Iranian-Saudi deadlock causes OPEC oil talks breakdown
Link to article
On 17 April 2016, officials from the 18 oil producing countries failed to reach an agreement to freeze oil production which will see oil oversupply continue to be a prevalent problem within the global economy. The idea of an oil production freeze first arose when oil prices fell below $30 a barrel in February. Saudi Arabia refused to agree to the output freeze unless Iran also agreed.
How does this relate to the HSC syllabus?
- Oil prices in 2016 have fallen as a result of excess supply in the market as oil producers significantly increased production. This supply outstripped faltering demand from the market for oil, causing prices to fall (Preliminary Topic 3 – Markets).
- An oil production freeze would have limited supply. With supply staying flat, demand for oil throughout the world economy was expected to gradually increase and ‘catch up’ to supply, bringing oil to equilibrium at a higher price (Preliminary Topic 3 – Markets).
- Low oil prices have had significant ramifications upon various economies:
- In the US, low oil prices have contributed to flat inflation and the risk of deflation. Since oil is used in the production of most goods and services, the cost of production has significantly decreased, causing the prices of goods and services to decrease therefore lowering the price level (HSC Topic 3 – Economic Issues). Decreasing price levels, a sign of deflationary pressures is more harmful to the economy than inflationary pressures since monetary policy is better equipped to reduce inflation.
- In emerging economies which produce oil, lower prices have damaged their exports and economic growth. Given that oil prices are lower, revenues from exports are lower, causing the value of exports to decrease in the short term and therefore aggregate demand to decrease. Saudi Arabia, as the second largest oil producer may have less to lose from failure of the OPEC talks since it benefits from economies of scale causing its costs for production of a barrel to remain low. Other OPEC members, such as Venezuela and Algeria, however, have not been able to reduce their costs and are suffering from lower export profits.
Reserve Bank’s Glenn Stevens shoots down ‘helicopter money’ desperados
Link to article
Glenn Stevens, governor of the Reserve Bank of Australia, has criticised the prospect of central banks using ‘helicopter money’ to boost flat global growth and inflation. It has been acknowledged that traditional monetary policy – adjusting the cash rate – is increasingly inadequate in solving the problems plaguing the global economy. Stevens commented that once helicopter money starts, history shows that it is hard to stop. He contends that governments still have the option of borrowing from financial markets to fund infrastructure projects. Stevens emphasises the need for governments to implement microeconomic policy including reducing protection that impedes productivity or slowing the transition from old industries to new.
How does this relate to the HSC syllabus?
- Helicopter money refers to when the central bank directly transfers money into consumers’ accounts, or finances tax breaks or government spending. This directly increases aggregate demand as money from the central bank is provided to consumers which increases their disposable income and therefore increases consumption. Furthermore, financing government spending enables the government to increase government spending without sacrificing the budget balance as funds are provided from the central bank. Since consumption and government spending is increased, aggregate demand will increase (AD = C + I + G + X – M) and by the multiplier effect, output will increase leading to economic growth (HSC Topic 3 – Economic Issues).
- Helicopter money is considered a more desperate measure for monetary policy than quantitative easing. Quantitative easing (QE) is a form of monetary policy that the European Central Bank, the Federal Reserve (US Central Bank) and Bank of Japan have implemented to stimulate their economies during and after the GFC. It involves the central bank buying government bonds using its bank reserves which increases the supply of money in the financial system. This means that consumers and businesses have easier access to credit which will encourage consumption and investment in the economy therefore increasing aggregate demand and economic growth (HSC Topic 3 – Economic Issues; HSC Topic 4 – Economic Policies and Management). Similar to traditional monetary policy where interest rates are reduced to stimulate the economy (loosening stance), QE stimulates the economy stimulates the economy through the transmission mechanism whereby money is accessed for lower rates within the financial system. Helicopter money, on the other hand, is a direct transferral of funds which is likely to have a greater impact on consumption and therefore economic growth.
- Mario Draghi, president of the European Central Bank, raised the prospect of using helicopter money since loosened monetary policy including European interest rates are now in negative territory and QE implemented since 2015 have not been effective in stimulating economic growth and inflation within the European region (HSC Topic 4 – Economic Policies and Management). The German Bundesbank has commented that use of helicopter money would bankrupt monetary policy and severely damage central bank balance sheets given that the central bank is injecting more money into the economy.
- Implementation of helicopter money runs the risk of higher long term inflation as it involves directly injecting money into the economy. An increase in money supply can cause monetary inflation. In the long term, excess supply of money will increase price levels, causing inflation (HSC Topic 3 – Economic Issues).
- During WWI, Germany was financing its military expenses by increasing its printing of banknotes, increasing money supply in the economy and caused hyperinflation. In 1922, a load of bread cost 163 marks. By November 1923, a loaf of bread cost 200 000 000 000 marks as price levels inflated.
- Stevens suggested other policy measures, mostly concerning fiscal policy, to stimulate the economy before resorting to helicopter money:
- Governments increasing their borrowing to fund infrastructure spending. Increasing government spending will increase aggregate demand, therefore increasing economic growth via the multiplier effect (HSC Topic 3 – Economic Issues). However, given the sovereign debt crisis, governments are now less reluctant to increase their deficits and some (e.g. Greece) agreed to implement austerity measures in exchange for funds from the IMF to repay their government debts.
- Implementing microeconomic reform. Microeconomic reform, including deregulating uncompetitive industries will increase aggregate supply in the long term as companies are exposed to more competition and are required to become more efficient to remain profitable (HSC Topic 4 – Economic Policies and Management). There have been calls in the global economy to increase microeconomic reform, especially in China as economists have commented that its current fiscal spending is aimed at increasing short term economic growth and is stalling long term goals for transitioning the economy and stabilising its banking system. So far, Mexico has been one of the few economies to implement microeconomic reforms through exposing its monopoly energy and telecommunications sectors to competition and loosening unfair dismissal laws. However, microeconomic reform has a long time lag which reduces their appeal to governments since short term growth prospects remain low.
Theresa Dang is an economics mentor at Keystone Education. She attended Sydney Girls High and achieved an ATAR of 99.70 in 2012. She is now studying Commerce and Law at the University of Sydney. She has experience in a global technology firm and a mutual fund.
Gary Liang is the founder and director of Keystone Education. He attended Sydney Boys High and achieved an ATAR of 99.95 in 2012. He achieved 5 state ranks in Mathematics, Mathematics Ext 1, Mathematics Ext 2, Chemistry and Economics. He is now studying Economics and Science (Advanced Mathematics) at the UNSW Australia, where he is the recipient of four scholarships.