supply side economics and crises

Question 1

what is the phillips curve?

Answer 1

the phillips curve shows that if aggregate demand was too low in an economy there would be unemployment whereas if the aggregate demand was to high, outpacing the economies employment of resources then spending would rise faster than production and inflation must result. the Phillips curve shows a negative relationship between the inflation and unemployment

Question 2

what is stagflation?

Answer 2

stagflation is whent he inflation increases at the same time that economic growth decreases

Question 3

what policies are not suitable when there is stagflation?

Answer 3

if inflation is a feature of the economy then there must be excess demand and insufficient production. therefore you cannot spend your way out of a recession if the recession is not due to a lack of aggregate demand.

Question 4

is the phillips curve trade off between unemployment and inflation false?

Answer 4

no one hundred years of data until 1958 was not wrong. US economist alan blinder uses the analogy of driving a car; speed and safety are a trade off- more of one means less of the other. however if the road and environmental conditions worsen the trade off doesn’t disappear but instead shifts to a new level

Question 5

what were the features of the supply side paradigm?

Answer 5

they gave up at attempts of keynisan demand management
they accepted that there was a natural rate of unemployment - unemployment above the natural rate was voluntary
they aimed to free up the sclerosis of markets
they got governments of the backs of business
work on increasing the supply of resources - especially enterprise
they believed there is no long run trade off between inflation and unemployment

Question 6

what are the main types of supply side policies?

Answer 6

privatise state industries
deregulate the labour markets
liberalise and mobilise
reduce government spending

Question 7

what are examples of privatising the state industry?

Answer 7

they could introduce quasi markets

Question 8

what are examples of deregulate labour market policies?

Answer 8

reduce the trade union power
remove protection on employment
reduce unemployment benefits
remove the minimum wage registration
increase wage flexibility
reduce income taxes and restore incentives

Question 9

what are examples of liberalising and mobilising policies?

Answer 9

free up markets and promote competition ( in goods services labour capital finance and banking)
prevent monopolies and restrictive practices
increase information on job availability
increase education and training

Question 10

what are examples of policies that reduce government spending?

Answer 10

balance budgets
reduce crowding out

Question 11

what was the washington consensus?

Answer 11

it was a term coined in 1989 referring to the policies allegedly promoted by the Washington institutions of the IMF, the world bank and the US treasury and state department. the policies were:
broaden the tax base and reduce the top marginal rates of tax
cut public spending and reduce budget deficits
free interest rates
free exchange rates
free trade
free capital controls and allow FDI
privatise state industry
deregulate markets

Question 12

what was the 1979 banking act?

Answer 12

it recognised commercial banks and licensed institutions
it computerised settlement systems

Question 13

what was the 1986 financial services act ?

Answer 13

it removed fixed commisions
the transitition from market floor to computerised trading
allowed mergers of investment banks and retail banks
facilitated the development of new products and markets

Question 14

what occured in the international debt crisis of 1982?

Answer 14

The underlying cause was huge global trade imbalances. The oil price hikes in the 70s meant that money flows were moving to OPEC countries and the OPEC countries couldn’t spend them fast enough. OPEC surplus started building up in international banks and so world interest rates sank and this was when stagflation was reducing the world price of dollars and sterlings

Through the 1980s, the regimes of thatcher and reagan cut back UK and US money supplies reducing inflation and increasing interest rates and forcing up their respective exchange rates.

Countries that were in debt to the US or the UK now had to pay a much greater sum of money and their debt grew. The crisis kicked off when mexico said it could not pay its bills and for a oil rich country to not be able to pay caused financial panic. The response was that the debts had to be repaid but this was during a stagnating world recession when export markets were closed. As a result the countries who were in debt had to forgo consumption and investment and were forced into austerity to pay back the debts.

Question 15

what was the lessons from the international debt crisis of 1982?

Answer 15

global imbalances are destabilising

Excessive borrowing will eventually worry creditors

Borrow only to invest, not consume

Austerity reduces incomes and increases debt/gdp ratios

Question 16

what was the east asian crisis?

Answer 16

tigers of east asia had been growing at rates of 7-10% prior to 1997

Internation investors ploughed money into the newly industrialized countries of east area

Growth was strong and exchange rates were stable and the past record of borrowing/debt repayments was good

Diminishing returns to capital was occuring, however more and more borrowed funds went into property and pushed up property prices and not increasing the MPK and domestic financial institutions were not transparant (crony capitalism)

The crisis started in thailand when the property bubble popped and panic erupted causing a flight of capital , a collapse in exchange rates and soaring debts and deep recession

Question 17

what was the lessons from the east asian crisis?

Answer 17

Property prices can go down as well as up

Inflows of capital can quickly reverse

International banking is liable to herd behaviour

Irresponsible borrowing and asset speculation is only possible with irresponsible lending

Question 18

what is the mexican peso crisis of 1994?

Answer 18

Mexicos response to 80s debt crisis was to deflate. From this it won the confidence of international finance and joined the north american free trade agreement in december 1992

Short term capital flooded into the country boosted by fixed exchange rate

Incomes rose and spending rose and imports were rising faster than exports

A sudden devaluation of the mexican peso triggered the tequila crisis where creditors cashed in their loans as fast as possible

What made this crash different was that this was communicated instantly worldwide through interconnected globalised capital markets and flows of hot money took place out of the country at frightening speed

Question 19

what are the lessons from the mexican peso crisis 1994?

Answer 19

Fixed exchange rates can trigger balance of payments crises

Globalised markets can spread the panic and spread recession

Debts incurred in foreign currency are crippling when devaluation occurs

Question 20

what was the russian crisis of 1998?

Answer 20

The crisis was triggered by the exogenous shocks of contagion from the east asian crisis and the decrease of oil and nonferrons metal prices ( russia is a big exporter)]

The long period of soft budget constraints and domestic non payments of industrial loans and taxes meant that russian economy was weak and fragile

Giant unstainable public debt and overvalued real exchange rates meant that foreign reserves were running out

A massive international loan repayment due in 1998 led to a loss of confidence and a massive capital outflow

The russian government had not built up investors confidence effectively so that rescue policies lost their effectiveness: the fixed rouble exchange rates could not survive

Question 21

what was the lessons from the russian crisis of 1998?

Answer 21

Increasing dependence on foreign markets means decreasing independence

Volatile primary export prices meant volatile earnings

If government continually support domestic industry there is no need for them to be efficent ( moral hazard)

Question 22

what was the argentian crisis of 2001?

Answer 22

Argentina removed protectionist policies freeing trade and privatised industry and removed capital controls

They tied the peso to the us dollar so domestic money supplies could not increase unless dollar reserves increased

Confidence and economic growth was robust but by end of 1993-98 the us economy was booming whilst the main markets for argentina exports were brazil and europe where growth was sluggish

As the us dollar increased so did the peso, making argetinas exports uncompetitive and so the economy declined by 25% over 1998-2001, tax revenues fell and unemployment and poverty rose. Deficits increased

The government tried to hide the state of the nations finance but there was a run on the banks fearing devaluation and all the banks were then closed provoking riots. The country defaulted on 132 billion dollars of us debt. The peso dollar price sank to 4-1

The presidency changed 4 times in just months .

Question 23

what were the lessons from the argentian crisis of 2001/

Answer 23

exchange rates should not be tied between countries with divergent growth paths

Governments should build budget surpluses when the economy is booming so they run deficits in a recession

Governments fall when rhey lose the trust of their people and their creditors

Question 24

what was the causes of the credit crunch and the great recession of 2007/2008?

Answer 24

Global trade imbalance as china and OPEC surpluses increased

Search for investment outlets- clearly east asia and russian markets were unrelaible so trade surpluses were invested into the largest financial markets where this increased the supply of funds would have the least distorting impact- wall street and london

Government promotion of mortage lending – they promote domestic home buying with policies such as tax incentives and mortage guarantees to banks and finance houses however this causes moral hazard

Financial innovation-colllateralised debt obligations were created to help the supply of home loans meet demand. Shadow banks were set up to keep these trades off bank balance sheets and out of sight

Irrational exuberance- there was too much optimism and sheer profitability of participating in us financial markets that caught on worldwide as financial asset here were eagerly purchased to bolster the balance sheets of institutions in a variety of financial centeres around the world.

Credit crunch – the lack of transparency as to who had sold what to whom and which banks balance sjeets were loaded with worthless CDOs meant that trust between financial institutions evaporated. The us government refused to bailout lehman brothers which caused banks not to lend to one another out of fear that the other bank will go under taking the borrowed money with them .

Question 25

what were the lessons from the credit crunch and the great recession of 2007/08?

Answer 25

If banks fail, government have no choice but to bail them out in order to protect peoples savings and indeed the entire financial system

The conversion of private sector debt into public debt has led many governments to cut back spending (austerity)

But bail outs invite moral hazard so banks will only bust and boom again

Basic economics: policies which reduce incomes will only make debt/income ratios worse

Basic politics: debt between equals is always solved by mutual agreement; debt between unequals always involves the powerful dictating terms to the powerless , usually accompanied by excessive moralising