2014-22 Kenia revises GDP

The new estimates, it is higher by a quarter!

Here is what happened:
Kenya revised its data to take account of expanding industries such as mobile-phone money transfers and informal businesses, while also changing the base year of the figures to 2009 from 2001

- adding expanding industries - good
- adding informal businesses - many countries start doing it (recall that Italy is adding prostitution and drugs to GDP, per EU directive)
- changing the base year - should make no difference.

2014-21 Exchange rate in action

In today's report, Bloomberg writes about what is happening with the ruble exchange rate and exchange rate policy

• the ruble has been falling because  of sanctions imposed on Russia by developed countries (US, Canada, Australia, Japan and European Union) resulting from its aggression in Ukraine
• sanctions raise uncertainty, making Russian assets less attractive. So two things happen: 

1. capital flows out of the country
2. interest rates increase

• Russia has ample foreign exchange reserves: $515 billion in 2013 according to CIA Factbook (for comparison, US has $150 bln, Canada has 70 bln of reserves and China has $4 trillion)
• the current system of exchange rate management in Russia is as follows:

1. there is a basket of currencies in terms of which the ruble is controlled
2. the ruble is allowed to move within a band
3. if it crosses the band, the central bank sells or buys rubles on the foreign exchange market

• Russia is considering:

1. Introducing capital controls to stem the outflow of capital (one specialist says this will not happen until reserves start falling by $20 bln a month)
2. Flexible exchange rates

Here is an important sentence:
The central bank widened the ruble’s trading band in August as it prepares for the shift to a freely floating ruble, abandoning a 15-year policy of tapping reserves to control currency movements in favor of using interest rates to manage inflation. 

What it means:
- current monetary policy is to manage the exchange rate, by intervening on the foreign exchange market
- they want to switch to flexible exchange rates and use monetary  policy to manage inflation, by changing interest rates (like, for example, Bank of Canada does)

What it stresses:
-they can either control exchange rates or the inflation rate, but not both at the same time. Monetary policy can accomplish only one thing at a time.

2014-20 Banksters

Two more stories today about banksters:
- manipulation of Libor - wow, people got fired and lost unpaid bonuses. What about paid bonuses?
- manipulation of foreign exchange rates

The BBC website is excellent since they actually explain things

Here is an explanation of LIBOR
1. banks submit estimates how much they would pay to borrow from other banks. The estimates submitted were sometimes false, to promote the interest of the submitters.

Oh, I understand now. So the market was organized on the interesting idea that bankers will provide truthful information.

Oh, not another smiling monkey.
OK

2. And how much depends on LIBOR?
Contracts worth $300 000 000 000 000

Here is an explanation of the forex scandal

By the way, according to the article the forex market is now over $5 trillion a day.

2014-19 Interest rates and bond prices

Interest rates are at record lows and will, eventually, increase. This means bond prices will fall

IMPORTANT: we will be studying the relationship between interest rates and bond prices later on in the course. Since a lot of students are unclear about the relationship, it is a good to think about it ahead of time.

1. What is a bond? It is a promise to pay predetermined amounts of money in the future. 
2. What determines the price of a bond? The amount you need to generate future payments identical to the payments the bond will provide.
3. How to avoid a mistake? Bu remembering that, once the bond is sold for the first time, the price at which it is sold is irrelevant.

I will provide a simple example, of a consol. A consol is a bond that has no maturity day. It pays the interest forever. It is easier to analyze a consol since you do not need to consider a maturity date.
In the example, the consol has a face value of $100, pays 5% per year, and sells for $100.

The points below correspond to the points above

1. The consol will pay the owner $5 per year forever.
2. How much do you need to earn $5 per year? 

- if the interest rate is 5%, you need $100. You deposit $100 in the bank and get 5% of $100, or $5 per year

- if the interest rate is 2.5%, you need $200. You deposit $100 in the bank and get 2.5% of $200, or $5 per year

- if the interest rate is 10%, you need   $50. You deposit $50 in the bank and get 10% of $50, or $5 per year.

So if the interest rate is 2.5% the price of the consol is $200, if the interest rate is 5% the face value of the consol is $100 and when the interest rate is 6.2% the price of a consol is - well, you can calculate it yourself

     3. To calculate the price of the consol, we took two things into account: the yearly payment, and the interest rate. The price at which the consol sold, nor the face value, entered into the calculation. As often happens, the consol could sell for $99 (at a discount) or for $101 (at a premium) - without affecting the price of the consol later on. Similarly, a consol with a face value of, for example, $120 which happens to pay $5 per year would have the same price as a consol with the face value of $100 which pays$5 per year.

2014-18 Innovations in lending

According to the New York Times article there is a new technology in town. Lenders providing car loans install a device that allows them to disable the car remotedly. This reduces the number of loan defaults and so allows them to extend credit to people who were considered too risky in the past.

As a result, the proportion of car loans that are subprime has been increasing, although it has not reached the pre-recessions levels, as you can see on the graph further in the article.

Conclusion: technology can improve the functioning of credit markets.

Of course people who use subprime loans are poor, not financially educated and can be exploited by unscrupulous lenders. But that is a separate problem.

2014-17 It was a slow news day until I found that a bank was fined $850 000

A small Swiss bank was fined for providing trading in offshore places to BC residents even though it was not registered. The services allowed some BC residents to do trades without disclosing their identity.

Two points:
- governments around the world have been trying to reduce the amount of money hidden in tax heavens to avoid taxes
-  Here are some other bank fines totals since 2009:

And here are the 10 biggest fines in the US, with explanations what happened

And here is the number of senior bankers who went to jail

2014-16 Do as Canada did

The finance ministers of the G20 group of countries just met in Brisbane, Australia. Canada's finance minister, Joe Oliver, said what we have already discussed: that the world economy is in poor shape. He also encouraged European governments to follow Canadian example by, in his words (I put it in a list):
“- promoting pro-growth policies,
- driving demand at home,
- aggressively pursuing free-trade agreements,
- enhancing job-matching services,
 - increasing the participation of all groups in the workforce and
- enhancing private-sector competition.”

2014-15 Women and central banking

Central banks are places full of men.

Carolyn Wilkins is the first woman to sign Canadian banknotes
You can read the discussion of the virtues of her signature's looks.
And now for something entirely different. Here is the original signature of the guy who signs US banknotes

On the other hand a woman, Janel Yellen, is the chair of the Federal Reserve

2014-14 A word from a WLU econ graduate

The new Senior Deputy Governor of the Bank of Canada, Carolyn Wilkins, BA '87, delivered her first policy speech. She said that the "neutral interest rate" has fallen from 4.5% to 5.5% in 2000s to 3%-4%

What is the neutral interest rate? In her own words, “The neutral rate is to economists what dark matter is to physicists. We are convinced it exists, it plays a central role in our models and analysis, but we can¹t directly observe it.”

Well, actually we do not know the value. What she calls the "neutral" interest rate is the rate which the Bank of Canada should maintain when the economy is operating at capacity (i.e. when output equal potential output, or the unemployment rate equals the natural unemployment rate). With such rate at full employment, inflation will be stable.

She also mentioned that the Bank of Canada does not know when the economy will return to full employment.

Two morals of that story:
1. The effects of the Great Recession will linger for quite some time
2. The Bank of Canada does not know what interest rate it should set or when. That makes the task of monetary policy difficult, wouldn't you say?

By the way, the Globe and Mail article is more detailed, but gremlins struck again. At the beginning of the article they write: " "3 to 4 per cent,” roughly 1.5 percentage points below its historical norm", at the end they write  " the historical norm of about 4 per cent". Go figure.

2014-13 Stocks and flows again

In post 2014-09 I talked about mistakes in comparing stocks and flows. Here is a good illustration, although the author of this Globe and Mail article actually may have remembered something from an economics class.
He compares foreign direct investment inflows with GDP. Sounds right: he compares flows with flows.

But while he writes about FDI inflows, he uses data on FDI stocks. So he does end up comparing the stock of direct foreign investment with GDP (a flow).

How bad is it? In a word: terrible. This is the main Saturday business article - two solid pages. According to the article, in some contries the "flow" of FDI is larger than GDP. That does not make any sense, since total investment in a country is a fraction of GDP (in Canada around 20%).

Is it difficult to find actual data? Not at all. Here is what I found googling OECD FDI (since he claims the data are from an OECD report) - see page 7. Here is the page from Wikipedia

The moral of the story: when you read something - think whether it makes sense. And the moral of the story for the Globe - not good

2014-12 US monetary policy is changing - but slowly

The Federal Reserve, the US central bank, has just finished its policy meeting. These meetings are held 8 times a year. They provide two things:
- decision in interest rates and other monetary policy measures
- description of what the Federal Reserve thinks is, and will, be happening in the economy and how it may react.
Not much in terms of news this time. The Federal Reserve confirmed that in October it is ending its  quantitative easing program which involved large scale purchases of securities in order to increase liquidity in the market and encourage lending.
It also provided forward guidance: it will start increasing interest rates next year but, for now, interest rates will remain low.

2014-11 Canada's exchange rate

In a speech on Tuesday the governor of the Bank of Canada denied rumours that the bank was trying to depreciate the dollar. 
He said Canada does better with a floating exchange rate. Controlling the exchange rate would lead to greater fluctuations in output, inflation and unemployment.
Why? If the exchange rate is controlled and, for example, demand changes, then output and employment need to adjust. If the exchange rate is floating, it does some of the adjustment.
So the Bank of Canada targets inflation and the exchange rate is set by the market.
As we will discuss in chapter 4, the central bank cannot control the inflation rate and the exchange rate at the same time. It must choose one and let the other be determined by market forces.

2014-10 The world economy is growing slower than expected

The OECD - Organization of Economic Cooperation and Development, has published a new report.
Growth forecasts have been reduced for Canada, the Eurozone and the U.S., unchanged for China, and increased for India. The report provides statistics, but not explanation.
So: the world economy is bad. But not that bad. This is an example of how not to illustrate a story

OECD, in its report, said that the European Central Bank (ECB) should, to stimulate the lagging Eurozone economy, engage in quantitative easing: purchases of various long-term assets from banks and other financial institutions. As you may recall, this was the topic of the first two entries this year: 2014-01 and 2014-02. OECD is saying they should do more. In practice this means the ECB should buy sovereign (i.e. government) bonds of Eurozone countries, as the markets for asset-based securities are small.

Here is an illustration, from the Economist, of how the stimulus from the ECB has been lagging behind:

By the way, this week the Federal Reserve holds its meeting and will likely announce the end of its program of quantitative easing. The easing, which involved the purchases of securities for up to$85 billion a month, can be seen in the graph above, as the increase in the Federal Reserve balance sheet since 2013.

2014-09 What every economics and business student should know

Here is  list of what Apple is worth more than

Should you know the details? Of course not. You should know which of the items on the list involve wrong comparisons.

Hint: cannot compare stocks and flows.  Why? Here is an example: you are going on a trip. The distance you will be driving is 90km. You are driving on a highway and doing 110. What is bigger: the distance you are driving or the speed with which you are driving? (see the hint at the end of this post).

The value (market cap) of Apple is a stock; many things listed on this website are flows. For example:

1. US stock market in 1977 - stock, so this is ok
2. annual prescription drug sales - flow. Wrong
3. 300 years of Irish beer consumption - that is a difficult one. The way I would read it is: the amount of beer the Irish drank between 1714 and 2014, That is a stock, OK.  (On the other hand, if the question was: it is worth more than the beer Irish drink over a period of 300 years, that would be a flow (per 300 years) - flow. Wrong)
4. Construction of interstate highways - stock,OK
5. Worldwide lottery sales - flow. Wrong
6. Global coffee industry There are two comparisons here:

The global coffee industry employ some 25 million people and generates $70 billion dollars a year. With a market cap of over $400 billion, Apple is worth more than 5 years of the coffee industry. In addition, Apple’s $46 billion in revenue in the last quarter eclipses the United States coffee industry value, estimated at $19 billion.

The first one compares Apple market cap: $400 bln, which is a stock, with 5 years of coffee sales, which is a flow. Wrong

The second compares Apple revenue - a flow, with the US coffee industry value. If this means the value of coffee sales, it is a flow so the comparison is ok. If that means the value of coffee companies in the US, that is a stock and the comparison is wrong.

The problems are two:

- the one you should avoid: mixing up stock and flows

- imprecise language. When you are driving and doing 110, you are driving 110 km/hour.

2014-08 Inequality

Inequality is the big problem now. Some call it the problem of the 21st century. Thomas Picketty, a French economist, wrote a book "Capital in the 21st century" which has become the most discussed economic book in many years. His  thesis is this: capital is taking a growing portion of output.
The reason: real wages grow at a rate smaller than the real interest rate. So if you have human capital but no money, your share of output falls.
The concern about inequality is the consequence of the fact that income inequality has been increasing in the last 30 years. Picketty argues that the trend towards more inequality has been interrupted by unusual events (Great Depression and the second world war) but it is a long-term trend. The level of income inequality now is back to what it was just before the Great Depression.
Note that median real incomes did not change much in the last 30 years, while incomes at the top of the distribution have been increasing. This is the case in the U.S. above all, but also in other developed countries, including Canada.

This Yahoo story is based the article Roger Martin, the former dean of Rotman  School of Management, UofT, points out to another reason for inequality. The current economy rewards talent, rather than accumulated capital. So people like LeBron James and Mark Zuckerberg earn a lot. Martin argues they earn too much.

Why does it all matter? Because there is evidence that the higher is inequality, the slower is economic growth.

2014-07. Scottish independence and currency

Here is a better article on Scottish choices
1. Currency union - but the British government and the Bank of England say they will not agree to that
2. Unilateral adoption of the British pound (Montenegro uses the Euro, and Panama uses the U.S. dollar)
That may be difficult as they will not control the money supply, and may face a shortage of banknotes
Also - no lender of last resort. If the banking system runs into trouble, it will be difficult to save it
3. Adopt the Euro
Scots are pro-European. But the process of adopting the Euro takes a few years, so it cannot be implemented right away.
Interesting point in the article: to allow independent Scotland into the EU, all members have to agree. Spain, which has its own separatist movement in Catalonia, may not.
4. Introduce own currency
Problems: it is hard to know how well it will work; at least for some time there will be a lot of uncertainty and so interest rates will have to be higher.
More importantly, if the separatists said now they want to introduce the Scottish Pound (how about the Sound for an abbreviation), the Yes vote will fail. People are scared of the idea of having a separate currency.

2014-06 Inside scoop: finally an Apple's wearable device

As I wrote last time, I have an inside scoop. Here is the mystery product, beyond iphone 6 and iwatch to be unveiled today

It is already in production

2014-05 How to deal with "too - big - to - fail" banks

The reason Lehman Brothers was allowed to fail was to avoid moral hazard and show that no bank is too big to fail. But the policy failed since the mess after Lehman collapse means a repeat is unlikely: if a big bank runs into trouble, it is now clear it will be saved to avoid a repeat of the Great Recession.

So what to do? Make the big banks safer by raising their capital requirements .

Right now bank reserves should exceed 7% of assets. An international organization, the Financial Stability Board, designated some banks as Globally Systematically Important Banks (G-SIB). The list of the banks is here (on page 3). Reserves of these banks should be higher, up to 9.5% of assets (note that banks sometimes hold excess reserves: JP Morgan's reserves are 9.8% of assets). The U.S. regulators consider an even higher requirement. Regulators require the extra reserves to reduce risk of a large bank failing.

There are two offsetting effects operating on large banks. They must hold more capital, reducing return on equity. On the other hand, since they are unlikely to fail, they can borrow money at lower rates. The net result is debatable but, I think, overall, it is good to be a big bank.

2014-04 Socialism, PLEASE, rest in peace

Venezuela, which has a socialist government, is in a terrible mess. It is in the news because a former minister wrote it should default on its debts. In principle it should be a rich country, since it has the the largest oil reserves in the world. But the government is mismanaging the economy. It controls prices, leading to shortages and waste. Venezuela has the cheapest gasoline in the world (here are some comparisons), but the government is unable to raise it. 

So what does the government do? It does not pay its bills. It owes suppliers huge amounts and so medication, flights and other goods and services are in short supply. In effect, it has defaulted internally, by not paying its domestic bills. But it still pays interest on bonds, to avoid an outright default. Interestingly, it stopped publishing economic data. Too embarrassing.

As long as international investors are willing to lend to Venezuela, this can go on for some time. And in fact they do, but the cost is high: "The extra yield investors demand to own Venezuelan sovereign bonds instead of Treasuries jumped 2.99 percentage points in the past month to 13.39 percentage points"

2014-03 Scottish Independence and the British Pound

A recent opinion poll showed, for the first time, that Scotland may vote for independence
The pound and shares of some banks fell as a result. Why? Uncertainty.
The central economic issue is currency. If Scotland separates it can introduce its own currency or try to stay with the pound. The third option: joining the Euro, is difficult as there is a long process involved.

Here is a Bloomberg article which compares this with Quebec

Just as it was the case with Quebec, the separatist side promises to keep the currency, while the central government says it will not allow that. In practice, Scotland can use the pound as long as it has sufficient supply of the actual banknotes. To secure the supply may be a bit tricky, since the Bank of England (note the name) may not be willing to send truckloads of banknotes to Scotland.

Why this discussion of using the pound? People do not like uncertainty. An introduction of a new currency may end in a large depreciation, with the Sound (Scottish Pound) falling a lot, making imported goods and services (think - tourism, Scotland is a small place with poor weather) becoming much more expensive.

2014-02 European Central Bank- continued

As I mentioned in class, this is an unusual posting. I numbered interesting passages in the text of the article and the numbered comments here refer to the numbers inserted in the article.

1. The Euro-zone economy is in a poor shape. Here is the comparison of changes in unemployment in the US and Eurozone since the Great Recession, from a presentation of Mario Draghi. And so Eurozone's central  bank - the ECB (European Central Bank), whose president is Mario Draghi, lowers short-term interest rates. This is standard monetary policy.

Here is a comparison of how the Eurozone has been doing since the Great Recession with the Great Depression

We analyze it in chapter 9 and discuss it in detail in chapter 10: Monetary policy.

2. Asset - based securities (ABS) are similar to bonds, in the sense that they pay interest for a specified period of time at a specified rate. The funds for interest payments come from interest received from the underlying assets. For example, student loan-based securities pay interest from repayment of student loans. These assets are risky since the number of people defaulting on student loans may suddenly increase.
The most popular type of ABS are mortgage based securities, simply because the mortgage loan volume is huge. Also, unlike with student loans, there is a collateral: if someone defaults on their mortgage, the house can be repossessed and sold, limiting losses.

We discuss this in chapter 1: The Great Recession. and in chapter 10: Monetary policy.

3. The Eurozone economy is in a poor shape and most countries suffer from very large debts. So the only option for stimulating the economy is monetary policy. The ECB promises to do what is needed.

We discuss it in chapter 10: Monetary policy and in chapter 11: Fiscal Policy, deficits and debt

4. Quantitative easing is a new type of monetary policies introduced during the Great Recession. In the past central banks would not buy ABS and similar securities because of the risk. As I mentioned in class, central banks have very little capital and so cannot take on risk. But once they reduced the policy rate to essentially zero, they needed new approaches.

That will be in chapter 10: Monetary policy

5. The U.S. has been using the unconventional policies big time. An increase in central bank assets raises liquidity in the markets and usually leads to inflation. As I mentioned in class, Germans are very averse to inflation.

We will talk about liquidity, money supply and inflation in chapter 3: Money.

6. Subprime loans were the major reason for the Great Recession.

We discuss them in chapter 1: The Great Recession.

7. It is the interest rate the ECB charges. And it shows the limit of traditional monetary policy, which involved reducing the interest rates. See point 1 above.

The problem with inability of further reducing the central bank  policy rate is called the zero - bound problem. We discuss it in chapter 10: Monetary policy

8. Very unusual policy. The goal is to force banks to lend, rather than park their funds at the ECB.

9. If interest rates go down, the currency depreciates.

We discuss it in chapter 4: Exchange rates.

10. If the currency depreciates, net exports rise.

We discuss it in chapter 4: Exchange rates and in chapter 9: The IS-IC model.

11. Inflation is too low. Everyone is scared of deflation.

The negative effect of deflation on unemployment is tenuous. What do we know about deflation? It happened on a large scale twice: during the Great Depression and in Japan's lost decade. It coincided with weak economy and high unemployment. But this does not imply causation.

To make a long story short, I had a cat. When it was young and tried to play with my keys, a car made some noise outside. The cat got scared, associated the keys with danger, and my keys was safe. He did not understand the difference between correlation and causation.

We discuss it in chapter 10: Monetary policy

12. If borrowers are perceived too risky, banks will not lend, making the task of stimulating the economy difficult.

We discuss it in chapter 1: The Great Recession.

Homework: check what happened with the exchange rate of the Euro last week. 
You can find it at Yahoo finance; just enter, in the search box on top, EURUSD=X or EURCAD=X or EURXXX=X where XXX stands for a currency abbreviation; you can find the abbreviations here

2014 - 01 European Central Bank to Start Asset Purchases After Further Rate Cut

This is likely the best article this term. It covers a lot of material we will be discussing:
- European debt problem
- Soverign debt crisis
- New approaches to monetary policy
- Lack of growth in Europe
- Interest rates and exchange rates
- Expansionary monetary policy
- Asset -based securities or collateralized debt obligations (for differences between ABS and CDO see here
- low supply of fcredit
- risky borrowers
- negative nominal interest rates
and so on.
As you can see, the only thing that is missing is details of what products Apple will introduce on September 9.
But I have an inside scoop. Watch this space on Tuesday.

Jurek's musings on economics Fall 2014 for ECO250 and 223

Welcome to the course blog. The way it works is this: I find interesting stories in newspapers, include links and provide comments. Then I talk about it at the beginning of the class.
You read the blog, preferably before class, in any case before exams, and
1. get interested in economics
2. read business sections and learn to understand what appears in good publications
3. learn to think critically and evaluate what you read, as there are serious errors even in the best papers, and errors are common in other publications
4. learn more economics
5. do well on exams.

About the last point: about 5%-10% of each exam will be based on blog entries. As there will be many entries I will let you know before exam which entries you can skip. The questions will be based on the comments to the articles and they will be easy to someone who read them, and difficult to figure out for someone who has not. In other words, low hanging fruit.

As classes are in the afternoon, I will read the morning papers and most of the blog will be based on what appeared that day. This means that the blog will not be synchronized with the course. I think current events are more interesting when they happen as we speak. For example the first entry deals with monetary policy which we will cover in November. If we waited till November, it would be old news.

Important There are two issues with newspaper articles: availability and permanency.

1. Availability. I will do my best to find articles in free sources. But with the paywall introduced by more and more publications, that is not always possible. The way to go around it is to use the possibility, provided by most sources, to read a fixed number of articles a year for free. If the limit is 10 and you use four browsers (Safari, Chrome, Firefox, IE) this is now 40 articles per computer. It is possible that some publications are available at university's computers. If you run into problems please let me know.

2. Permanency. Articles sometimes disappear from the web, especially for news agencies like AP, CP, Bloomberg, Reuters, which I will use since they provide free access. Also, news agencies often update the articles. The only way to avoid problems is to read the blog as early as possible or download the articles right away.