Malawi Budget Statement 2009/2010 link.

http://www.finance.gov.mw/downloads/Bud2009.pdf

The Economic debate of our time? FT.com

Rising government bond rates prove policy works, The Financial Times Online
June 3, 2009 12:33am
by Martin Wolf

Is the US (and a number of other high-income countries) on the road to fiscal Armageddon? Are recent jumps in government bond rates proof that investors are worried about fiscal prospects? My answers to these questions are: No and No. This does not mean there is no reason for worry. It is rather that there are powerful arguments against fiscal retrenchment right now and strong reasons for welcoming recent moves in the bond markets.

Last week, the Financial Times carried two columns arguing that the US fiscal path was unsustainable, one by Stanford University’s John Taylor and the other by the Harvard historian Niall Ferguson. The latter, in turn, was a comment on a debate with, among others, the New York Times columnist and Nobel laureate Paul Krugman at the end of April.
On one point all serious analysts agree: public debt cannot rise, relative to gross domestic product, without limit. To embark on fiscal stimulus in the short run, one must be credible in the long run.

So what is the disagreement? Prof Ferguson made three propositions: first, the recent rise in US government bond rates shows that the bond market is “quailing” before the government’s huge issuance; second, huge fiscal deficits are both unnecessary and counterproductive; and, finally, there is reason to fear an inflationary outcome. These are widely held views. Are they right?
The first point is, on the evidence, wrong. The jump in bond rates is a desirable normalisation after a panic. Investors rushed into the dollar and government bonds. Now they are rushing out again. Welcome to the giddy world of financial markets.

At the end of December 2008, US 10-year Treasury yields fell to the frighteningly low level of 2.1 per cent from close to 4 per cent in October (see chart). Partly as a result of this fall and partly because of a surprising rise in the yield on inflation-protected bonds (Tips), implied expected inflation reached a low of close to zero. The deflation scare had become all too real.
What has happened is a sudden return to normality: after some turmoil, the yield on conventional US government bonds closed at 3.5 per cent last week, while the yield on Tips fell to 1.9 per cent. So expected inflation went to a level in keeping with Federal Reserve objectives, at close to 1.6 per cent. Much the same has happened in the UK, with a rise in expected inflation from a low of 1.3 per cent in March to 2.3 per cent. Fear of deflationary meltdown has gone. Hurrah!

It is true that spreads between conventional US bonds and bonds issued by Germany and the UK have narrowed (see chart). But US yields were extraordinarily depressed during the panic.

Normality returns.
If inflation expectations are not worth worrying about, so far, what about the other concern caused by huge bond issuance: crowding out of private borrowers? This would show itself in rising real interest rates. Again, the evidence is overwhelmingly to the contrary.
The most recent yield on Tips is below 2 per cent, while that on UK index-linked securities is close to 1 per cent. Meanwhile, as confidence has grown, spreads between corporate bonds and Treasuries have fallen (see chart). One can also use estimates of expected inflation derived from government bonds to estimate real rates of interest on corporate bonds. These have also fallen sharply (see chart). While riskier bonds are yielding more than they were two years ago, they are yielding far less than in late 2008. This, too, is very good news indeed.
Now turn to the fiscal policy. The argument advanced by opponents is either that fiscal policy is always unnecessary and ineffective or, as Prof Ferguson suggests, redundant, because this is not a “Great Depression”. Monetarists argue fiscal policy is always unnecessary, since monetary expansion does the trick. Economists who believe in “Ricardian equivalence” – after the early-19th-century economist David Ricardo – argue fiscal policy is ineffective, because households will offset any government dis-saving with their own higher savings.

Economists disagree fiercely on these points. My approach is “Keynesian”: in extreme moments, the excess of desired savings over investment soars. Again, monetary policy, while important, becomes less effective when interest rates are zero. It is then wise to wear both monetary belt and fiscal braces.

A deep recession proves there is a huge rise in excess desired savings at full employment, as Prof Krugman argues. At present, therefore, fiscal deficits are not crowding the private sector out. They are crowding it in, instead, by supporting demand, which sustains jobs and profits.
Prof Ferguson argues that fiscal expansion was unnecessary because this is only a mild recession. The question, however, is why it is only a mild recession, since precursors of a depression were surely present.

The answer, in part, is the aggressive monetary policies of central banks and the rescue of the financial system. But is that all? What would have happened if governments had decided to cut spending and raise taxes? One might disagree on how much deliberate fiscal loosening was needed. But one of the most important reasons this is not the Great Depression is that we have learnt a lesson from experience then, and in Japan in the 1990s: do not tighten fiscal policy too soon. Moreover, historically well-run economies are certainly able to support higher levels of public indebtedness very comfortably.

This, then, brings us to the last concern: the fear of inflation. This is essentially the question of how to exit from current extreme policies. People need to believe that the extraordinarily aggressive monetary and fiscal policies of today will be reversed. If they do not believe this, there could well be a big upsurge in inflationary expectations long before the world economy has recovered. If that were to happen, policymakers would be caught in a painful squeeze and the world might indeed end up in 1970s-style stagflation.

The exceptional policies used to deal with extreme circumstances are working. Now, as a result, policymakers are walking a tightrope: on one side are premature withdrawal and a return to deep recession; on the other side are soaring inflationary expectations and stagflation. It is irresponsible to insist either on immediate tightening or on persistently loose policies. Both the US and the UK now risk the latter. But their critics risk making an equal and opposite mistake. The answer is both clear and tricky: choose sharp tightening, but not yet.

Write to martin.wolf@ft.comMore columns at www.ft.com/martinwolf

Copyright The Financial Times Limited 2009

UK New Tax Year 2009/2010 highlights.

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New tax year (09/10). The good and the bad

The 2009/10 tax year began on Monday, and it's all change. Bizarrely though, this year’s Budget is after the start of the tax year, so changes then may be backdated (last year's figures in brackets).

The boosts to income ...

1. • Personal allowance UP! Every man, woman and child can now earn £6,475 (£6,035) before paying income tax. For those aged 65-74, it’s £9,490 (£9,030), and for over-75s, £9,640 (£9,180).
2. • Basic rate tax threshold UP. You now pay 20% tax on the first £37,400 (£34,800) over the personal allowance, meaning under 65s hit the higher 40% rate at £43,875 (£40,835).
3. • National insurance start point UP. You now need to earn £110 per week (£105), before paying for NI, usually 11%.
4. • State pension UP. It's £95.25 (£90.70) a week for a single person.
5. • Pension credit UP. The minimum guaranteed income's now £130 for single pensioners (£124.05), and £198.45 for couples (£189.35). See the State Pension guide.
6. • New Health in Pregnancy Grant. All pregnant women will get a non-means-tested £190 in their 25th week. More in the Pregnancy Grant discussion.
7. • Inheritance tax threshold UP. You can leave £325,000 (£312,000) tax-free. See the Inheritance Tax guide.

And the hits ...

1. • Fiscal drag. This isn’t Alistair Darling in women’s clothes, it’s when increased allowances aren’t as generous as they seem. If wages and/or inflation increase by more than the allowances, effectively the government gets more tax revenue anyway, and the real value of the increase is less.
2. • National insurance upper earnings UP. You will pay 11% NI on earnings up to £43,888 a year (£40,040) and 1% above that.
3. • ISA limits. No change. Yet again, the amount savable tax-free hasn’t increased with inflation or earnings. See the Top Cash ISAs guide.
4. • Child Tax Credit family element. No change. Many families get this, and the freeze at £545 is an effective cut. Yet the means-tested element has increased to £2,235. See the Benefits Check-Up guide.

Discuss these changes with other MoneySavers in the Forum: New Tax Year 09/10.

Has Keynes trumped Adam Smith?

Source (Link): AdamSmith.org

Written by Mark Skousen (February 2009)

Friday, 27 February 2009

The problem today is Keynesian-style policy, the darling of the establishment politicos and media giants: big government solutions, deficit spending, easy money, bailouts. Keynes has suddenly trumped Adam Smith. And that's dangerous. One day last week, I walked into the largest Barnes & Noble bookstore in New York and saw a big display table up front with all kinds of books on John Maynard Keynes and Keynesian economics. One book, The Return of Depression Economics, was written by Paul Krugman, the caustic New York Times columnist who just won the Nobel Prize. Another book was called The Case for Big Government by Jeff Madrick, the editor of Challenge magazine. I can understand writing a book in support of good, efficient, strong, and productive government, but “big” alone? Most Americans prefer the motto “cheaper and better.” The biggest surprise at Barnes & Noble was to see my own book, The Big Three in Economics, prominently displayed along side all the Keynesian and Marxist books. It has suddenly become my most successful book. But mine was the only book there that took a dim view of Keynes and Marx and their solutions to the financial crisis (always more government, more taxes, and more regulations). For my money, Adam Smith and his followers (Ludwig von Mises, Friedrich Hayek, Milton Friedman, Murray Rothbard) deserve to be on top of the Totem Pole of Economics. Unfortunately, Keynes is all the rage now. The British economist became famous in the 1930s for advocating going off the gold standard, running deficits and bailing out troubled banks with easy money as a way to end the Great Depression. Today’s politicians, from George Bush to Barack Obama, have suddenly become Keynesians during this financial crisis, spending money they don’t have in a vain effort to right the ship. Even Newsweek has gone so far to say, “We are all socialists now.” Alan Greenspan, the ex-student of Ayn Rand, now favors nationalization of the big American banks Citibank and Bank of America. Every investor and gold bug should know the enemy: Keynes, the advocate of big government and the welfare state, and Karl Marx, the radical who advocated outright state socialism and total central control of the means of production. After World War I, Randolph Bourne observed, “War is the health of the state.” Today he might say, “A financial crisis is the health of the state.” It looks like modern-day statists are getting their wish. We’re getting big government, good and hard. Adam Smith and Milton Friedman are out of favor, while John Maynard Keynes, the patron saint of bailouts, inflation, and the welfare state, is making a comeback with a vengeance. The tentacles of the leviathan state are growing by leaps and bounds. In 2009, global governments will be the largest shareholders in commercial banks, reversing 20 years of retreat by the state. The costs of entitlements are exploding upwards, and Congress hasn’t had the courage to address future liabilities. Social Security and Medicare are government-sponsored Ponzi schemes that will make Bernie Madoff’s embezzlement look like a picnic. The late management guru Peter Drucker said, “Government is better at creating problems than solving them.” In fact, wrote a cynical Ducker, government has gotten bigger, not stronger, and can only do three things well -- taxation, inflation, and making war. According to Drucker, the state has become a "swollen monstrosity….Indeed, government is sick -- and just at a time when we need a strong, healthy, and vigorous government." (He said all this in 1969.) If you want to solve problems, he counseled, you must turn to business and the private sector. But where does one get the straight scoop on Keynes, Marx, and their nemesis, Adam Smith and the followers of free-market capitalism? I have no apologies for where I stand on the issue. In writing The Big Three, I commissioned a Florida woodcarver, James Sagui, to create “The Totem Pole of Economics.” (The Tolem Pole of Economics is shown on the back cover of the book.) Clearly, my hero is Adam Smith, the author of The Wealth of Nations, published in 1776, a declaration of economic independence. Adam Smith, the 18th century philosopher, is on top of the Totem Pole for his advocacy of a revolutionary new doctrine which he called a “system of natural liberty,” what we might call laissez faire or free-market capitalism. He used the “invisible hand” to symbolized how the private actions of individual entrepreneurs would lead to the public good. Today's advocates of Smithian economics have real solutions to the crisis, as I've outlined in previous HUMAN EVENTS columns: suspend "mark to market" accounting rules, make the Bush tax cuts permanent, slash the corporate tax rate, and mostly importantly "do no harm." Also, it wouldn't hurt to take a look at the Canadian banking system, ranked #1 in the world in soundness (US is #40) for its conservative reserve requirements and nationwide branching. (Not a single Canadian bank has failed in either the Great Depression or now.) Keynes is ranked below Adam Smith, because he supported big government and the welfare state as a way to stabilize the crisis-prone capitalist economy, the “middle ground” between laissez faire and totalitarian socialism. But as we have seen, Keynesian activism has led to much mischief in the world today, and countries that have adopted his bureaucratic, regulated mindset have witnessed “slow growth” and “stagflation” style economies. And Marx is the “low man” on the Totem Pole. His radical solution, government ownership and control of the production, distribution and consumption of goods and services, would be, as Hayek says, “the road to serfdom.” Adam Smith and his “system of natural liberty” have come under attack many times by his arch enemies, the Marxists and Keynesians. But Smithian economics has nine lives, and has always managed a comeback. With your help, Adam Smith will return. Click here for a copy of The Big Three in Economics.

What is the New Trade Theory? (oldie)

view entire article and comments at
http://www.marginalrevolution.com/marginalrevolution/2008/10/what-is-new-tra.html
Posted by Alex Tabarrok on October 13, 2008 at 10:33 AM | Permalink

Congratulations to Paul Krugman on his Nobel. Here is a primer on one of Krugman's key contributions, New Trade Theory. Tyler has more links below.

Ricardo showed that every country (and every person) has a comparative advantage, a good or service that they can produce at a lower (opportunity) cost than any other country (or person). As a result, production is maximized when each country specializes in the good or service that they produce at lowest cost, that is in the good in which they have a comparative advantage. Since specialization in comparative advantage maximizes production, trade can make every country better off.

But what determines comparative advantage? In Ricardo it is the natural products of the soil, Portugal is good at producing wine and so England has a comparative advantage in cloth. Heckscher, Ohlin and Samuelson among others extended the model to show how factor proportions can determine comparative advantage - countries with a lot of labor relative to capital, for example, will tend to have a comparative advantage in labor intensive goods production.

Notice, however, that in the Ricardian model and its extensions the determinants of comparative advantage like geography and factor proportions lie outside of the model. New Trade Theory of which Paul Krugman can be said to be the founder, brings the determinants of comparative advantage into the model.

Consider the simplest model (based on Krugman 1979). In this model there are two countries. In each country, consumers have a preference for variety but there is a tradeoff between variety and cost, consumers want variety but since there are economies of scale - a firm's unit costs fall as it produces more - more variety means higher prices. Preferences for variety push in the direction of more variety, economies of scale push in the direction of less. So suppose that without trade country 1 produces varieties A,B,C and country two produces varieties X,Y,Z. In every other respect the countries are identical so there are no traditional comparative advantage reasons for trade.

Nevertheless, if trade is possible it is welfare enhancing. With trade the scale of production can increase which reduces costs and prices. Notice, however, that something interesting happens. The number of world varieties will decrease even as the number of varieties available to each consumer increases. That is, with trade production will concentrate in say A,B,X,Y so each consumer has increased choice even as world variety declines.

Increasing variety for individuals even as world variety declines is a fundamental fact of globalization. In the context of culture, Tyler explains this very well in his book, Creative Destruction; when people in Beijing can eat at McDonald's and people in American can eat at great Chinese restaurants the world looks increasingly similar even as each world resident experiences an increase in variety.

Thus, Krugman (1979) can be thought of as providing another reason why trade can be beneficial and a fundamental insight into globalization.

Moreover, Krugman (1979) began the task of bringing the reasons for comparative advantage within the model. In that paper, Krugman also hypothesizes briefly about what happens when we allow migration within the model. Recall, that in Heckscher-Ohlin-Samuelson factor proportions explain trade patterns but are themselves determined outside of the model. When people and capital can move, however, factor proportions are themselves something to be explained.

Krugman (1991) (JSTOR and here) brings increasing returns together with capital and labor migration and transport costs into one model. Krugman's (1991) model has become a workhorse of economic geography and international trade. The model is too complex to explain here but the reasons for that complexity are clear to see - when everything becomes "endogenous" small initial differences can make for big effects. To minimize transport costs, for example, firms want to locate near consumers but consumers want to locate near work! Thus, there are multiple equilibria and at a tipping point the location decisions of a single firm or consumer can snowball into big effects. So Krugman has been a leader in introducing tipping points, network effects and thus the importance of history into international trade as well as into economics more generally.

Posted by Alex Tabarrok on October 13, 2008 at 10:33 AM | Permalink