Avoiding Tax and Panama

The big story at the moment surrounds Panama, which many folk may know best from Prison Break rather than its financial sector. A truly massive leak of confidential files from a law firm (terabytes, not just gigabytes…) is causing embarrassment and more for many leading global figures. UK Prime Minister David Cameron is fending off questions about his family’s involvement with the law firm via his father, while the Icelandic Prime Minister was more deeply embroiled and has already bitten the bullet. Links to Vladimir Putin do not appear to have caused quite so much shock and consternation

What exactly is going on, and why does it matter from a macroeconomic perspective? It must matter, since it pertains to billions of dollars. Economies have billions of dollars (or pounds, or euros) moving around within them, and hence that billions ended up in Panama rather than the places that the people mentioned above are located is of interest.

Towards the end of term we covered the Balance of Payments, which is the financial account of a country – what financial flows go in and out of a country. Clearly, it seems, considerable flows went out of the UK, Iceland, and Russia to Panama, and for what? Money is moved from one place to another usually for some purpose – for example an investment, or to pay for imported goods. The claim, however, is that much of these financial flows were “offshore” – moving of money primarily for the purpose of avoiding paying taxes.

In the case of Ian Cameron, the PM’s dad, their company Blairmore Holdings was based in Panama, it would seem, to avoid paying as much tax as would be paid in the UK. However, as the leaks appear to make clear, major decisions about the firm were still made in the UK (based on documented meetings of board members revealed in the leaks) – which apparently is the test of where a company is “located”. What this makes clear is the difficulty of regulation – definitions have to be made for things that are easy to think about, but harder to pin down the detail of – what is the definition of where a company is located? And once a definition is made in a country’s law, it will provoke those in that country to consider ways in which that law can be avoided. As a result, it’s likely that those involved will claim nothing illegal was done, regardless of the wider moral implications about doing right and wrong.

Economic activity, you’ll learn more as you study further in microeconomic topics, tends to need some level of regulation. However, that regulation need not be a panacea, and need not lead to unintended consequences. The rise of offshore tax havens came primarily in response to higher tax rates in major Western economies, particularly in the 1970s, and of course regulation is something that many in favour of the UK leaving the EU cite as a reason to leave. A very thoughtful friend of mine has noted the link between these two – the UK remains a place for lots of finance taking place onshore, and is so at least in part because of its position within the single market (single market = more customers = more revenues). If that attraction was lost, the UK may need to consider other ways to retain its position, which may include more favourable tax and regulatory arrangements for finance – yet financial markets are precisely the markets where the clamour for “more regulation” has been greatest since the financial crisis.

As with anything in macroeconomics, it’s complicated, but it’s well worth studying!

The Bank and Brexit

On a regular basis representatives of the Bank of England meets with the Treasury Select Committee, a body of MPs that examines the expenditure, administration and policy of HM Treasury, HM Revenue & Customs, and associated public bodies, including the Bank of England and the Financial Conduct Authority”. Today there has been a hearing at the Treasury Committee on “The economic and financial costs and benefits of UK’s EU membership”, in which governor Mark Carney gave evidence.

At the meeting, Carney was accused of being “pro-EU”, apparently because he wrote in a pre-hearing letter to the committee: “EU membership reinforces the dynamism of the UK economy”. As definitions and details are all important, particularly in the Brexit debate, thankfully the report then states: “A more dynamic economy is more resilient to shocks, can grow more rapidly without generating inflationary pressure or creating risks to financial stability and can also be associated with more effective competition. ”

It’s hard to imagine how an evaluation of the costs and benefits of the UK’s EU membership could avoid being pro-EU whilst making statements about the benefits of EU membership, and highlights the difficulty of providing any kind of appraisal in these politically-charged days. Nonetheless, it is important to do so, and also important to go to the source and read/listen to what’s happened. The link above is to the pre-hearing report put together by the Bank, and is well worth reading on the costs and benefits of EU membership.

The Economics of Crime

Economists apply economic theories to all sorts of walks of life, not least crime and organised crime (organised crime should reduce overall crime, just as a monopoly reduces output in a market). It might be of interest to find that something as mundane as the money supply, and even the denomination of bank notes, can be hugely important when it comes to organised crime.

This article, by Mike Bird at The Wall Street Journal, points out two things about the money base – the amount of money that a central bank prints and puts out into general circulation – and in particular, the existence of large denomination notes. By large, the main target are the €200 and €500 notes the ECB circulates.

It’s long been accepted that such sized notes are the preserve of organised crime, since such people need ways to carry around large amounts of cash to avoid detection. As such, in the UK we only have a £50 note and nothing larger, and the largest note, er sorry, bill, in the US is the $100 bill.

But there’s another issue at the moment, namely the problem with negative interest rates. The Bank of Japan, Japan’s central bank, recently adopted a negative interest rate. Hence the central bank charges banks who deposit cash reserves at the central bank, rather than paying interest. It is to be expected then that banks will do the same with their customers.

Faced with a negative interest rate, i.e. a charge on depositing money with banks, cash then becomes a better option since it has a zero rate of interest (well, it loses value with inflation but if inflation is low or negative, as it is in Japan, then its value is not changing much or increasing). If large denomination bills like €500 exist, then millions of euros can easily be transported around without requiring large briefcases…

Who said the economics of large denomination notes was boring?…

Unemployment Down but a Rate Rise Unlikely

Two macroeconomic stories have adorned the main headlines on the BBC website in the last 24 hours.

First, Mark Carney, current Governor of the Bank of England, ruled out interest rate rises in the near future – highly unlikely in 2016, it seems. Then this morning the news is that unemployment, the number of people not in work but seeking work (hence counted as part of the labour force) is at its lowest level since 2005.

As with many economic variables, a change in any direction is not unambiguously a good thing; for interest rates, which have been low for many years now, this is good for borrowers (for example, people with mortgages to buy houses), but bad for savers. This is because the rate the Bank of England sets heavily influences the rates set by banks around the country, so borrowers will continue to have to pay back their loans on lower interest rates, but savers will continue to earn very little interest on their savings.

The reality that the Bank doesn’t think a rate rise is likely implies the Bank thinks the prospects for economic growth are not so great; this comes on the back of the Chancellor’s warning about a dangerous cocktail of factors affecting UK growth in the coming year. Prospects for growth have reduced.

This comes, though, in stark contrast to the good news from the labour market. That unemployment is falling is generally a good thing – it’s hard to think of particularly convincing reasons why it wouldn’t be. Sometimes people point out that the fall might be based only on workers going into short-term or zero-hours contracts, or part-time or self-employment, all of which are seen as less secure jobs for workers, and signs not of high confidence amongst employers.

It may also be that some are back to work, but the 5% that remain have been out of work for a long time and are starting to become discouraged. If people have stopped looking for work, they stop being classed as unemployed and hence the unemployment rate can fall due to this. It is quite standard that after recessions the number of long-term unemployed increases, and while this does not excuse the reality or make light of it, it does present a problem for the government in attempting to find policies to get such people back into the workforce.

Optimism, anxiety and the state of the economy

Yesterday US President Obama gave an annual speech that US Presidents give, called the State of the Union address. Conservative thinkers here think that David Cameron should initiate a similar thing, but that’s by the by. The BBC reports that Obama’s final SOTU (everything it seems gets an acronym in the US) conveyed a message regarding optimism and anxiety.

You may think trivial emotions like optimism and anxiety are utterly irrelevant when it comes to how economic outcomes are determined, but you’d probably be wrong. Indeed, one of the early Keynesian business cycle theories that we’ll cover later in term suggests that co-ordination failures occur because some people are less optimistic and hence don’t do particular things (e.g. produce less thinking they won’t sell all that much), leading others to do the same – the pessimism of some is contagious.

The antidote to such failures of co-ordination might be more co-ordinated positive speak – such as Obama encouraging everyone to be optimistic. It sounds almost silly, but what is the empirical evidence? Here’s some bedtime reading on the matter, work by an economist called Sylvain Leduc who considers business confidence and economic fluctuations. Work I’ve been doing myself suggests that the Bank of England’s Monetary Policy Committee, which determines monetary policy (the setting of interest rates to achieve an inflation target), pays a lot of attention to business confidence when considering the state of the economy.

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…

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…

School Trip to the Bank of England

Yesterday a group of us from the economics department went to the Bank of England in London. We spent time in the Bank of England Museum before having a talk about the history of the museum, bank notes and gold.

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The museum is a number of things, but perhaps most obviously it’s a museum of economics; in the main hall there’s a number of displays talking about the monetary system; definitions of inflation, for example:

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It’s hugely important to have quick and easy definitions for terms like inflation, money, and quantitative easing. If nothing else, you can at least prove your friends wrong when they make grand assertions about economic matters.

The opening hall is full of exhibits that make the point that monetary policymaking is hard work:

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Here, you can pull up and down the lever on the right to affect where the ball is, between deflation and inflation of 10%+. The problem is that on the left there’s an “economic shock” which makes it very hard to ever get the ball to 2%. Not too dissimilar to the outcomes of actual inflation over recent years…

What is an economic shock? Another exhibit had genuine BBC news footage from throughout recent decades from events such as the oil crises in the 1970s, the stock market crash of 1987 and the UK’s exit from ERM in 1992 – all huge events that had considerable impacts on wider economic activity.

Perhaps the most exciting exhibit is a bar of gold – value close on £300,000! As you can see, high security:



The talk we had talked through the history of a state bank and central bank and how it developed, along with the development of bank notes from bits of paper to the soon-to-be plastic £5, £10, £20 and £50 notes we now use.

All in all, a fascinating museum, educational and good fun at the same time. If you are in London and within easy reach of the Bank, I’d highly recommend getting along – it’s free!


Yesterday’s News: Carney and the EU

This week the Bank of England Governor, Mark Carney, gave a speech on the EU in Oxford. It’s well worth reading the whole thing, rather than the various responses to it. It’s not particularly long, and there’s even a bit of humour injected in places.

Firstly, why does it matter that the Bank of England Governor has given a speech? It matters because he is head of the institution tasked with carrying out monetary policy – what happens to interest rates, essentially, to keep inflation at around 2%, and also financial regulation – to try and ensure another financial crisis doesn’t occur.

What is the context? As you’ll be aware, the UK is holding a referendum by the end of 2017 on its membership of the EU. The UK, as a very open economy, is highly affected by international events – both good and bad. At times, high demand from Europe and elsewhere has helped drive UK growth, but at other times instability in neighbouring countries has inhibited our growth. Additionally, it means our policy decisions affect others in the same way that many decisions we make on a crowded train impact those who happen to be sat/stood near us.

What did Carney have to say? Essentially, he said that the founding principles of the EU: freedom of movement of goods and services, capital and labour, have been a good thing for the UK economy. These are arguments we’ll cover in much more detail next term, but here’s some food for thought in the meantime. However, he did add caution (something Eurosceptics have been quick to seize upon): financial regulation may threaten the UK economy in the future, as may the unwillingness of other European nations to reform and become more competitive.

All things we’ll be talking about in much more detail in the Spring: see you then!

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 :-)))