2015-20 Interest rates and house prices

One of the biggest issues in Canada is the boom in house prices, especially in Vancouver and in Toronto.
Why are prices going up? The main reason is low interest rates. The rate on a 5 - year discount mortgage is now 2.5%; it was 5% before the Great Recession. Mortgage payment is the same on a loan 30% higher when the interest rate is 2.5% rather than 5%. And of course, as house prices go up, people rush into the market.
Why is this a problem? Because, eventually, interest rates will goup and the housing market may crash.
Also, with baby boomers starting to downsize, the demand for housing may start to fall.

2015-19 Monetary policy in Europe

Monetary  policy in Europe is facing problems which, until the Great Recession, did not really exist.
1. Inflation is too low
2. Interest rates on bank reserves are negative
3. Money supply increase is unprecedented

The head of the ECB, Mario Draghi, said on Friday that the economic situation warrants further monetary easing.
With interest rates on reserves already negative, the ECB may increase its quantitative easing program. In recent months the ECB has been buying 60 billion euro a month of mostly government bonds. It seems it is not enough; inflation in the Eurozone last month was 0.1%. The ECB target is inflation of just under 2%.
In the past, central banks worried about inflation being too high. Now they have two worries
1. Inflation is too low
2. It is hard to raise the inflation rate.
What is the problem with low inflation? Inflation expectations are also low, limiting how much the real interest rate can be reduced

2015-18 Why we talk so much about monetary policy, and other monetary policy issues

As you have noticed, i mention monetary policy a lot. This is because it is the only game in town. In this article the author simply says:

Eurozone economic growth eases despite low oil prices; central bank under pressure to do more

Not a word about fiscal policy. With debts much higher now than before the Great Recession, there is little scope for fiscal policy.

In the second article the FED chair, Janet Yellen, stresses the need to evaluate new approaches to monetary policy that were introduced in the Great Recession. We will be talking about these approaches today. Bottom line: we are not sure how well they work. Monetary policy is hard.

The third article discusses Yellen's opposition to  a proposal by some politicians that monetary policy should be run by an inflexible rule (we will discuss the benefits and problems of using a rule today or in the next lecture  and see an example of such rule in chapter 14). She has three arguments:

1. Such rule would be too inflexible and would not allow the FED to react to events

2. Politicians do not have sufficient knowledge to design a good rule

3. Such rule would undermine central bank independence.

2015-17 Economic effects of terrorist attacks

Economists predict a weaker economy in France, but no major effect in the medium or long term.

Tourism may fall. France is the biggest tourist destination in the world, so it may have an effect on France. People will go to restaurants less and may be less likely to spend lavishly for Christmas.

The effect on the stock market will likely be minor, if any, as the attacks happened on Friday after markets close in Europe, providing traders sufficient time to figure out what to do. Perhaps there will be some panic selling by retail investors, but large investors will use the opportunity to buy.

There were two major attacks in Europe before: in Spain in 2004 and in London in 2005.In neither case were there significant effects on the respective economies; both Spain and London are major tourist destinations.

On the other hand, the 9-11 attack had a significant effect on the US economy.

2015-16 Job market reports, monetary policy and expectations

Last week there were new job market reports in both Canada and the US. In Canada, the number of new jobs was 44 000, of which 32 000 was in the public sector, likely people hired to help with the federal election. The private economy employment increased by 12 000, in line with expectations. Employment in Alberta fell (those low oil prices) while employment in Ontario and BC increased.

The US job market report was, potentially, of more consequence. This is because everyone is speculating whether the US central bank will raise interest rates in December. US non-farm employment increased by almost 300 000, the highest amount since last December. Unemployment fell to 5%.

As the FED has a dual mandate (it wants low inflation and low unemployment), trades expect the short-term interest rates to be raised in December. This means other interest rates increase right away, and prices of bonds fall.

What are the consequences? As interest rates in the US rise, the US dollar appreciates (this is the interest-rate parity). The  price of oil in dollars falls since the price is in US dollars and appreciation of the US dollar raises the cost of oil in other currencies.

Note there are a couple of errors in the article.

The first: The euro fell to $1.708 , its lowest since April, and last traded down 1.31 percent at $1.0738 (should be 1.0708 - a big difference)
The second: average hourly earnings rose a respectable 9 cents (I have no idea what this should be)
So you should verify numbers you see, even from respectable sources (this one is from Reuters)..

2015-14 Global economy is weak

The global economy is weak. The weakness takes place despite the fact that

- the FED has not changed interest rate

- the Bank of Japan and the European Central Bank continue the policy of quantitative easing, i.e. buy various long-term assets to stimulate the economy

- the Chinese central bank recently reduced interest rates and reserve requirements.

Here is an amazing statistic:

"Appetite for safe assets is so strong in Europe that about 30 per cent of the $6.3 trillion of sovereign bonds in the euro area have negative yields, index data compiled by Bloomberg show. That means buyers who hold to maturity are willing to accept small losses in return for the promise that most of their money will be returned."

People are talking about the new normal, with low interest rares and low inflation rates.

Prices in Europe did not change in October after falling 0.1% in September. German exports are falling, and it looks like China will have the slowest growth in 25 years.

All this news suggests that the FED should wait with raising interest rates because demand is too weak to increase the inflation rate.

2015-13 US nearing full employment

According to a survey of economists, the US is approaching full employment.

The article provides a nice definition of full employment: "“Full employment” is a term economists use to signify an economy in balance: where there is no longer cyclical economic weakness, but also no pressures pushing the inflation rate ever higher. The term doesn't signify an economy in which everyone has a job, let alone a good one."

The unemployment rate in the US is 5.1%. During the Great recession it was 10%, so the decline since 2009 is 5%. In comparision, the unemployment rate in Canada during this period fell by less than 2%
Not everything is great, however. Participation rate, at 62.4% is the lowest since 1977, when a smaller proportion of women were in the labour force.
The participation rate has not been increasing. This is a surprise. Many economists thought the low participation rate following the Great Recession was due to discouraged workers, who would return to the labour force once the unemployment rate declines. But this has not happened.
One possible explanation is that more people retire before age 65 and that young people stay in school longer.
No wage increases. Another surprise is that wages remain flat despite the low unemployment rate. Some economists argue that wages will start to increase eventually; other point out to the increase in benefits.

2015-12 Growth projections for the advanced and emerging economies

We talked a few times about international linkages between countries. An article in the Economist focuses on international linkages between regions. It is based on the projections by the International Monetary Fund about growth in the next 5 years. There are three scenarios considered

• baseline
• there is a slowdown in emerging economies (a 4% drop in investment)
• there is a slowdown in emerging economies (a 4% drop in investment) and capital outflow from emerging economies.

As you can see from the graphs below, emerging economies slowdown would reduce growth quite a bit: by 2% in BRICS countries, 1% in other emerging economies and .3% in advanced economies. A panic which leads to a capital outflow from emerging economies would make things worse in all regions.

Note also that the predictions suggest convergence: poor countries are expected, in every scenario, to grow faster than rich countries.

2015-11 Monetary policy decision of the Bank of Canada

Here is a page on upcoming events from the Bank of Canada.
Today at 10:00 the Bank of Canada will announce its interest rate decision, and publish the Monetary Policy Report. As these announcements can influence markets, there is an embargo on releasing the information until 10am.
Note the frequency: the Bank of Canada announces the interest rate decision 8 times a year (about every 6 weeks). The dates of these decisions are pre-announced, as the Bank does not want to surprise the markets. In extraordinary situations, there may be an unscheduled decision.
The Monetary Policy Report is published 4 times a year. It contains the assessment of the economy by the Bank staff, and provides indication of the likely direction of monetary policy.

2015-10 What goes in the monetary policy decision

The US central bank (FED) has been considering an increase in interest rates. The policy rate has been near zero since 2008, i.e. the Great Recession. This is unprecedented, both in terms of level, and length. An increase in the policy rate would signal a return to normality.
These two articles summarize what the FED takes into account when deciding on whether to raise interest rates.

The first article points to
- retail sales
- produce price inflation
- lower investment in the energy sector due to falling energy prices

The second article points to
- growth in manufacturing
- the state of the labour market, as seen from the number of new unemployment claims.

Bottom line: economic activity is slowing down, while the labour market is tight, with record low new unemployment claims. The mixed signals make the FED task difficult.

2015-09 Exchange rates and arbitrage

Today we will be talking about purchasing power parity, which is a theory of exchange rate determination in the long run. If prices of goods in one country are lower than in another (i.e. the real exchange rate is less than one) arbitrage will often take place: goods will be bought in the cheaper country and exported to the more expensive country. The process will go on until price differences are eliminated, i.e.until the real exchange rate is one.
Here is an example. As the Canadian dollar depreciated, grey market exports of cars from Canada to the U.S. has been increasing.
Here is why. A certain car in the U.S. cost $US43 395, and in Canada $Can45 944. As the nominal exchange rate is $0.75, the real exchange rate is - well - something for you to figure out.

Why the purchasing power parity not always works? In class we will discuss several reasons. The article gives another: a concerted action by the manufacturer to prevent arbitrage. Nissan is threatening Canadian dealerships that sell to U.S. buyers with termination.

A car is an unusual product in that it has to be registered and is identifiable. So Nissan's tactic cannot be used for most goods and services. But, by differentiating products across countries (for example by providing only local warranties) manufacturers try to reduce arbitrage.

2015-08 Growth returns

The Canadian economy seems to be growing again. In the last two months the economy grew by 0.7%, which if continued would be about 4% per year. That is fast growth by past standards.
A few months ago, commentators worried about a recession. Why? They were using a simple definition of a recession: two consecutive quarters of output decline. But as you have seen, the actual definition of a recession is more complex. According to the C.D. Howe institute, a recession is a "pronounced, pervasive and persistent decline in aggregate economic activity"
Over the past two quarters, the decline in output was not very pronounced: it was only 0.1%-0.2%. To figure out whether the decline is persistent, one needs to wait a little. It turns out it was not persistent as the economy grew in June and July. And it was not pervasive because most of the decline was in the oil sector and in car production.
The author of the article argues that the decline in output before June was due to temporary factors: unscheduled maintenance at oil facilities in Alberta and a retooling of a Chrysler minivan plant. With the temporary factors gone, the GDP is growing again.

2015-07 The dollar is falling

On Tuesday, the Canadian dollar exchange rate in terms of the US dollar fell to the lowest level since 2004. This article discusses why, and what the consequences are:

Why?

• Resource prices are falling
• The Canadian economy is weak and the Bank of Canada is unlikely to raise interest rates in the near future

Consequences: the depreciation of the dollar

• cushions the blow to the economies of the oil-producing provinces
• leads to higher exports
• leads to the improvement to the tourism balance
• the economy will adjust from commodity-led growth to export-led growth

What is not mentioned is that some prices of imported products in Canada have been increasing. But inflation is not increasing significantly

2015-06 The effect of aging population

During the course we will be talking about a very important change: the fact that populations of developed countries are aging rapidly. This will have profound effect on taxes, government revenue, retirement age and income in the future. The obvious effect is that, as there will be fewer working people for each retired person, the portion of national income that will need to be transferred from the working population to the nonworking population will increase. This article from the Economist talks about other effects of aging population:

• higher real interest rates
• higher wages
• reduction in inequality

The article attributes the changes to the end of two big demographic shifts

• entry of baby-boomers to the labour force
• the addition of China and the former communist countries to the world economy, which greatly increased world workforce.

The increase in the number of workers led to slow wage growth, and imports from China reduced the cost of manufactured goods, producing deflationary pressures and allowing central banks to reduce interest rates. In addition, the Chinese saved a lot, leading to further decrease in interest rates. Slow wage growth reduced the share of wages in GDP and led to higher inequality. These trend will come to an end.

As the population is aging, the pool of savings fall since old people save less than middle-aged people. There will be pressure for wages to rise as old people will require more help. Higher wages will increase the share of labour income in GDP.

2015-05 The Volkswagen scandal

You may have heard of the Volkswagen scandal.
This article shows what happened with stock market price.
What is the business lesson?

2015-04 Latest inflation data

Here are the latest data on inflation (from August 2015):
Inflation = 1.3%
Food inflation = 3.6%
Gasoline inflation = -12.6%
Core inflation = 2.1% (was 2.4% last month)
Goal - inflation between 1% and 3%, preferably close to 2%
Bank of Canada thinks there were temporary factors that raised the inflation rate, in particular the depreciation of the Canadian dollar

2015-03 Thursday's question: will the FED raise interest rate today (they did not)

You can read this to see the predictions before the decision is announced later today.

There is a great graph in the article showing the rate since 1985.

It shows the Federal Funds Target Rate: the rate at which financial institutions lend reserves to each other overnight.

As you can see:

• the Federal Funds rate was greatly reduced (by 5%) in the recession that followed the bursting of stock market bubble in 2000

• the FED started increasing it in 2004, and it rose significantly (by 4%)

• When the Great recession hit, it very rapidly reduced (by 5%) the rate to just above zero

• The rate has been constant since 2008.

2015-02 Canada's lagging innovation and productivity

Not everything is rosy about the Canadian economy. According to the Wold Economic forum, OECD and IMF, Canada's innovation and business productivity performance is weak

• According to WEF, Canada is 26th for business innovation
• According to OECD: Canada is 22nd in business investment on research and development
• According to IMF: Canada is 17th in business productivity

Canadian small and medium size firms export relatively little and do not use cutting edge technology.
The author thinks that government policy directed specifically at innovation, and innovation clusters, would help.

2015-01 China's economy is slowing down

Last month the Chinese stock market fell dramatically, as investors became concerned that growth in China is slowing down. This article summarizes the most recent data.

• GDP may grow by less than 7% in 2015, the slowest since 1990

• Both imports and exports are falling, showing weak demand both in China and abroad

• Investment in fixed assets grew by 10.9%, slower than the expected 11.1%

• But retail sales grew by 10.8%, faster than expected 10.5%

1. Some notes on these numbers

• The Chinese economy grows incomparably faster than economies of developed countries

• Data are never simple: some things are better, some worse, and figuring out what is happening is not straightforward.

• A lot of attention is put on small deviations from expectations

2. The article also talks about macroeconomic policy:
"China’s central bank has lowered interest rates five times since November and has repeatedly relaxed banks’ reserve requirements in an effort to put a floor beneath the sputtering economy.[...]Further policy easing is widely expected in coming months, and the government is also trying to increase investment in infrastructure projects to support growth."

• To stimulate the economy, the central bank lowers interest rates. This is monetary policy.

• In addition, in China reserve requirements are lowered (there are no reserve requirements in Canada)

• Investment in infrastructure is another way to stimulate the economy. This is fiscal policy.

3. Finally, there is a point which shows that China matters and it affects other countries:

"Fears of a global economic slowdown led by China have roiled markets worldwide in recent weeks, prompting speculation that the Federal Reserve may hold off on raising interest rates this week."

The Federal Reserve (the US central bank) is making its policy decision this week. They were planning to raise the short-term interest rate (the Federal Funds rate). But, given the events in China, they may delay the increase.

By the way, the rate has been between 0% and 0.25% since the end of 2008.