Business-cycle and Ricardian-equivalence

The business cycle is an important objective to refer in order to operate an economic policy. Controlling business cycle is a significant policy for government because during the recession, government inevitably have to spend for the social security due to rise in both unemployment rate and the absolute poverty rate i.e. fall in the average income level. These factors are very crucial elements in economy because these factors are (In particular, unemployment is) a lugging indicator in economy. There are two main government demand management policies intervening into the business cycle; the monetary policy and the fiscal policy.

Some economists put priority on the counter-cyclical government expenditure plan. This policy connotes the fiscal policy is effective to control the business cycle. This reason is based on Keynesian theory denoting that the liquidity of money supply by the monetary policy is ineffective. These economists believe that the increase in government expenditure helps to overwhelm economic recession rather than the extra cash flow. Furthermore, the tax cannot be increased during the recession time as tax rise may perpetuate the recession. Therefore, they support to reduce the tax in order to stimulate the economic activity and incur national debt in order to cover the cost for the government expenditure.

By contrast, this point of view has been contradicted by Neoclassical economists. According to the Neoclassical point of view, the tax deduction does not have much impact on economy. The reason is that individuals may prefer save the amount of extra income from tax deduction to predict their extra expenditure for the interest payment for the government debt. This theory is called "Ricardian Equivalence".



Focusing on the graph, individuals prefer spending for consumption at both current and future time at the level of their utility curve. Therefore, although there is an tax deduction it does not have any effect on the current consumption level and eventually they still have to pay the interest payment through taxation in order to pay back for the debt incurred in the past. Thus, Ricardian equivalence states that the fiscal plan should be fixed over time.

Neoclassical theorists put emphasis on the monetary policy and the supply-side reforms in order to tackle with the recession.


Nevertheless, there has been a counter argument against Ricardian equivalence. Some economists argued that Ricardian equivalence might be true if the recession is not serious and the absolute poverty level is lower. Otherwise, tax deduction and
debt incuring are required.



Focusing on the graph above, if individuals have not gained enough income to consume, the extra tax deduction can increase the current consumption level because it expands the borrowing constraint. During the recession, some individuals may face this borrowing constraint which denotes the incapability of their income to both spend and save. Therefore, the Recardian equivalence might be contradicted in terms of the aspect that unless tax deduction and debt incurring take place, it may induce the recession lugging.

Currently... Septermber-October 2007

Hi everyone! I have not been able to update this blog for a while. Actually my course in uni is so tough that I continuously need to revise it. Furthremore, I am working at the part-time job about 21 hours a week. Therefore, I tend to be too preoccupied to update decent and academic document.

However, as the midterm break is coming soon I may have much more times for the update and I have got a quite interesting topic to write about! The topic is gonna be an "Economic Theory". I will introduce an economic policy of Hayato Ikeda the former prime minister with refering to Kenynesian economic growth theory.


* In addition: I attach a copy of one of my uni course works which is one of the most interesting one.

"Labour economics: Wage Cyclicality"

In terms of Keynesian Theory of “sticky wage”, the wage is counter-cyclical by means of the business cycle. Keynesian theory adjusts wage is fixed because wage is determined by a contract for a certain period so it hardly changes. Unlike the classical theory which denotes the “neutrality of money”, Keynesian theory indicates money supply influences an economic growth and the value of wage comparing to a current inflation rate. This theory clarifies that change in the price level influences how nominal wage, which is the actual wage individuals are paid, is worth, and then refers to “real wage” which is denoted as nominal wage divided by price inflation.



Focusing on the graph above, as an economic growth, implies aggregate demand rises from AD0 to AD1, occurs price rises from P0 to P1. Simultaneously, labour supply curve goes rightward alongside labour demand because more individuals are now willing to participate in an economic activity. All in all, price rise lowers real wage (W/P), which implies nominal wage is less worth than the current price level. On the other hand, economic recession causes price goes down which create aggregate demand goes down. This shifts labour supply to the leftward alongside labour demand because individuals are more likely to be expelled from labour market because of job loss and rise in real wage. J M Keynes put emphasis on the impact of real wage during the recession. He inferred as price level goes down revenues of sales goes down and the value of nominal wage which is fixed by contracts is higher comparing to the current price level. Therefore, employers are willing to cut down numbers of employees due to the rise in their cost coverage.




Real wage is the measure how nominal wage is worth comparing to the current price level. The reason why government policy makers care about the real wage level is it causes a fluctuation in employment rate. The rising real wage during a particular recession period causes rise in unemployment. Unemployment is quite lagging so then affects to remains an unemployment rate higher than expected in later periods. People might be used to being unemployed and structural unemployment is concerned after some individuals are unemployed for a relatively longer period.

≫ Keynesian theory highly put emphasis on wage counter-cyclicality along the business cycle
- It does not account either change in labourers demanded or wage pro-cyclicality

- Wage is fixed by contract
- During the recession price keeps going down due to the pessimism about future
- “Exogenous fall in investment” causes economic growth more stagnated i.e.

- Lowering interest-rate is less effective because of the pessimism
- Fiscal policy, creating public sector jobs and taxation policy, is more affective

≫ Friedmanite theory assumes wage is more likely counter-cyclical
- During the growth, technological advance may causes wage pro-cyclicality due to a rise in demand of labourers

- Although wage is reasonably flexible but there is a gap between the price inflation rate and the wage inflation late e.g. Price (5%); Nominal-Wage (2%)
- Lack of Rationale: During the recession, the real price fall can be lower than expected
- Monetary policy is affective in the short-run
- Information should promote the rational expectation.

Major Richard Sharpe, 95th Rifles!!

"Richard Sharpe, 95th Rifles!"

Ummmmm, as I have been reading Sharpe series, I tend to image a lot about Sharpe's 95th rifles' actions. Even I tend to a wee bit feel like Richard Sharpe especcially when I am in a hard mission in my daily life, and then I tend to pretend like holding a rifle and swinging a sword :) hahahahahaha.

Sharpe is a series of novel writing about success story of an ambitious and generous British man called Richard Sharpe. Sharpe was originally born as an illegitimate son, and he volunteered as a private in British Army during Napoleonic War period. He started from Private, and then he has been gradually promoted to Sergeant, Lieutenant, Captain, and then to Major. In Sharpe's Waterloo, he was finally promoted to Lieutenant Colonel!

This novel and DVD is highly recommendable to practice the English of Millitary, Social Class, Romance and historical aspects of Napoleonic period! Highly recommendable!!



Rifles! Make Ready! Fire!!!!!!!!

Mechanism of Deflation spiral and critic of Japanese policies --- Sequel

Speaking of the motivation of labour correlated to the wage level, this has been explained by the school of marginal theory referring to the graph below:



The propensity to allocate time to labouring can depend on the wage incentive. During the wage level is lower, the correlation of labouring time and wage is highly positive, which implies people tend to work harder as wage goes up. Also, most of people appreciate that if individuals earn extraordinary high wage the correlation of labouring time and wage can be negative as these individuals hold enough cash already to sustain their minimum standard of living by working little. But this situation is not the situation of majority of individuals so this essay ignores this part, then it focuses more on the lower wage earners and individuals those earn about between the slightly lower and moderately higher than average. The efficient wage level is where labourers are encouraged to allocate time to work at the efficient level whenever the wage level is, which implies the wage elasticity of supply is perfectly inelastic. At this level, the unemployment rate reaches to the natural rate which denotes the level of economic activity is moderate and stable. However it is quite difficult to detect the stationary point between the positive correlating point and the perfect inelastic point, where is supposed to be a most suitable point to settle the minimum-wage level. Furthermore, if economists overestimate this point, it harms the supply-side, which is the side employs labourers from the labour market, and encourages employers to hire less labourers therefore conversely increases the unemployment rate. Thus, this situation is more likely to concern an expected simultaneous rise in economic growth and wage inflation. The economic growth which does not stimulate rise in the wage level in the lower than average occurs in current Japanese economy. As it explained in the prequel the deflation spiral instigates the situation unamendable to decrease the involuntary unemployment rate and the long term cause to induce the recession again.

In order to eliminate the situation Japanese economy has been in, both the change in labour laws and the encouraged price inflation are recommendable. During the operation of Zero-Interest-rate policy some economists suggested to operate the fiscal intervention into the private market in order to stimulate both the efficient economic growth, this connotation implies the situation in which the economic growth benefits social stability and environmental protection, and reduce the unemployment. In the situation where economic growth occurs but the price inflation is stagnated, the amendment of labour law can be the priority over the fiscal intervention. In order to distort the deflation spiral concerning to the lowering unemployment, the rise in minimum wage at the moderate level is insisted and the reinforcement of employment contracts to promote flexibility for labourers to secure appropriate labouring time and proper wage paid or alter a job is inevitably required. By means of the fiscal policy, the government could have increased the public sector jobs which can employ potential labourers who were reluctant to be employed by the private sector due to the current situation or invested into the private sector industries which encourages positive externalities like investing for venture businesses to encourage the market competition, improving and advancing the education level, reducing pollution level, increasing sufficiency rate of agricultural products, etc. Also an increase in public sector jobs may stimulate the rise in demand of labourers in labour market, which keeps the wage level up and then prevents the deflation spiral more likely.

By contrast, although this essay puts emphasis on the fiscal intervention into market in order to rise the demand of labourers and then accelerate the price inflation level it also warns the “excess” fiscal intervention. For example, Japanese Communist Party claims, aiming to increase public service, and introduction of universal coverage of the health service and a free education system, to inevitably increase the tax revenue. This top up of tax revenue takes the stagnation of the GDP growth for granted with intend to focus on the long run growth of both business and society. This is a typical Neo-Marxist of economic policy. We post modern Keynesians indeed contradict this opportunistic focus on the long run expectation of economic growth and the abandoned short run focus. The theory introduced in this essay affirms an importance of the budget balance of a proportion of GDP growth and the government expenditure. Although as same as Japanese Communist Party the theory of this statement regards high of the social stability, it strongly insists on both a non-volatile and upward economic growth and a deliberate fiscal intervention rather than a volatile economic growth.



Focusing on the graph above,

Currently... August 2007

Hi everyone! I have been quite relaxed as I have settled in a new place which is just 20 miles away from my old place. Although it is now a bit inconvenient to commute to university I love this town so much! Very peace and quiet with a lot of nice neighbours! Also a big spectacular cathedral is in the view from the window in my room!

By the way, I have currently been enjoying Sharpe, a historical fiction in the Napoleonic period about a war between Britain and France in Iberia and Pyrenees. Actually I have now got both the original nobels and DVDs which I borrowed from a friend in uni. This friend recommended me to read some nobels which intrigues me to read enough to learn English with fun! So from her selection of books, I found the series of Shape is most enticing! Quite thrilling and passionate! Also as a part of my daily entertainment, I asked her if I could borrow a set of the DVD series as well. I have now watched all the series of DVDs, and finished reading Sharpe's Rifle, and Sharpe's Eagle. I am now reading Sharpe's Gold as I follow the chronological order, rather than the order of date of publication. But I have just started reading from Sharpe's Rifle rather than Sharpe's Tiger which was published quite later than Sharpe's Waterloo as my friend has not purchased that book and I did not like to skip too further the order of date of publication.

Shape is the name of hero and the chief of a skirmish line called 95th rifel, South Essex.

Mechanism of Deflation spiral and critic of Japanese policies --- Prequel

Prequel:

Why unemployment does not decrease although GDP (gross domestic product) level and the stock price rise? This phenomenon has been explained by many macroeconomists since the major world great depression occurred in 1929. During this depression, although the aggregate product level of major developed nations itself was high there was a major excess supply of product which was not consumed by consumers. The reason was explained by John Maynard Keynes. The lack of aggregate demand (AD), which means the ability to consume of total population, created a huge gap between a level of aggregate product and the ability to consume. The similar phenomenon in 1929 occurred in current Japanese economic situation. By means of the major market liberalisation conducted by former prime minister Koizumi’s structural reformation, the GDP level has recovered after a decade depression period however the unemployment level still remains high, especially among youth population. Furthermore, some macroeconomists suspect this economic recovery is temporary and the business cycle comes back to recession. These reasons are underling the fact that the price level does not rise with the GDP growth. The high level of unemployment rate is related to the “real wage” level related to this stagnation in price rise. In order to solve this problem related to the relation between the price inflation level and the real wage level, a reformation in the fiscal policy and the labour law is required according to some macroeconomists. However, an excess intervention of the fiscal policy into market, mostly pronounced by Japanese Communist party, should be prevented. All in all, this essay indicates key solutions with a reformation of the labour market and the moderate balance in monetary and fiscal policy.



The graph above explains why the previous mentioned negative paradox occurs. In fact thanks to the market liberalisation and the adaptation to the global market AD shifted to right. However, as the supply-side factors has been only considered the demand-side, which implies the ability of total population to consume, has been ignored. The increase in ΔM based on the Zero-Interest-rate policy could not stimulate individual enterprises and consumers to borrow despite of the expectation. This cause is underlining on the fact Japanese are unsecured to borrow cash due to the negative prediction of Japanese market and also the Japanese tend to save their income far more than other nationalities. This aspect indicates although the investment into entrepreneurs has been encouraged the average consumption level has been still stagnated. Therefore, the demand of goods and services has not been stimulated enough to rise the price level. Furthermore, the current Japanese labour market is reformed to allow employers to hold a strong control over labour contract and lowered individual rights of labourers. This situation is based on two following reasons. The first reason is that the market for entrepreneurship is less competitive such as less venture business industries are born so that the market is fully monoplised by traditional huge enterprises and transnational enterprises mainly coming from USA. This fact has also shifted SRAS to the right as shown in the graph above because entrepreneurs have become willing to supply their product with the more flexible condition to exploit the factors of production. The second reason is that this situation allows entrepreneurs to employ labourers with fixed contract with lower wage and longer working hours. All in all, this overall Japanese current economic situation has stagnated the price inflation level meanwhile economic grow might be supposed to be faster than the stable level; this implies ΔY>ΔY*. Thus, it has also shifted SRAS to the right as shown in the graph above because entrepreneurs have become willing to supply their product with the more flexible condition to exploit the factors of production.

Speaking of the unemployment rate which remains still significantly high, this case also indicates that as ΔW is a fixed valuable and ΔP is a flexible valuable　ΔP is required to (ΔW -ΔP) becomes equal to ΔY* in order to avoid the economic growth grows excessively faster. This reason is based on the attempt to stabilise the real wage level (W/P) as observing to the graph below.




Focusing on the graph above, the deflation is the type of recession which lowers both price and growth level so that the price and growth level is below the stable level, which means an economic activity level is well below under their capacity. During such a deflation, as the price level is always dropping the wage level is as such. The motivation of labourers thus goes down, and then the aggregate productivity level goes down simultaneously. Therefore, the price level goes down by means of the lack of aggregate productivity. This situation is called “deflation spiral” which Japanese economy has been suffering from in 1990s. In order to surmount a deflation, either an exogenous technological advance, for example a new invention or an importation of a foreign technique, should be expected, a central bank should lower the interest rate and increase the money supply into market, public sectors should recruit unemployed individuals more, or a government increase investment level into private sectors. The previous two actions rely on a spontaneous recovery by means of private sector’s own efforts, which is called Supply-side policy. The supply side factor implies producers’ ability to produce and the spontaneous effort to surmount economic recession. The second action is based on the monetary policy creating an excess money supply level. The last two actions are operated by the government intervention into a private market by means of the fiscal policy. The monetary policy exploits the money supply level (ΔM) to pushes the aggregate demand (AD) along the sort-run aggregate supply (SRAS), which is related to the nominal wage level (ΔW) and the growth level (ΔY), which means both the wage level and growth catch up a rise in the price level stimulated by the monetary policy. The fiscal policy on the other hand operates the planned efforts to surmount economic recession, which leads ΔP to artificially rise regardless of ΔM and ΔW by means of increasing a number of jobs in the public sector and/or investing for private sectors with tax revenue. Furthermore, in terms of this dynamic economics theory ΔW is assumed to be fixed unlike other variables such as ΔP and ΔM because in the real world nominal wage is generally determined by labour contracts with employer rather than the current price change or a daily change in economic growth.

Former Prime Minister Junichiro Koizumi promoted his structural reformation which cut government expenditure and alternated Japanese market structure in order to adapt the global market and encourage foreign investment. This structural reformation permitted M&A, deregulation of merge and monopoly, and also highly deregulated labour market. Under Koizumi’s structural reformation Japanese Central Bank installed the Zero-Interest-rate policy in order to encourage private industries to borrow cash to stimulate their economic activity. This structural reformation opted to highly rely on the monetary policy and exaggerates the supply-side effort to surmount the decade economic recession and sacrifices the fiscal intervention and ignores the fact that some labourers can be more exploited under a lower wage and the involuntary unemployment rate may increase further. As a matter of fact, owing to the market liberalisation led by this structural reformation the foreign investment has been encouraged and more transnational corporations access to the Japanese market. Furthermore, major Japanese enterprises started to put priority on global competition rather than domestic one. Giant enterprises such as Japanese car making companies are encouraged to gain much power to create extra profit by forming monopoly in the domestic market, which has enabled these enterprises to transfer a part of their profit into further investment plan to explore their brunches in the global market. Some middle sided enterprises tried to merge with even a former rival company; for example the game soft companies Square and Enix merged together. Nonetheless, there is an unexpected paradox which is the fact although the Japanese stock price and the GDP level have rose the commodity price level hardly rises, the average quality of life of Japanese individuals has not been improved, and the unemployment rate is still remained significantly high.



The real wage level (W/P) denotes how valuable the nominal wage rate is with comparison to the price inflation level (ΔP). So as ΔP is lower, it sounds better for wage earners as it sounds like they are able to purchase commodities with cheaper price however the fact is totally depressing. As it has clarified that the nominal wage inflation ΔW is fixed due to the real world fact the wage contract can only be changed after several years if ΔP is well higher than ΔW employers attempt to employ less labourers. This is because the sales price is lower so the revenue is too low to cover the cost including wage for labourers and to make a desirable amount of profit. Therefore, employers consequently cut the number of labourers employed in attempt to cut the cost. Then as shown in the graph above the unemployment rate becomes exceeding the natural rate of unemployment level. Furthermore, continuously lowering ΔP cause to decrease ΔW in a longer length of time unless labourers, government, or something else coming exogenously intervenes. As the unemployment rate rises, the employer may find it is feasible to lower the nominal wage level to employee labourers with the much lower cost. This causes labourers to lose purchasing ability further and thus to lower ΔP further.


* To be continued!!