfitters, Aéropostale, Gap Inc., Urban Outfitters, Chico’s and Talbots. “If inventory is growing ahead of sales growth, there is a need to be more promotional to move the goods,” Mr. Lejuez said. Although sales over Thanksgiving weekend were surprisingly strong, Mr. Lejuez said they seemed to have cut into shopping that more typically would occur in December. Sales were sluggish the first two weeks after Thanksgiving, though they improved in the third week, according to the International Council of Shopping Centers. In e-mail inboxes, the promotional cadence is rapid. Retailers sent about 5.6 e-mails each last week on average, according to the e-mail marketer Responsys. That was a 26 per cent increase over the same week last year, and matched the record high hit during the week of Cyber Monday this year. Stores including Macy’s and Toys “R” Us are offering 24-hour shopping in the days before Christmas, and many stores moved “Super Saturday,” a promotion that falls on the final Saturday before Christmas, back a week hoping to spur sales. The deals are a boon for people who have put off shopping. “Last-minute Christmas shopping,” posted a Twitter user named Samra Tekeste. “Literally everything is on sale, LOL. Knew my procrastination would come in handy some day.” Another Twitter user with the handle BossNugget suggested that the King of Prussia mall near Philadelphia hang up a sign saying “It’s Almost Christmas, and Everything Is on Sale.” The big discounts mean that retailers are willing to sacrifice profits for revenue. “More and more each year, sales become less of the issue, and it’s more about what retailers have to do to get those,” Mr. Lejuez said. “There’s a little more pressure on that out-the-door price than we would have thought, and, I think, what the market would have anticipated.” And, after Christmas, the value of most merchandise slides. “The inventory is worth so much less in two weeks,” said the chief executive of a retailer, who asked not to be named because he did not want to reveal his store’s strategy. “With that kind of
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inventory, you’ve got to get rid of it. Whatever the margin is today, it’s that much lower next week and the week after when traffic stops.” Answer ALL of the following questions. 1 Using the concept of elasticity of demand (price income and cross) explain the price cutting behaviour of retailers illustrated in the passage above. 2 What problems are posed for retailers if inventories grow faster than sales? 3 The passage tells us that food prices have increased. What factors might have caused this? 4 With reference to costs, what is the main factor determining whether firms increase their opening hours to twenty four? 5 How are profits and revenue related and why might retailers be willing to “sacrifice profits for revenue”? Assignment 2
Inflation fears have vanished – suddenly it's all about growth
Manufacturing surveys from around the world provide a miserable message – growth momentum is fading Steven King Independent Monday 06 June 2011 Earlier in the year, it seemed as though inflation was the big problem. In response, the European Central Bank raised interest rates. The hawks on the Bank of England's Monetary Policy Committee wanted to follow suit. And many investors thought that, before the year was out, the US Federal Reserve would do exactly the same. How things change. Suddenly, fears about inflation have vanished. The big problem now is growth. Surveys of manufacturing activity from around the world provide a consistently miserable message: the momentum of economic growth is fading. And while that's a welcome result in parts of the emerging world where inflation really has been a threat, it's a lot more worrying for nations in the developed world where recovery is still in its infancy. If the pace of expansion in the US and in many parts of Europe was already disappointing, the situation now is even worse. On one level, this is all rather surprising. With interest rates more or less at zero, with massive budget deficits and with central banks throwing caution to the wind by turning on their printing presses, the amount of economic stimulus seemingly on offer is huge. So why hasn't it worked? Let me offer an analogy. Imagine it's been snowing and the roads are icy. You are driving up a hill. Close to the top, you have to stop at a junction. But when you attempt to move off again, you find that the wheels merely spin on the ice. You have no traction. The harder you try, the worse it gets. The car is stuck. You have plenty of power, but that power is totally ineffective. Eventually, you have no choice but to abandon your car. What follows is a long, slow and very cold walk. Policy-makers have much the same problem. Their policies have little traction. Faced with large amounts of debt – either in the private sector or, increasingly nowadays, in the public sector – people are simply unwilling or unable to respond positively to the inducements on offer from central banks and governments. The Keynesian "reset" – the idea that a big stimulus would allow an economy to "jump" from a high unemployment setting to a full employment setting – just hasn't happened. The clearest example of all this comes from the US. On Friday, we learnt that American employment rose a
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mere 54,000 in May and that unemployment had gone up to 9.1 per cent. Even worse for a nation with a long tradition of "fire and hire" – and, yes, I deliberately put the words in that order – many US citizens are struggling to find new work. The result has been an unprecedented rise in long-term unemployment. With all this weakness, it's no surprise that investors are no longer convinced that central bankers will be raising interest rates any time soon. One way to measure this is to take a look at 10- year government bond yields. In effect, they are a sum of expected future levels of short-term interest rates. Investors have recently decided to put their misgivings about the US budget deficit to one side and, instead, focus on the weakness of the US economy, figuring that interest rates will now be lower for longer. Reflecting this new thinking, 10-year yields momentarily dropped below 3 per cent at the end of last week, suggesting growing doubts about the pace of recovery. You might think that the continuation of very low interest rates for a while longer might be a good thing. It isn't. A healthy economy full of vitality and the joys of risk-taking should have relatively high interest rates. Only those economies unable to stand on their own two feet experience continuously very low interest rates. Low interest rates today are not a sign of future strength but, instead, of ongoing current weakness. There is little credit supply, even less credit demand, insipid money supply growth and miserable fiscal austerity. Housing markets, meanwhile, are no longer able to deliver the turbo-charged recoveries of old. To be fair, things could have been a lot worse. Faced with the biggest financial crisis in living memory, policy-makers have done well to avoid the worst of all outcomes, the descent into a Great Depression Mark II. It's all too easy to forget how bad the original version was: US GDP down 30 per cent from peak to trough and male unemployment up to 25 per cent of the American workforce. The numbers on this occasion are nothing like as bad. That's good news. But many people have gone further, suggesting not only that we've avoided a Great Depression Mark II but that we have also avoided the stagnation that was experienced by Japan over the last 20 years. Unfortunately, this is a little less obvious. One of the overriding features of Japan's experience has been the persistence of very low interest rates. Even when they did go up, they immediately had to go back down again, suggesting the Bank of Japan has been using the Grand Old Duke of York approach to monetary policy. And the reason why interest rates couldn't rise was exactly as it is in the West today: the Japanese were busily paying off their debts and were not prepared to borrow more at any interest rate. Indeed, the only sector of the economy that did borrow was the government. So public debt went through the roof. Sounds familiar? But if we are suffering from a variant of Japan's debt difficulties, why has inflation been so high? To be fair, high inflation is mostly a UK phenomenon: it's nothing like as elevated either in the US or through much of Europe. The difference is partly explained by sterling's earlier weakness and by big increases in VAT that will ultimately subtract from growth rather than persistently add to inflation. Nevertheless, inflation in the Western world has been higher than expected given the ongoing weakness of economic activity. The answer lies with the strength of oil, food and metals prices relating not just to the upheavals in the Middle East and North Africa – which certainly have provided an extra boost to oil prices – but also to the impact of strong growth in the emerging world more broadly. That strength, in turn, is linked to monetary conditions in China and other emerging nations which still link the value of their currencies to the US dollar. They use "second hand" versions of
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US monetary policy.
When the Federal Reserve sets monetary policy for the US economy, it is also defining monetary conditions for many parts of the emerging world too. These countries mostly don't have the West's debt difficulties. Offer them low interest rates and their economies boom. Demand for commodities surges. Commodity prices soar. For the Western world, food and energy inflation goes up. With weak labour markets, higher prices rise are not matched by higher wages. That means we're all facing real wage cuts. And wage cuts imply lower growth. Lots of people happily talk about a Plan B, as if it's possible to simply wave a magic wand to get us all out of this mess. But until they come up with a solution to the ongoing Japan-style difficulties associated with high debt and low incomes, their magic wands will remain as limp as their ideas. Dreams are all well and good, but every so often it's useful to take a dose of reality. Answer ALL of the following questions. 1 Why is inflation an economic problem? 2 How does an increase in interest rates work to contain/reduce inflation? 3 Why is encouraging growth important? 4 Explain fully the phrase underlined in the passage above. 5 Explain the sentence “Housing markets, meanwhile, are no longer able to deliver the turbo-charged recoveries of old”. 6 Explain the sentence in bold font in the passage above. 10 EXAMPLE OF AN …show more content…
ASSIGNMENT
The following example is designed to give you an indication of the style that we try to encourage in the construction of your assignments in Business Economics. Notice that each answer directly addresses the issues posed in the question and the approach is analytical so that reasoned argument is apparent throughout each answer. Points are fully explained and there is a clear line of development with each sentence leading into the next and each paragraph following the preceding paragraph. Notice also that, where appropriate, reference is made to the data. Read the stimulus material below and answer ALL of the questions that follow it. For most of the last two hundred years, the pound sterling was the major international currency. It was used in both in international trade and financial transactions. However, for over fifty years now the US dollar has been the world’s most important currency and many of the commodities traded on the world’s exchanges are now priced in dollars. Central banks hold the bulk of their reserves of foreign currency in dollars and in some countries dollars are accepted for making transactions as readily (even more so in some countries) as domestic currency. The Japanese Yen and the German Mark have also been widely used internationally, but neither has challenged the supremacy of the dollar. However, on January 1999, a new currency, the euro, was created and the question arises about whether this will replace the dollar as the world’s major international currency. Table 1 below gives some relevant information. Comparing the United States and the Euro Area in 1999 Share of world GDP (%) 21.9 15.8 Share of world exports (%) 15.3 19.4 Financial markets (($ billions) 40, 543.8 24,133.4 Table 1 Source: IMF and ECB (adapted) Questions
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1 2 3 4
Distinguishing between private and official transactions, outline the functions of an international currency? Illustrate and explain the use of money as an international medium of exchange. What advantages does a country gain if its currency is used as an international currency? Assess the factors that will determine whether the euro will replace the US dollar as the world’s major currency.
Answers 1 Economists define money in terms of its functions. ‘Money is as money does’ is a widely used phrase, but what does money do? In fact, money has three functions. It is a unit of account, a store of value and a medium of exchange. To function as a unit of account, money must provide a common denominator for expressing relative values. In other words, prices must be set in terms of money. To function as a store of value, the purchasing power of money must be relatively stable over time. Money cannot be a store of value if its value is eroded by inflation! To function as a medium of exchange, money must be used to purchase goods and services. In other words, it is quite literally ‘exchanged’ for goods and services. At the international level, money performs its functions in private transactions and in official transactions. Private transactions occur between private individuals, households and organisations. Official transactions take place between governments or their agents, mainly their central banks. In private transactions a currency serves as a unit of account if international contracts are invoiced in that currency. It serves as a store of value if international assets such as bonds are denominated in that currency. (Note that many organisations issue dollar denominated bonds, not just organisations in the USA. These bonds are held privately as investments since they pay a rate of interest or offer a capital gain.) Finally currency serves as a medium of exchange if it is a ‘vehicle currency’. This simply means that two other currencies are converted into the vehicle currency. On the world’s foreign exchanges, most business is transacted through US dollars. For example, there is no active branch of the foreign exchange market selling (buying) Egyptian pounds for Turkish lira. However, both of these currencies can be traded for dollars and through the vehicle currency, they can be bought and sold against each other. In official transactions, a currency serves as a unit of account if it is used to express the value of an exchange rate peg, that is, the rate at which one currency is fixed against another. It serves as a store of value if governments and/or central banks hold this currency as part of their reserves and it serves as a medium of exchange if it used for intervention purposes to stabilise an exchange rate. Money functions as an international medium of exchange when it is used as an intervention currency to stabilise an exchange rate. For example, prior to joining the euro, countries are obliged to maintain their currencies at a fixed rate against the euro. The rate is not rigidly fixed against the euro and a currency is allowed to fluctuate by 15 per cent of the fixed rate. To stabilise the exchange rate within the limits of fluctuation, it might be necessary for the central bank to intervene. The diagram below is used to explain how this works. For convenience we take the euro fixed against some other currency such as the Polish Zloty. In figure 1, DZ0 and SZ0 are the original demand and supply for zloties against the euro. The demand for zloties varies inversly with the exchange rate because as the because as the exchange rate depreciates (zloties become cheaper in terms of euros), exports from
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3
4
Poland become cheaper.
It is assumed that demand for Polish goods is elastic and therefore as their price falls, a greater quantity will be demanded and more zloties will be demanded to pay for them. Conversely, as the exchange rate depreciates, imports into Poland become more expensive and, assuming demand for imports is elastic, a smaller quantity will be demanded and fewer zloties will be supplied. Figure 1 here Assume that the exchange rate is fixed at fixed at x euros per zloty and e1 and e2 are the limits of fluctuation under the fixed exchange rate. With demand and supply of zloties initially given by DZ1 and SZ1 respectively, the exchange rate is initially in equilibrium at its fixed rate. Assume now that the supply of zloties increases as Polish residents demand more imports. There is downward pressure on the exchange rate and, if supply shifts to SZ2, the authorities will be obliged to intervene to prevent the exchange rate moving below its lower margin. The most direct method of intervention is for the authorities to use their reserves of euros to buy up the excess supply of zloties at the fixed exchange rate. This implies an increased demand for zloties. Downward pressure on the zloty is neutralised when the demand for zloties shifts to DZ1. The major advantage a country gains from other countries using its currency internationally is seignorage revenue. This is the difference between the cost of producing money and its purchasing power. Issuers of money (usually
governments) can gain substantially from seignorage revenue. For example, a UK £50 note costs only a few pence to produce, but it gives £50 of purchasing power to the UK Government! Seignorage revenue is particularly important when other countries hold a different country’s money. In the case of the United States, every dollar held abroad enables the United States to consume goods and services from abroad without having to pay for these with exports. Alternatively dollars held abroad enable United States citizens to acquire real assets such as property or to gain interest income. Seignorage revenue is clearly very important! Many factors determine the extent to which a currency is acceptable as an international currency. One very important factor is the size of the country’s economy because this determines the potential use of the currency in international markets. The size of a country’s economy is linked with its economic importance. For example, the export sector of many countries as a percentage of their GDP is many times larger than the United States. However the US dollar is the dominant international currency. Table 1 shows that in 1999, the percentage share of the world GDP of the United States was roughly one third greater than that of that of the euro area. This will shrink as the euro area grows and so in terms of economic size, there is no reason why the euro might not at least rival the dollar as an international currency in the future. Another factor determining the acceptability of a currency on the international stage is the importance of that currency in international trade and the size and openness of its financial markets. Both of these are major determinants of the demand for a currency on the world’s markets. As for the first of these, the euro is far more important in terms of international trade than the dollar .Table 1 shows that in 1999, approximately 19 per cent of total world exports are invoiced in euros while about 15 per cent are invoiced in US dollars. However, Table 1 also shows that the financial market of the United States is considerably larger than that of the euro area and is almost 70 per cent bigger. (This, of course, will change if the UK joins the euro!) The convertibility of a currency also determines its use as an international currency. In this sense there is no difference between the euro and the dollar. They are both free of restrictions on conversion and can be equally easily exchanged for other currencies.
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A currency’s acceptability internationally also depends on the political and macroeconomic environment and the policies pursued by the relevant authorities. A stable macroeconomic environment is important in encouraging confidence and macroeconomic policies impact upon that stability and the rate of economic growth. It is generally accepted that a low inflation environment is most conducive to efficiency and economic growth. Political stability is also important in encouraging confidence in a currency and greater economic growth. Countries which suffer from hyperinflation often find that their currencies cease to be used internally and barter and/or currency substitution (another country’s currency is used officially or unofficially as domestic money) become common place. It is unthinkable that the currency of a country experiencing hyperinflation could perform any role internationally. In this sense, the United States and Europe have similar economic and political environments. Politically they are stable and economically they are both low inflation environments. So could the euro replace the dollar as the major international currency? It certainly seems possible. The euro performs all of the functions of an international currency and, especially as the euro area grows, the importance of the euro as an international currency will grow. However, the euro is a new currency and the dominance of the dollar is unlikely to be challenged for some time to come!
Euro price of 1 zloty
DZ0
DZ1 SZ0 SZ1
e1 x e2
DZ1 SZ0 SZ1 DZ0
Quantity of zloties
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ASSIGNMENTS
You are required to complete both below. The word limit is 2,500 words for each assignment but this does not include the stimulus material given here, the questions that follow it, or the bibliography that you are required to include at the end of each assignment. Specific guidance will be given on how to approach each assignment in class but the style to be adopted is strongly analytical. This means that your points must be supported by reasoned argument. Wherever possible, appropriate data should be used to support your arguments and diagrams that support and illustrate your arguments are encouraged. Please note that although your submission will be judged in a holistic manner and credit will be awarded wherever the discussion …show more content…
merits it, you should try to answer each question fully within the appropriate section. Within this general guideline, allocate your time and effort as you think appropriate. Assignment 1
Retailers Are Slashing Prices Ahead of Holiday
By STEPHANIE CLIFFORD New York Times, Published: December 22, 2011 Half off at the entire store at Ann Taylor. Sixty per cent at Gap. Forty per cent off almost everything at Abercrombie & Fitch. Going into the holiday season, inventories had grown much faster than sales at several retailers including Urban Outfitters. Aggressive last-minute deals in the days before Christmas are good for procrastinators, but they could be an alarm bell for the retail industry. While scattered markdowns are standard every year, discounts across entire stores — which analysts say are more widespread than last year — suggest merchants are stuck with too much merchandise. “It’s really a game of chicken,” said David Bassuk, managing director and head of the retail practice at the consultant firm AlixPartners. Many retailers entered the season “with pretty optimistic plans” that shoppers would rush into stores and pay full price, Mr. Bassuk said. But that did not pan out, and the final days before Christmas have retailers being “much more aggressive in terms of promotions being offered,” he said. Shoppers are filling their holiday lists against the backdrop of an uncertain year, with stubbornly high unemployment, increased food prices, volatile gas prices and unpredictability for stocks and Europe’s debt crisis. The government on Thursday said that third-quarter economic growth had
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not been as brisk as it previously estimated, because of a drop in consumer spending on services like health care. Toys “R” Us announced on Thursday new deals on dozens of items for Friday and Saturday, including ‘buy one, get one half off” on popular toys like Legos. A sampling of other promotions: Up to 70 per cent off toys at Amazon; up to 50 per cent off gifts at Restoration Hardware; 40 per cent off almost everything at American Eagle Outfitters, Talbots, Limited and Wet Seal; and 30 per cent off everything at J. Crew. “There’s been kind of a waiting game with retailers,” Gerald L. Storch, the chief executive of Toys “R” Us, told CNBC last week. “And it looks like the consumer wins.” Paul Lejuez, an analyst at Nomura Equity Research, surveyed mall deals over the weekend and said he was concerned. “It looks like 40 per cent is the new level you have to be at, 40 per cent off, to drive traffic. Those that weren’t at that level weren’t getting their fair share,” he said. Going into the holiday season, inventories had grown more than three times as fast as sales at several retailers, including American Eagle Outfitters, Aéropostale, Gap Inc., Urban Outfitters, Chico’s and Talbots. “If inventory is growing ahead of sales growth, there is a need to be more promotional to move the goods,” Mr. Lejuez said. Although sales over Thanksgiving weekend were surprisingly strong, Mr. Lejuez said they seemed to have cut into shopping that more typically would occur in December. Sales were sluggish the first two weeks after Thanksgiving, though they improved in the third week, according to the International Council of Shopping Centers. In e-mail inboxes, the promotional cadence is rapid. Retailers sent about 5.6 e-mails each last week on average, according to the e-mail marketer Responsys. That was a 26 per cent increase over the same week last year, and matched the record high hit during the week of Cyber Monday this year. Stores including Macy’s and Toys “R” Us are offering 24-hour shopping in the days before Christmas, and many stores moved “Super Saturday,” a promotion that falls on the final Saturday before Christmas, back a week hoping to spur sales. The deals are a boon for people who have put off shopping. “Last-minute Christmas shopping,” posted a Twitter user named Samra Tekeste. “Literally everything is on sale, LOL. Knew my procrastination would come in handy some day.” Another Twitter user with the handle BossNugget suggested that the King of Prussia mall near Philadelphia hang up a sign saying “It’s Almost Christmas, and Everything Is on Sale.” The big discounts mean that retailers are willing to sacrifice profits for revenue. “More and more each year, sales become less of the issue, and it’s more about what retailers have to do to get those,” Mr. Lejuez said. “There’s a little more pressure on that out-the-door price than we would have thought, and, I think, what the market would have anticipated.” And, after Christmas, the value of most merchandise slides. “The inventory is worth so much less in two weeks,” said the chief executive of a retailer, who asked not to be named because he did not want to reveal his store’s strategy. “With that kind of
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inventory, you’ve got to get rid of it. Whatever the margin is today, it’s that much lower next week and the week after when traffic stops.” Answer ALL of the following questions. 1 Using the concept of elasticity of demand (price income and cross) explain the price cutting behaviour of retailers illustrated in the passage above. 2 What problems are posed for retailers if inventories grow faster than sales? 3 The passage tells us that food prices have increased. What factors might have caused this? 4 With reference to costs, what is the main factor determining whether firms increase their opening hours to twenty four? 5 How are profits and revenue related and why might retailers be willing to “sacrifice profits for revenue”? Assignment 2
Inflation fears have vanished – suddenly it's all about growth
Manufacturing surveys from around the world provide a miserable message – growth momentum is fading Steven King Independent Monday 06 June 2011 Earlier in the year, it seemed as though inflation was the big problem. In response, the European Central Bank raised interest rates. The hawks on the Bank of England's Monetary Policy Committee wanted to follow suit. And many investors thought that, before the year was out, the US Federal Reserve would do exactly the same. How things change. Suddenly, fears about inflation have vanished. The big problem now is growth. Surveys of manufacturing activity from around the world provide a consistently miserable message: the momentum of economic growth is fading. And while that's a welcome result in parts of the emerging world where inflation really has been a threat, it's a lot more worrying for nations in the developed world where recovery is still in its infancy. If the pace of expansion in the US and in many parts of Europe was already disappointing, the situation now is even worse. On one level, this is all rather surprising. With interest rates more or less at zero, with massive budget deficits and with central banks throwing caution to the wind by turning on their printing presses, the amount of economic stimulus seemingly on offer is huge. So why hasn't it worked? Let me offer an analogy. Imagine it's been snowing and the roads are icy. You are driving up a hill. Close to the top, you have to stop at a junction. But when you attempt to move off again, you find that the wheels merely spin on the ice. You have no traction. The harder you try, the worse it gets. The car is stuck. You have plenty of power, but that power is totally ineffective. Eventually, you have no choice but to abandon your car. What follows is a long, slow and very cold walk. Policy-makers have much the same problem. Their policies have little traction. Faced with large amounts of debt – either in the private sector or, increasingly nowadays, in the public sector – people are simply unwilling or unable to respond positively to the inducements on offer from central banks and governments. The Keynesian "reset" – the idea that a big stimulus would allow an economy to "jump" from a high unemployment setting to a full employment setting – just hasn't happened. The clearest example of all this comes from the US. On Friday, we learnt that American employment rose a
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mere 54,000 in May and that unemployment had gone up to 9.1 per cent. Even worse for a nation with a long tradition of "fire and hire" – and, yes, I deliberately put the words in that order – many US citizens are struggling to find new work. The result has been an unprecedented rise in long-term unemployment. With all this weakness, it's no surprise that investors are no longer convinced that central bankers will be raising interest rates any time soon. One way to measure this is to take a look at 10- year government bond yields. In effect, they are a sum of expected future levels of short-term interest rates. Investors have recently decided to put their misgivings about the US budget deficit to one side and, instead, focus on the weakness of the US economy, figuring that interest rates will now be lower for longer. Reflecting this new thinking, 10-year yields momentarily dropped below 3 per cent at the end of last week, suggesting growing doubts about the pace of recovery. You might think that the continuation of very low interest rates for a while longer might be a good thing. It isn't. A healthy economy full of vitality and the joys of risk-taking should have relatively high interest rates. Only those economies unable to stand on their own two feet experience continuously very low interest rates. Low interest rates today are not a sign of future strength but, instead, of ongoing current weakness. There is little credit supply, even less credit demand, insipid money supply growth and miserable fiscal austerity. Housing markets, meanwhile, are no longer able to deliver the turbo-charged recoveries of old. To be fair, things could have been a lot worse. Faced with the biggest financial crisis in living memory, policy-makers have done well to avoid the worst of all outcomes, the descent into a Great Depression Mark II. It's all too easy to forget how bad the original version was: US GDP down 30 per cent from peak to trough and male unemployment up to 25 per cent of the American workforce. The numbers on this occasion are nothing like as bad. That's good news. But many people have gone further, suggesting not only that we've avoided a Great Depression Mark II but that we have also avoided the stagnation that was experienced by Japan over the last 20 years. Unfortunately, this is a little less obvious. One of the overriding features of Japan's experience has been the persistence of very low interest rates. Even when they did go up, they immediately had to go back down again, suggesting the Bank of Japan has been using the Grand Old Duke of York approach to monetary policy. And the reason why interest rates couldn't rise was exactly as it is in the West today: the Japanese were busily paying off their debts and were not prepared to borrow more at any interest rate. Indeed, the only sector of the economy that did borrow was the government. So public debt went through the roof. Sounds familiar? But if we are suffering from a variant of Japan's debt difficulties, why has inflation been so high? To be fair, high inflation is mostly a UK phenomenon: it's nothing like as elevated either in the US or through much of Europe. The difference is partly explained by sterling's earlier weakness and by big increases in VAT that will ultimately subtract from growth rather than persistently add to inflation. Nevertheless, inflation in the Western world has been higher than expected given the ongoing weakness of economic activity. The answer lies with the strength of oil, food and metals prices relating not just to the upheavals in the Middle East and North Africa – which certainly have provided an extra boost to oil prices – but also to the impact of strong growth in the emerging world more broadly. That strength, in turn, is linked to monetary conditions in China and other emerging nations which still link the value of their currencies to the US dollar. They use "second hand" versions of
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US monetary policy.
When the Federal Reserve sets monetary policy for the US economy, it is also defining monetary conditions for many parts of the emerging world too. These countries mostly don't have the West's debt difficulties. Offer them low interest rates and their economies boom. Demand for commodities surges. Commodity prices soar. For the Western world, food and energy inflation goes up. With weak labour markets, higher prices rise are not matched by higher wages. That means we're all facing real wage cuts. And wage cuts imply lower growth. Lots of people happily talk about a Plan B, as if it's possible to simply wave a magic wand to get us all out of this mess. But until they come up with a solution to the ongoing Japan-style difficulties associated with high debt and low incomes, their magic wands will remain as limp as their ideas. Dreams are all well and good, but every so often it's useful to take a dose of reality. Answer ALL of the following questions. 1 Why is inflation an economic problem? 2 How does an increase in interest rates work to contain/reduce inflation? 3 Why is encouraging growth important? 4 Explain fully the phrase underlined in the passage above. 5 Explain the sentence “Housing markets, meanwhile, are no longer able to deliver the turbo-charged recoveries of old”. 6 Explain the sentence in bold font in the passage above. 10 EXAMPLE OF AN …show more content…
ASSIGNMENT
The following example is designed to give you an indication of the style that we try to encourage in the construction of your assignments in Business Economics. Notice that each answer directly addresses the issues posed in the question and the approach is analytical so that reasoned argument is apparent throughout each answer. Points are fully explained and there is a clear line of development with each sentence leading into the next and each paragraph following the preceding paragraph. Notice also that, where appropriate, reference is made to the data. Read the stimulus material below and answer ALL of the questions that follow it. For most of the last two hundred years, the pound sterling was the major international currency. It was used in both in international trade and financial transactions. However, for over fifty years now the US dollar has been the world’s most important currency and many of the commodities traded on the world’s exchanges are now priced in dollars. Central banks hold the bulk of their reserves of foreign currency in dollars and in some countries dollars are accepted for making transactions as readily (even more so in some countries) as domestic currency. The Japanese Yen and the German Mark have also been widely used internationally, but neither has challenged the supremacy of the dollar. However, on January 1999, a new currency, the euro, was created and the question arises about whether this will replace the dollar as the world’s major international currency. Table 1 below gives some relevant information. Comparing the United States and the Euro Area in 1999 Share of world GDP (%) 21.9 15.8 Share of world exports (%) 15.3 19.4 Financial markets (($ billions) 40, 543.8 24,133.4 Table 1 Source: IMF and ECB (adapted) Questions
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Distinguishing between private and official transactions, outline the functions of an international currency? Illustrate and explain the use of money as an international medium of exchange. What advantages does a country gain if its currency is used as an international currency? Assess the factors that will determine whether the euro will replace the US dollar as the world’s major currency.
Answers 1 Economists define money in terms of its functions. ‘Money is as money does’ is a widely used phrase, but what does money do? In fact, money has three functions. It is a unit of account, a store of value and a medium of exchange. To function as a unit of account, money must provide a common denominator for expressing relative values. In other words, prices must be set in terms of money. To function as a store of value, the purchasing power of money must be relatively stable over time. Money cannot be a store of value if its value is eroded by inflation! To function as a medium of exchange, money must be used to purchase goods and services. In other words, it is quite literally ‘exchanged’ for goods and services. At the international level, money performs its functions in private transactions and in official transactions. Private transactions occur between private individuals, households and organisations. Official transactions take place between governments or their agents, mainly their central banks. In private transactions a currency serves as a unit of account if international contracts are invoiced in that currency. It serves as a store of value if international assets such as bonds are denominated in that currency. (Note that many organisations issue dollar denominated bonds, not just organisations in the USA. These bonds are held privately as investments since they pay a rate of interest or offer a capital gain.) Finally currency serves as a medium of exchange if it is a ‘vehicle currency’. This simply means that two other currencies are converted into the vehicle currency. On the world’s foreign exchanges, most business is transacted through US dollars. For example, there is no active branch of the foreign exchange market selling (buying) Egyptian pounds for Turkish lira. However, both of these currencies can be traded for dollars and through the vehicle currency, they can be bought and sold against each other. In official transactions, a currency serves as a unit of account if it is used to express the value of an exchange rate peg, that is, the rate at which one currency is fixed against another. It serves as a store of value if governments and/or central banks hold this currency as part of their reserves and it serves as a medium of exchange if it used for intervention purposes to stabilise an exchange rate. Money functions as an international medium of exchange when it is used as an intervention currency to stabilise an exchange rate. For example, prior to joining the euro, countries are obliged to maintain their currencies at a fixed rate against the euro. The rate is not rigidly fixed against the euro and a currency is allowed to fluctuate by 15 per cent of the fixed rate. To stabilise the exchange rate within the limits of fluctuation, it might be necessary for the central bank to intervene. The diagram below is used to explain how this works. For convenience we take the euro fixed against some other currency such as the Polish Zloty. In figure 1, DZ0 and SZ0 are the original demand and supply for zloties against the euro. The demand for zloties varies inversly with the exchange rate because as the because as the exchange rate depreciates (zloties become cheaper in terms of euros), exports from
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Poland become cheaper.
It is assumed that demand for Polish goods is elastic and therefore as their price falls, a greater quantity will be demanded and more zloties will be demanded to pay for them. Conversely, as the exchange rate depreciates, imports into Poland become more expensive and, assuming demand for imports is elastic, a smaller quantity will be demanded and fewer zloties will be supplied. Figure 1 here Assume that the exchange rate is fixed at fixed at x euros per zloty and e1 and e2 are the limits of fluctuation under the fixed exchange rate. With demand and supply of zloties initially given by DZ1 and SZ1 respectively, the exchange rate is initially in equilibrium at its fixed rate. Assume now that the supply of zloties increases as Polish residents demand more imports. There is downward pressure on the exchange rate and, if supply shifts to SZ2, the authorities will be obliged to intervene to prevent the exchange rate moving below its lower margin. The most direct method of intervention is for the authorities to use their reserves of euros to buy up the excess supply of zloties at the fixed exchange rate. This implies an increased demand for zloties. Downward pressure on the zloty is neutralised when the demand for zloties shifts to DZ1. The major advantage a country gains from other countries using its currency internationally is seignorage revenue. This is the difference between the cost of producing money and its purchasing power. Issuers of money (usually
governments) can gain substantially from seignorage revenue. For example, a UK £50 note costs only a few pence to produce, but it gives £50 of purchasing power to the UK Government! Seignorage revenue is particularly important when other countries hold a different country’s money. In the case of the United States, every dollar held abroad enables the United States to consume goods and services from abroad without having to pay for these with exports. Alternatively dollars held abroad enable United States citizens to acquire real assets such as property or to gain interest income. Seignorage revenue is clearly very important! Many factors determine the extent to which a currency is acceptable as an international currency. One very important factor is the size of the country’s economy because this determines the potential use of the currency in international markets. The size of a country’s economy is linked with its economic importance. For example, the export sector of many countries as a percentage of their GDP is many times larger than the United States. However the US dollar is the dominant international currency. Table 1 shows that in 1999, the percentage share of the world GDP of the United States was roughly one third greater than that of that of the euro area. This will shrink as the euro area grows and so in terms of economic size, there is no reason why the euro might not at least rival the dollar as an international currency in the future. Another factor determining the acceptability of a currency on the international stage is the importance of that currency in international trade and the size and openness of its financial markets. Both of these are major determinants of the demand for a currency on the world’s markets. As for the first of these, the euro is far more important in terms of international trade than the dollar .Table 1 shows that in 1999, approximately 19 per cent of total world exports are invoiced in euros while about 15 per cent are invoiced in US dollars. However, Table 1 also shows that the financial market of the United States is considerably larger than that of the euro area and is almost 70 per cent bigger. (This, of course, will change if the UK joins the euro!) The convertibility of a currency also determines its use as an international currency. In this sense there is no difference between the euro and the dollar. They are both free of restrictions on conversion and can be equally easily exchanged for other currencies.
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A currency’s acceptability internationally also depends on the political and macroeconomic environment and the policies pursued by the relevant authorities. A stable macroeconomic environment is important in encouraging confidence and macroeconomic policies impact upon that stability and the rate of economic growth. It is generally accepted that a low inflation environment is most conducive to efficiency and economic growth. Political stability is also important in encouraging confidence in a currency and greater economic growth. Countries which suffer from hyperinflation often find that their currencies cease to be used internally and barter and/or currency substitution (another country’s currency is used officially or unofficially as domestic money) become common place. It is unthinkable that the currency of a country experiencing hyperinflation could perform any role internationally. In this sense, the United States and Europe have similar economic and political environments. Politically they are stable and economically they are both low inflation environments. So could the euro replace the dollar as the major international currency? It certainly seems possible. The euro performs all of the functions of an international currency and, especially as the euro area grows, the importance of the euro as an international currency will grow. However, the euro is a new currency and the dominance of the dollar is unlikely to be challenged for some time to come!
Euro price of 1 zloty
DZ0
DZ1 SZ0 SZ1
e1 x e2
DZ1 SZ0 SZ1 DZ0
Quantity of zloties
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