Chapter 7 Blog

Link: http://business.theglobeandmail.com/servlet/story/RTGAM.20090401.wcarney0401/BNStory/Business/home

Summary

Mark Carney, the governor of the Bank of Canada made a prediction that trends in the global economy will result in the recession persisting into the second half of the year during a speech delivered to a business audience in Yellowknife on Wednesday. Some of the factors hindering the economy include, weaker global growth, the selling off of inventories rather than new production, worsening labour markets and spare factory capacity which would cause the recession to extend further into the year. Mr Carney also made a remark that the contraction in the first quarter looks likely to be at its worse since 1961 where quarterly GDP was first collected. The International Monetary Fund and World Bank also made predictions that the world will shrink for the first time since World War Two. A large factor in Canada's economic recovery is dependant on the recovery of the global economy as 40 percent of Canada's gross domestic product is from the country's exports. This drop in trade will result in Canada's GDP to drop by 3 percent in 2009 and it also limits the growth next year to 0.3 percent according to the Organization for Economic Co-operation and Development (OECD). The OECD also made a comment that Stephen Harper should spend more to stimulate the economy and that Mark Carney should decrease borrowing costs. Carney has indeed lowered the lending rate by 4% since December 2007 which leaves it at a record low of 0.5 %. The central bank has devised a plan to lower market borrowing rates by buying securities such as government debt and corporate bonds. Carney concluded his speech by telling bankers that measures taken by Canada and other economies will take time to fully take effect and, also warned that lowering borrowing costs and increasing deficits can further damage consumer confidence and businesses.

Connection to Chapter 7

The main focus of this chapter is about the money supply and the Canadian Banking system. These two aspects of the Canadian economy play a large role in influencing the economy. As mentioned in the article, governments and central banks are relied upon to entice demand in order to stimulate the economy. In times of recession, the monetary policy of banks would be to increase the money supply as a means of providing an incentive for consumers to spend more. Another measure that banks take in times of recession is lowering interest/lending rates, like what Mr. Carney has done. The inverse relationship between interest rates and the demand for money can also be applied to analyze the monetary policy that will be implemented by the Bank of Canada. With lower interests, the demand for money goes up because the cost of borrowing it and taking out a loan is lowered. This will also encourage further spending by the consumers.

Reflection

I agree with Carney's last statement that the Bank of Canada should be prudent in making decisions regarding the monetary policy. Lowering interest rates will not necessarily result in increased GDP especially in times of recession where the psychology of consumers is to save rather than spend. I think we can also expect lower reserve rates in deposits during these periods of recession so that a larger loan can be taken out by the bank in order to encourage more spending. Banks should also be patient in allowing the measures taken by banks and governments around the world to take effect as continuing to lower interest rates can prove to be harmful to business and consumer confidence.

Chapter 6 Blog

Link:http://www.economist.com/displaystory.cfm?story_id=13248177


Summary


This article reports on the recent measures that the Bank of England has undertaken to ease the effects of the recession on the economy. On March 5th the Central Bank lowered its interest rates, bringing the base rate down to 0.5 %. This decline in interest rates began in October when it was at 5%. A new policy of "quantitative easing" has also been started which involves the government buying debt securities, and private assets for 75 billion pounds ($105 billion) and pay for this with their own money. Quantitative easing is a common practice when banks have lowered their interest rates to zero and they want to ease further. It is intended to increase the money supply. This policy was also implemented to counter deflation. Consumer price inflation experienced a drop from 5.2 % last autumn to 3% in the year of January. It is predicted that it will drop to 0.7 % by the end of 2009 and with an economy in debt like Britain's, deflation would result in a deeper hole. The Bank of England also expects GDP to decline by 3% in 2009, the steepest drop since the second world war. The main purpose of quantitative easing is to prevent the money supply from taking a large hit and at the same time boost GDP by providing a large supply of money.


Connection to Chapter 6


The key component of this chapter would be Gross Domestic Product. GDP is effected by trends in investment and savings. There is a positive relationship between GDP and investment, more investment resulting in an increase in GDP. The challenge posed by banks in times of recession would be to provide incentives for people to invest and that is the situation presented in the article. By decreasing interest rates, the Bank of England is enticing consumers into borrowing loans in order to invest and increase the GDP. In times of recession, people are inclined to save which lowers the aggregate demand and less money will circulate the business sector, lowering GDP. This chapter also discusses the business cycle and one of the theories associated with it would be the monetary theory. The monetary theory states that changes in the money supply are key factors in GDP. The policy of quantitative easing was implemented to influence the GDP by increasing the money supply in order to boost economic expansion. The quantitative easing policy also has the power to bring the multiplier into effect on GDP as investment and consumption spending would increase. The expenditure multiplier would be necessary to take into account when measuring how effective lowering interest rates would be.


Reflection


The fact that the Bank of England is trying to fight deflation is a testament to the state of the GDP level in England. I personally remain sceptical about how effective these new measures will be considering the tendency for people to save in these discretionary periods. Most people in periods of recession would probably be hesitant to borrow loans even if under low interest rates due to the chance that they would have a hard time paying it off. Indeed the Paradox of thrift could also be applied to the current recession. People continue to save but it lowers business activity resulting in increased unemployment and a decrease in their ability to save. This of course has consequences on GDP as shown in England and the response of the bank is to decrease interest rates and increase money supply. I am also concerned about the state of GDP in Canada as the recession is expected to get worse after growth in GDP is reported to have slowed down over the past couple of months. After reading this chapter and the article above it has become clearer to me the challenges that governments and banks face in guiding a country through a recession. It is not as easy as simply lowering interest rates as the psychological state of people during recession tells them to save. Overall, consumer confidence must be restored in order to pull the economy out of the recession but doing this is no easy task for the banks and government.