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Articles for the ‘Economics for Business 6e: Ch 19’ Category

When pessimism takes over

Over 2015 quarter 3, stock markets around the world have seen their biggest falls for four years. As the BBC article states: ‘the numbers for the major markets from July to September make for sobering reading’.

  US Dow Jones: –7.9%
  UK FTSE 100: –7.04%
  Germany Dax: –11.74%
  Japan Nikkei: –14.47%
  Shanghai Composite: –24.69%

So can these falls be fully explained by the underlying economic situation or is there an element of over-correction, driven by pessimism? And, if so, will markets bounce back somewhat? Indeed, from 30 September to 2 October, markets did experience a rally. For example, the FTSE 100 rose from a low of 5877 on 29 September to close at 6130 on 3 October (a rise of 4.3%). But is this what is known as a ‘dead cat bounce’, which will see markets fall back again as pessimism once more takes hold?

As far as the global economic scenario is concerned, things have definitely darkened in the past few months. As Christine Lagarde, Managing Director of the IMF, said in an address in Washington ahead of the release of the IMF’s 6-monthly, World Economic Outlook:




Words such as these are bound to fuel an atmosphere of pessimism. Emerging economies are expected to see slowing economic growth for the fifth year in succession. And financial stability is still not yet assured despite efforts to repair balance sheets following the financial crash of 2008/9.

But as far as stock markets are concerned, the ECB is in the process of a massive quantitative easing programme, which will boost asset prices, and Japan looks as if it too will embark on a further round of QE. Interest rates remain very low, and, as we discussed in the blog Down down deeper and down, or a new Status Quo?, some central banks now have negative rates of interest. This makes shares relatively attractive for savers, so long as it is believed that they will rise over the medium term.

Then there is the question of speculation. The falls were partly due to people anticipating that share prices would fall. But has this led to overshooting, with prices set to rise again? Or, will pessimism set in once more as people become even gloomier about the world economy? If only I had a crystal ball!

Markets see their worst quarter in four years BBC News (1/10/15)
Weak Jobs Data Can’t Keep U.S. Stocks Down Wall Street Journal, Corrie Driebusch (2/10/15)
What the 3rd Quarter Tells Us About The Stock Market In October EFT Trends, Gary Gordon (2/10/15)
The bull market ahead: Why shares should make 6.7pc a year until 2025 The Telegraph, Kyle Caldwell (5/9/15)
Is the FTSE 100′s six year run at an end? The bull and bear points The Telegraph, Kyle Caldwell (24/8/15)

The stock market bull may not be dead yet CNNMoney (29/9/15)
IMF’s Lagarde: More volatility likely for emerging markets CNBC, Everett Rosenfeld (30/9/15)
What’s next for stocks after worst quarter in four year CNBC, Patti Domm (30/9/15)
Global markets to log worst quarter since 2011 CNBC, Nyshka Chandran (30/9/15)

Managing the Transition to a Healthier Global Economy IMF, Christine Lagarde (30/9/15)


  1. Distinguish between stabilising and destabilising speculation. Is it typical over a period of time that you will get both? Explain.
  2. What is meant by a ‘dead cat bounce’? How would you set about identifying whether a given rally was such a phenomenon?
  3. Examine the relationship between the state (and anticipated state) of the global economy and share prices.
  4. What is meant by (a) the dividend yield on a share; (b) the price/earnings ratio of a share? Investigate what has been happening to dividend yields and price/earnings ratios over the past few months. What is the relationship between dividend yields and share prices?
  5. Distinguish between bull and bear markets.
  6. What factors are likely to drive share prices (a) higher; (b) lower?
  7. Is now the time for investors to buy shares?
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The Shanghai Stock Exchange: a burst bubble?









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Predicting the stock market: it’s normally too late











  2. Why have bond yields fallen dramatically since 2008?
  6. Will ignoring stock market forecasts make people better investors?
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A new look for New Look?







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The risks of fossil fuel investment

Many UK coal mines closed in the 1970s and 80s. Coal extraction was too expensive in the UK to compete with cheap imported coal and many consumers were switching away from coal to cleaner fuels. Today many shale oil producers in the USA are finding that extraction has become unprofitable with oil prices having fallen by some 50% since mid-2014 (see A crude indicator of the economy (Part 2) and The price of oil in 2015 and beyond). So is it a bad idea to invest in fossil fuel production? Could such assets become unusable – what is known as ‘stranded assets‘?

In a speech on 3 March 2015, Confronting the challenges of tomorrow’s world, delivered at an insurance conference, Paul Fisher, Deputy Governor of the Bank of England, warned that a switch to both renewable sources of energy and actions to save energy could hit investors in fossil fuel companies.

‘One live risk right now is of insurers investing in assets that could be left ‘stranded’ by policy changes which limit the use of fossil fuels. As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies – a growing financial market in recent decades – may take a huge hit. There are already a few specific examples of this having happened.


Much of the known reserves of fossil fuels could not be used if climate change targets are to be met. And investment in the search for new reserves would be of little value unless they were very cheap to extract. But will climate change targets be met? That is hard to predict and depends on international political agreements and implementation, combined with technological developments in fields such as clean-burn technologies, carbon capture and renewable energy. The scale of these developments is uncertain. As Paul Fisher said in his speech:

‘Tomorrow’s world inevitably brings change. Some changes can be forecast, or guessed by extrapolating from what we know today. But there are, inevitably, the unknown unknowns which will help shape the future. … As an ex-forecaster I can tell you confidently that the only thing we can be certain of is that there will be changes that no one will predict.’

The following articles look at the speech and at the financial risks of fossil fuel investment. The Guardian article also provides links to some useful resources.

Bank of England warns of huge financial risk from fossil fuel investments The Guardian, Damian Carrington (3/3/15)
PRA warns insurers on fossil fuel assets Insurance Asset Risk (3/3/15)
Energy trends changing investment dynamics UPI, Daniel J. Graeber (3/3/15)

Confronting the challenges of tomorrow’s world Bank of England, Paul Fisher (3/3/15)


  1. What factors are taken into account by investors in fossil fuel assets?
  2. Why might a power station become a ‘stranded asset’?
  3. How is game theory relevant in understanding the process of climate change negotiations and the outcomes of such negotiations?
  4. What social functions are filled by insurance?
  5. Why does climate change impact on insurers on both sides of their balance sheets?
  6. What is the Prudential Regulation Authority (PRA)? What is its purpose?
  7. Explain what is meant by ‘unknown unknowns’. How do they differ from ‘known unknowns’?
  8. How do the arguments in the article and the speech relate to the controversy about investing in fracking in the UK?
  9. Explain and comment on the statement by World Bank President, Jim Yong Kim, that sooner rather than later, financial regulators must address the systemic risk associated with carbon-intensive activities in their economies.
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Getting out the crystal ball

The New Year is a time for reflection and prediction. What will the New Year bring? What does the longer-term future hold? Here are two articles from The Guardian that look into the future.

The first, by Larry Elliott, considers a number of scenarios and policy options. Although not totally doom laden, the article is not exactly cheery in its predictions. Perhaps ‘life will go on’ and the global economy will muddle through. But perhaps a new recession is around the corner or, even worse, the world is at a tipping point when things are fundamentally changing. Unless policy-makers are careful, clever and co-ordinated, perhaps a new dark age may be looming. But who knows?

Which brings us to the second article, by Gaby Hinsliff. This argues that people are pretty hopeless at predicting. “History is littered with supposed dead certs that didn’t happen – Greece leaving the euro, the premature collapse of the coalition – and wholly unimagined events that came to pass.” And economists and financial experts are little better.

Two years ago, The Observer challenged a panel of City investors to pick a portfolio of stocks and rated their performance against that of Orlando, a ginger cat who selected his portfolio by tossing a toy mouse at a sheet of paper. Inevitably, the cat triumphed.

But is this fair? If capital markets are relatively efficient, stock prices today already reflect knowable information about the future, but clearly not unknowable information.

It’s the same with economies. When information is already to hand, such as a pre-announced tax change, then its effects, ceteris paribus, can be estimated – at least roughly.

But it’s the ‘ceteris paribus‘ assumption that’s the problem. Other things are not equal. The world is constantly changing and there are all sorts of unpredictable events that will influence the outcomes of economic policy and of economic decisions more generally. And central to the problem are people’s attitudes and confidence. Mood can swing quite dramatically, from irrational exuberance to deep pessimism. And such mood changes – often triggered by some exogenous factor, such as an international dispute, an election or unexpected economic news – can rapidly gather momentum and have significant effects.

Predicting the long-term future is both easier and more difficult: easier, in that short-term cyclical effects are less relevant; more difficult in that changes that have not yet happened, such as technological changes or changes in working practices, may themselves be key determinants of the future global economy.

One of the most salutary lessons is to look at predictions made in the past about the world today and at just how wrong they have proved to be. Perhaps we need to call on Orlando more frequently.

Why ‘life will go on’ thesis about global economy might not pass muster in 2015 The Guardian, Larry Elliott (28/12/14)
Who knows what the new year holds? Certainly none of us The Guardian, Gaby Hinsliff (26/12/14)


  1. Give some examples of factors that could have a major influence on the global economy, but which are unpredictable.
  2. Is economic forecasting still worthwhile? Explain.
  3. Look at some macroeconomic forecasts made in the past about the world today. You might want to look at forecasts of agencies such as the IMF, the OECD, the World Bank and the European Commission. You can find links in the Economics Network’s Economic Data freely available online. Explain why such forecasts have differed from the actual outcome.
  4. Why, if capital markets were perfect, might Orlando be just as good as a top investment manager at predicting the future course of share prices?
  5. In what ways is economic forecasting similar to and different from weather forecasting in its methods, its use of data and its reliability?
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A take-over between medical giants












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Pensioner hazard

In his Budget on March 19, the Chancellor of the Exchequer, George Osborne, announced fundamental changes to the way people access their pensions. Previously, many people with pension savings were forced to buy an annuity. These pay a set amount of income per month from retirement for the remainder of a person’s life.

But, with annuity rates (along with other interest rates) being at historically low levels, many pensioners have struggled to make ends meet. Even those whose pension pots did not require them to buy an annuity were limited in the amount they could withdraw each year unless they had other guaranteed income of over £20,000.

Now pensioners will no longer be required to buy an annuity and they will have much greater flexibility in accessing their pensions. As the Treasury website states:

This means that people can choose how they access their defined contribution pension savings; for example they could take all their pension savings as a lump sum, draw them down over time, or buy an annuity.

While many have greeted the news as a liberation of the pensions market, there is also the worry that this has created a moral hazard. When people retire, will they be tempted to blow their savings on foreign travel, a new car or other luxuries? And then, when their pension pot has dwindled and their health is failing, will they then be forced to rely on the state to fund their care?

But even if pensioners resist the urge to go on an immediate spending spree, there are still large risks in giving people the freedom to spend their pension savings as they choose. As the Scotsman article below states:

The risks are all too obvious. Behaviour will change. People who no longer have to buy an annuity will not do so but will then be left with a pile of cash. What to do with it? Spend it? Invest it? There are many new risky choices. But the biggest of all can be summed up in one fact: when we retire our life expectancy continues to grow. For every day we live after 65 it increases by six and a half hours. That’s right – an extra two-and-a-half years every decade.

The glory of an annuity is it pays you an income for every year you live – no matter how long. The problem with cash is that it runs out. Already the respected Institute for Fiscal Studies (IFS) has said that the reform ‘depends on highly uncertain behavioural assumptions about when people take the money’. And that ‘there is a market failure here. There will be losers from this policy’.

We do not have perfect knowledge about how long we will live or even how long we can be expected to live given our circumstances. Many people are likely to suffer from a form of myopia that makes them blind to the future: “We’re likely to be dead before the money has run out”; or “Let’s enjoy ourselves now while we still can”; or “We’ll worry about the future when it comes”.

The point is that there are various market failings in the market for pensions and savings. Will the decisions of the Chancellor have made them better or worse?

Pension shakeup in budget leaves £14bn annuities industry reeling The Guardian, Patrick Collinson (20/3/14)
Chancellor vows to scrap compulsory annuities in pensions overhaul The Guardian, Patrick Collinson and Harriet Meyer (19/3/14)
Labour backs principle of George Osborne’s pension shakeup The Guardian, Rowena Mason (23/3/14)
Osborne’s pensions overhaul may mean there is little left for future rainy days The Guardian, Phillip Inman (24/3/14)
Let’s celebrate the Chancellor’s bravery on pensions – now perhaps the Government can tackle other mighty vested interests Independent on Sunday, Mary Dejevsky (23/3/14)
A vote-buying Budget The Scotsman, John McTernan (21/3/14)
L&G warns on mis-selling risks of pension changes The Telegraph, Alistair Osborne (26/3/14)
Budget 2014: Pension firms stabilise after £5 billion sell off Interactive Investor, Ceri Jones (20/3/14)

Budget publications
Budget 2014: pensions and saving policies Institute for Fiscal Studies, Carl Emmerson (20/3/14)
Budget 2014: documents HM Treasury (March 2014)
Freedom and choice in pensions HM Treasury (March 2014)


  1. What market failures are there in the market for pensions?
  2. To what extent will the new measures help to tackle the existing market failures in the pension industry?
  3. Explain the concept of moral hazard. To what extent will the new pension arrangements create a moral hazard?
  4. Who will be the losers from the new arrangements?
  5. Assume that you have a choice of how much to pay into a pension scheme. What is likely to determine how much you will choose to pay?
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“Why buy a football club?”, asks Linda Yueh







  1. How can the returns to investment be measured?
  2. How can a company’s operating profit be calculated?
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Making economic sense of politicians’ statements

Politicians often make use of economic statistics to promote their point of view. A good example is a claim made by the UK Prime Minister on 23 January 2014. According to the latest statistics, he said, most British workers have seen their take-home pay rise in real terms. The Labour party countered this by arguing that incomes are not keeping up with prices.

So who is right? Studying economics and being familiar with analysing economic data should help you answer this question. Not surprisingly, the answer depends on just how you define the issue and what datasets you use.

The Prime Minister was referring to National Statistics’ Annual Survey of Hours and Earnings (ASHE). This shows that in April 2013 median gross weekly earnings for full-time employees were £517.5, up 2.25% from £506.10 in 2012, and mean gross weekly earnings for full-time employees were £620.30, up 2.06% from £607.80 in 2012 (see Table 1.1a in the dataset). CPI inflation over this period was 2.4%, representing a real fall in median gross weekly earnings of 0.15% and mean gross weekly earnings of 0.34%.

But when adjustments are made for increases in personal income tax allowances, then, according to the government, except for the richest 10% of the working population, people had an average increase in real take-home pay of 1.1%.

But does this paint the complete picture? Critics of the government’s claim that people are ‘better off’, make the following points.

First, the ASHE dataset is for the year ending April 2013. The ONS publishes other datasets that show that real wages have fallen faster since then. The Earnings and Working Hours datasets, published monthly, currently go up to November 2013. The chart shows real wages from January 2005 to November 2013 (with CPI = 100 in December 2013). You can see that the downward trend resumed after mid 2013. In the year to November 2013, nominal average weekly earnings rose by 0.9%, while CPI inflation was 2.1%. Thus real weekly earnings fell by 1.2% over the period (click here for a PowerPoint of the chart).

Second, there is the question of whether CPI or RPI inflation should be used in calculating real wages. RPI inflation was 2.9% (compared to CPI inflation of 2.4%) in the year to April 2013. The chart shows weekly earnings adjusted for both CPI and RPI.

Third, if, instead of looking at gross real wages, the effect of income tax and national insurance changes are taken into account, then benefit changes ought also to be taken into account. Some benefits, such as tax credits and child benefit were cut in the year to April 2013.

Fourth, looking at just one year (and not even the latest 12 months) gives a very partial picture. It is better to look at a longer period and see what the trends are. The chart shows the period from 2005. Real wages (CPI adjusted) are 8.0% lower than at the peak (at the beginning of 2009) and 5.0% lower than at the time of the election in 2010. The differences are even greater if RPI-adjusted wages are used.

But even if the claim that real incomes are rising is open to a number of objections, it may be that as the recovery begins to gather pace, real incomes will indeed begin to rise. But to assess whether this is so will require a careful analysis of the statistics when they become available.

UK pay rising in real terms, says coalition BBC News (24/1/14)
Are we really any better off than we were? BBC News, Brian Milligan (24/1/14)
Government take-home pay figures ‘perfectly sensible’ BBC Today Programme, Paul Johnson (24/1/14)
Take-Home Pay ‘Rising Faster Than Prices’ Sky News, Darren McCaffrey (25/1/14)
David Cameron hails the start of ‘recovery for all’ The Telegraph, Peter Dominiczak (23/1/14)
Is take-home pay improving? The answer is anything but simple The Guardian, Phillip Inman and Katie Allen (24/1/14)
Cameron’s ‘good news’ about rising incomes is misleading says Labour The Guardian, Rowena Mason (24/1/14)
The Tories’ claim that living standards have risen is nonsense on stilts New Statesman, George Eaton (24/1/14)
FactCheck: Conservative claims on rising living standards Channel 4 News, Patrick Worrall (25/1/14)
Living standards squeeze continues in UK, says IFS BBC News (31/1/14)
Richest have seen biggest cash income squeeze but poorest have faced higher inflation IFS Press Release (31/1/14)

Average Weekly Earnings dataset ONS (22/1/14)
Annual Survey of Hours and Earnings, 2013 Provisional Results ONS (12/12/13)
Consumer Price Inflation, December 2013 ONS (14/1/14)
Inequality and Poverty Spreadsheet Institute for Fiscal Studies
An Examination of Falling Real Wages, 2010 to 2013 ONS (31/1/14)


  1. Why are mean weekly earnings higher than median weekly earnings?
  2. Explain the difference between RPI and CPI. Which is the more appropriate index for determining changes in real incomes?
  3. Find out what benefit changes have taken place over the past two years and how they have affected household incomes.
  4. How have gross weekly earnings changed for the different income groups? (The ASHE gives figures for decile groups.)
  5. Which is better for assessing changes in incomes: weekly earnings or hourly earnings?
  6. How would you define a change in living standards? What data would you need to be able to assess whether living standards have increased or decreased?
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