Basket Case

Enticing picture of coffee from the BBC’s story

In recent weeks we’ve covered inflation, and back at the start of the term discussed the importance of prices in determining all sorts of important economic variables, from national output (GDP) to most recently, the exchange rate.

Inflation is the rise in the general price level over some period of time. What is the general price level? This is determined via a “basket of goods”, supposedly what the average person buys and hence representative of prices the average person faces.

What is the “basket of goods”? The Office for National Statistics regularly updates the basket, which is reassuring, and the most recent updates were announced today: coffee pods are in, but nightclub fees are out. As a nation we are more in a hurry, making our real coffee via Nespresso machines and the like rather than the longer and more drawn out approach using a real coffee machine/pot, while we’re going to nightclubs less, apparently. What do you think?

The Price of Petrol

Oil price

As students, I suspect there is little likelihood you (a) listen to Radio 4 in the morning, and (b) listen to it before 8am. However, if you do, you’ll have heard a section of the Today programme on petrol prices, which the RAC expects will fall below a pound before Christmas.

This is, of course, music to the ears of anybody who drives a car. But as you’ll be increasingly aware as a student of economics, the demand side of the market is only one side – there’s also the supply side. Contrary to how we might view large oil companies, the huge range of fluctuation in the price of oil makes it clear that they are price takers, rather than price makers, when it comes to the price of oil, and subsequently the price of petrol.

The graph above shows why petrol is so cheap again – the price of oil has fallen by close to 60% over the last 18 months, and this is part of a general fall in commodity prices over this time period. This raises questions, and perhaps the most pertinent are (1) why? and (2) what does it mean?

On the why, one explanation that Vince Cable (who came to the university earlier in term) put forward was that China and other strong growth economies of recent years like Russia and Brazil are all either slowing down or in recession. This removes a huge amount of demand for commodities.

On the what does it mean: the likelihood is it means job losses as firms that mine and trade in these commodities have to cut back given decreased revenues from their activities. It seems more than likely this would affect the UK, and Scotland in particular where the oil industry resides. But equally, other large mining companies are headquartered in the UK, and this may result in job losses.

It’s not all good…

Global Monetary Policy

While our focus is often just on what the Bank of England is up to (speaking of which, today is December’s interest rate announcement from the Bank of England), there are other more important central banks out there, most notably the European Central Bank (ECB), and the Federal Reserve, representing the eurozone and the US respectively.

This article in the Guardian worries about what seems likely to happen this month: the US will tighten monetary policy while the ECB will loosen policy further.

Why does this matter? The worry is of considerable exchange rate movements. As we’ll learn towards the end of next term, one of the ways in which we believe exchange rates move in the shorter term as economists is via relative interest rate movements. This is because rates of interest reflect how much an investor could earn by moving their wealth into that country.

Hence, everything else being equal, if interest rates are higher in the US than in the eurozone, it is feared people will move their wealth out of European assets into US-based assets, increasing the demand for US dollars, and reducing the demand for euros. This would then lead to an appreciation in the value of the dollar (more demand), and a depreciation in the value of the euro (less demand). This need not be a bad thing, since a recovering economy ought to be aided by a weaker currency.

Of course things aren’t necessarily that simple; if eurozone producers use goods imported from the US to make their goods, and if eurozone consumption is often of US-produced goods, then eurozone economic activity would likely be negatively affected by the movements.

The bottom line is that larger than normal exchange rate movements ought to be expected in the coming months…

Economic Modelling and Board Games

If you are in your first year, you may well have just become aware that we’re planning on a big board game experiment next term in macroeconomics. You might be thinking: why?!

One reason, we’ll admit, is that a number of us in the economics department quite enjoy playing board games. We’re not particularly weird and whacko in that respect: the board game industry is also thriving, with board game cafes are cropping up in the UK such as Draughts in London.

However, as economists we have another angle: board games are models. A model is a simplified version of reality, of something we wish to study or understand more. Of course, board games aren’t necessarily designed necessarily with that in mind – but nonetheless, games like Risk do provide some model of global warfare, games like Monopoly must provide some model of the property market, however warped and horrifying each might be.

Settlers of Catan is the particular game we’re using next term, and you might ask why? Well, Settlers is a game about settling: about groups of people settling in areas and developing. We can think about it as modelling the origins of growth – what does it take for groups to survive and prosper?

In the game, once initial settlements (and roads) have been placed, players must optimise given the constraints of the inputs available to them – land that produces, at random, materials necessary to further develop (build more settlements, build cities). Such development might be aided by trade: two players deciding that some swap of materials they have is mutually beneficial. The rate at which materials are traded reflects their value in the game – their relative scarcity, and hence we have inflation and deflation in a barter economy.

Quickly, you can see we can think about Settlers as an economic model. And that’s what we’ll do next term. You’ll be playing the game in Week 2, and for your essay at the end of term, you’ll be writing about Settlers as an economic model.

What do you need to do right now? You need to fill out this survey, as it will help us to set up game tables that enable us to best learn about the kinds of factors that lead to economic growth (and help you to write a better essay next term). And perhaps brush up on your knowledge of the game of Settlers of Catan 🙂

Inflation is still Deflation

united-kingdom-inflation-cpiThis morning the latest inflation numbers have been released: -0.1%. That is, deflation. The Consumer Price Index, what the Bank of England uses to measure inflation, has barely changed since February – see above. To give some context, the Bank of England’s inflation forecasts since February have all suggested inflation would have risen back up to around 0.5% by now, yet persistently inflation is around zero.

Why does this matter? It matters on a number of levels; to mention a few:

  • Inflation is seen as a barometer of how well the economy is doing. Strong demand across the economy, given a fairly fixed supply, would yield inflation, and hence this suggests the economy is far from capacity (where supply would be fairly fixed).
  • Inflation is what the Bank of England must set its monetary policy to influence. The target is 2% with a 1% band either side, and hence inflation is below target. In this situation, the Bank might be expected to try and generate a bit of inflation to push back towards its target, yet interest rates, the tool the Bank uses, are already at their (effective) lower bound of 0.5%. It certainly doesn’t suggest the Bank is about to raise interest rates, another fear some have.
  • Inflation is the norm. Deflation has not been; I noted the one historical deflationary UK episode a few weeks ago. Japan has found itself fixed in zero/negative inflation territory for a long time now – it’s not the norm, and at least as far as Japan, and possibly increasingly the UK, are finding, it’s unexpectedly persistent too.

We’ll spend time looking at inflation next term…

Making Money on Macro?

Twitter is great for leaning more about macroeconomics, believe it or not. I happened across this tweet just now:

I’d highly recommend following the link; you’ll find a detailed account of a bet two macroeconomists agreed two years ago about inflation given GDP growth.

What is there to learn there?

1) Macroeconomics is very hard! Andrew Lilico readily admits he doesn’t understand how quantitative easing (QE) has affected inflation, and admits he’s unsure about how the labour market is currently working. The thing about QE is that is was “unconventional monetary policy”, which meant it wasn’t normal, hence there isn’t lots of examples of it previously being used elsewhere to get some sense of how it might work (you can count the uses on one hand, pretty much: Japan, UK, US, now Eurozone). This is problematic for us as macroeconomists: how then can we hope to understand how policy will work? The answer is we try and develop our theoretical understanding of how the economy works; but this has risks too…

2) Forecasting is not economics! Forecasting is predicting the future, and the future need not be the same as the present – things change all the time that have dramatic impacts on how events will turn out. Portes suggests that only an oil shock would have led to him losing the bet, and in fact one did occur, but a negative shock – something essentially nobody expected. More dramatic examples of forecast failure would be those in and around natural (and unnatural) disasters: e.g. forecasting output in Japan for the year ahead, just before the earthquake and tsunami struck in 2013. We can understand the economy perfectly well, but if things change tomorrow, our forecast will be wrong. Forecasting is different from economics. If you’re interested in forecasting, do think about taking my third year course on forecasting! 🙂

3) Knowledge is money! If you do know the economy well, and study macroeconomics hard, there’s no reason why you can’t hope to make financial gains using that information. This need not be betting related, either; better knowledge about the economy can lead to better ideas about how to store your wealth, about what line of work to go into, about when (and where) to buy a house. Much of this is common sense of course, but there’s no doubt a bit of economic nous can help you augment that common sense. All the more reason to study economics :-)))