Global Economy

For those of you who have been watching the news recently, you should know that there is fear that the global economy could double-dip which the USA in serious risk. Below is a summary of the main uncertainties the global economy faces.

The IMF says…

· There is sluggish economic growth

· Governments need to rethink their policies

· The UK growth forecast needs to be reduced (and George Osborne said so too). Economic growth in the UK has been revised to a mere 1.1%

· Deficit reduction plan needs to be delayed

Eurozone

· Italian credit rating degraded

· Protests in Greece

· 40% of our exports go to the eurozone.

All advanced economies are facing tough times.

The UK government should focus more on capital spending (spending on infrastructure). This will stimulate the economy because infrastructure provides the correct conditions for business and enterprise to flourish. It will create jobs in the short run and long run, and should increase economic growth in the long run.

It's good to be on the ball with all the latest economic news.

The J Curve Effect

When imports and exports are less elastic, devaluation of the currency can lead to a worsening effect on the balance of payments (BoP). This is because as the exchange rate falls, imports are more expensive, thus spending more on imports results in a larger deficit. Demand for imports does not fall immediately after devaluation because:

·     There may be lack of substitutes available (e.g. raw materials, oil…)

·     Deals already agreed have to be fulfilled

·     Manufacturers of substitutes need time to adjust their manufacturing process/production.

After T1, spending on imports fall and the BoP deficit starts to improve. However this improvement may be short lived because higher import prices can lead to greater inflation, decreasing the country’s export competitiveness.

Open Economy/Closed Economy

The table below shows the cases for an open economy.



Case Study: Iceland

·     Deregulation of the financial system in 2000 led to a large growth in Iceland’s banks.

·     Iceland’s economy is small and so the banks expanded overseas and began to export financial services which enabled them to accumulate a lot of wealth (assets).

·     Because of this, Iceland began to import many luxury goods to maintain high standards of living for the rich population (Iceland’s HDI was the highest in the world in 2008).

·     In the economic crisis, Iceland’s banks also owned toxic assets thus the country’s financial system crashed and the economy shrunk.

·     The exchange rate fell.

·     Unemployment rose.

·     This case study is an argument against free trade and therefore for import controls because deregulation led to overexposure to free trade and capital. It argues the case against an open economy.