Seminar Tutorial 10 - Money & The Business

Cycle
Question 1:
Economists use some terms frequently. Be sure you fully understand their meaning and
provide short-form definitions for the following

a) GDP - GDP (gross domestic product) is the total value of all goods and services
produced within a country, within a specific time.

b) Inflation - inflation measures the rate of change of the general price level. Inflation
generally occurs to increasing price levels.

c) Hyperinflation - hyperinflation is an extreme form of inflation whereby the price level

increases at a very high rate, to a point where money becomes virtually worthless.

d) Stagflation - where an economy experiences both high inflation and low output (and thus
low employment levels) simultaneously.

Question 2:
Summarise and explain the different opinions in your lecture notes on why an economy may
fluctuate between upturns and downturns.

Wicksell’s cumulative process:

Theorised that money and credit have a huge impact on economic activity.
Extended on Böhm-Bawerk’s idea that interest was a payment for waiting, and that
interest rates are related to capital investment. Wicksell noticed how the economy
became more dependent on banks as the source for payment funds. Moreover, the
interest rate charged by banks didn’t reflect and equilibrium between saving and
investment.
Wicksell concluded that market reactions would lead further away from equilibrium
in the short-term causing fluctuations within the economy.
A rise in r/i should lead to a rise in savings as it becomes more profitable to save
rather than spend → however, production processes that take less time will be
cheaper as the cost of investments required for long-term processes increases for
producers → this typically leads to an equilibrium rate of interest whereby both
options are balanced → the market then reacts to any ‘fluctuations’- when the
interest rate is below eq then there will be a readjustment eq → however, if the
supply of credit from banks is highly elastic, then these fluctuations may not correct
themselves- i.e., supply might only respond, without demand for saving also
responding.
 In this case, Wicksell argued that a ‘cumulative process’ would occur until banks
had to raise interest rates and reduce lending in order to stay profitable.
This leads to almost a business-cycle-like cyclical changes in the rate of interest →
products that raise productivity would lead to an increased interest rate as more
people want to consume. However, these changes would take time to be
implemented, however cumulative rises and falls would be seen.
Austrian theory (monetary theory of the cycle):
Bankers had an incentive to keep interest rates low in order to stimulate higher
levels of borrowing.
Low interest rates lead to over-investment in capital compared to level of savings,
causing a rise in the cost of capital goods in comparison to consumer goods →
however, consumers are incentivised to consume as it’s cheap (low cost of
borrowing), leading to an excess in demand → this leads to inflation → as credit
levels in the economy rise, the inflationary situation will continue until credit reaches
a maximum, where r/i rises → this causes a fall in output (lowering production due
to increased cost of borrowing- lack of access to investment funds) and thus an
increase in unemployment → this would leave many goods and products of value
uncompleted and therefore worthless.
In essence, it is possible to sustain a ‘boom’ through credit expansion, but the
inevitable crash would be much greater- this is seen in 1920s USA.
Hayek and Mises instead advocated for a non-interventionist ‘neutral money’ policy
where the interest rate was set to keep the level of money income constant-
demand and supply are therefore balanced.
Swedish theory:
Countered the Austrian theory, stating that the natural money was dependent upon
expectations about the future.
Instead, they believed that an eq of savings and investment could happen at any
interest rate if the inflation rate was accounted for.
Only unexpected changes in price would disrupt the savings/investment
relationship.
Benjamin Anderson’s theory:
Believed that prices changed for reasons unrelated to monetary policy.
If money supply couldn’t vary, the velocity of circulation would just increase.
He explained that the great crash in 1920s happened due to an over-extension of
credit, like the Austrians.
Schumpeter’s theory:
Explained the depression was part of several previously statistically verified cycles.
Kodratiev long cycle- around 40 years- a technical innovation growth cycle.
Jugular cycle- 10 years- investments into fixed capital.
Mitchell-Parsons short-cycle- 40 months long
 Alvin Hanson added that a long-term decline in prices was caused by a global shortage
in gold.
Ralph Hawtrey believed that monetary policies could help stabilise the fluctuations but
couldn’t stabilise the economy as a whole.
Alfred Marshall

Question 3:
Briefly – in a nutshell - explain the difference in policy approaches to stimulating the
economy in an economic downturn between ‘Monetarists’ versus ‘Keynesians’.

Keynesians believe that fiscal policy is key to stimulating economic activity in a

recession whilst monetarists believe that fiscal policy simply causes inflation with no
long-term increase in output.
Keynesians advocate for increased government spending during recessions, whilst
monetarists prefer to run a balanced budget.
Monetarists generally reject any policy that targets a boost in aggregate demand as it
simply increases inflation, whereas Keynesians advocated stimulus via fiscal policy.

Question 4:
Explore some economic data. You may wish to include the images of these graphs for your
own
notes.
a) Easily interactive Long period growth data is available from the ‘Our world in data’
website:

i. Specifically look at GDP per capita in England (in 2013 prices) interactive graph:
https://ourworldindata.org/grapher/gdp-per-capita-in-the-uk-since-1270. What was the per
capita income in 1700, 1800, 1900, 2000? [Graph is clickable]

1700- £1,668.33

1800- £2,331.73

1900- £4,870.75

2000- £24,402.14

ii. Now let’s see how this compares with other countries by looking at the changes in income
around the world since 1950 (to 2016):
https://ourworldindata.org/uploads/2019/06/GDP-per-capita-horizontal-higher.png Which
country has the highest GDP per capita (in 2016)? What rank is the UK?

Highest GDP per capita, 2016- Norway ($76,397)

UK rank- 19th
iii. Use the interactive GDP per capita graph: https://ourworldindata.org/grapher/gdp-per-
capita-maddison?tab=chart&country=~GBR. Add onto a comparative chart: UK, Ireland,
Germany, Norway and USA (clicking on edit countries and regions) and set the timeline to
go from 1800. How does the UK’s experience compare to those countries?

The UK is below the other countries in GDP per Capita

Norway is increasing exponentially in the early 2000s
The UK is growing at a steady rate after experiencing a dip in GDP per capita during the
2008 financial crisis but has since managed to recover

b) The BBC website provides an historical peek at interest rates (with its no longer updated
economy tracker) https://www.bbc.co.uk/news/business-11013715 . For ease of access, I
have replicated the evolution of interest rates below.
Describe the key features of this graph:

The Bank of England interest rate remained fairly constant until around World War I,
where there was a continuous fluctuation from around 11% to 2%. This is likely due to a
sense of overproduction (high interest rates) also paired with low consumption rates
(low rates to encourage spending).
The rates once again saw a spike as a result of the Wall Street crash. This was due to a
lack of consumer confidence leading to low consumption. It once again hit a peak of
11%.
World War II saw a different interest rate response than WWI. Instead of the fluctuating
rates seen previously, there was a gradual increase of rates between 1939-1945. This
was likely due to the building-up of economy post-war and post-crash causing lower
interest rates to mover to a consumer-based economy as more developed economies
tend towards. It was during the inter-war years that that the rates hit a low of 2% and
raised to a peak of 17% during WW2.
Black Wednesday saw the value of the pound plummet, and with it consumer
confidence and spending. It is therefore clear as to why the interest rate hit a historic
low in an effort to boost consumption.

c) According to the UK Office of National statistics (ONS), Average (median) full time salary
in the UK was £479 per week in 2008 (before the impact of the financial crisis and
subsequent recession) and in 2022 it was £642. Use the Bank of England inflation tracker
[www.bankofengland.co.uk/monetary-policy/inflation/inflation-calculator] to calculate the
value of average earnings from 2008 to compare to 2022. Has median full time salary
increased or decreased over time? What is the rate of change in income?
Average earnings in 2008- £479, adjusted to 2018 inflation rate- £687.97
Inflation averaged 2.6% a year
The rate of change of income - 6.7% decrease in median full time salary.