Economic Essay 43: Equilibrium and Demand Side Shocks

Explain the process by which neo-classical economists argue that the economy can adjust to long-run equilibrium following a negative demand side shock. Use a diagram to support your answer.

In response to a negative demand-side shock, an economy can adjust through various mechanisms. Here's a simplified explanation of the adjustment process:

1. Decreased Demand: A negative demand-side shock occurs when there is a reduction in overall demand for goods and services in the economy. This can happen due to factors such as a decline in consumer spending, investment, or exports.

2. Reduced Output and Employment: As demand decreases, businesses experience a decline in sales and may respond by reducing production. This can lead to lower output levels and potentially result in layoffs or reduced hiring, leading to higher unemployment.

3. Price Adjustments: In response to the reduced demand, businesses may lower prices to stimulate demand and attract customers. Lower prices can incentivize consumers to spend more, which helps increase aggregate demand.

4. Resource Reallocation: The adjustment process may also involve resource reallocation. Industries or sectors that were more severely affected by the demand shock may reduce their production and reallocate resources to areas with relatively higher demand.

5. Wage and Price Flexibility: Neo-classical economists emphasize the role of wage and price flexibility in the adjustment process. They argue that in a flexible labor market, wages can adjust downward, allowing firms to reduce labor costs and adjust production levels accordingly.

6. Market Rebalancing: Over time, as prices and wages adjust, the economy moves towards a new equilibrium. Lower prices and wages make goods and services more affordable, stimulating demand. As demand starts to recover, firms increase production, leading to a gradual adjustment and stabilization of the economy.

It's important to note that the adjustment process can vary in speed and effectiveness depending on the specific circumstances, market conditions, and policy responses. Additionally, the adjustment process may be influenced by factors such as the level of government intervention, the presence of rigidities in the labor market, and the availability of fiscal and monetary policy measures to support the economy during the adjustment period.

IMF chief: how the world can make the most of new special drawing rights

Kristalina Georgieva  in The FT 

On Monday, IMF member countries start receiving their shares of the new $650bn special drawing rights allocation — the largest in the fund’s history. This injection of fresh international reserve assets marks a milestone in our collective ability to combat an unprecedented crisis. 

In 2009, during the global financial crisis, a $250bn SDR allocation helped to restore market confidence. This time around, as the world continues to grapple with the Covid-19 pandemic, SDRs are even more important. The additional liquidity will bolster confidence and global economic resilience. 

SDRs can help countries with weak reserves reduce their reliance on more expensive domestic or external debt. And for states hard pressed to increase social spending, invest in recovery and deal with climate threats, they offer a precious additional resource. 

It is crucial, however, that these SDRs are used as effectively as possible — with accountability and transparency, and with as much as possible going to countries most in need. 

So how can we make the most of the new allocation? 

First, by making SDRs available to member countries quickly. With SDRs distributed in proportion to IMF quota shares, closely related to a country’s economic size, about $275bn is going to emerging and developing countries. Low-income countries are receiving about $21bn — over 6 per cent of gross domestic product in some cases. 

Vulnerable countries will be able to use the new SDRs to support their economies and step up the fight against the virus and its variants. Combined with grants and other essential support from the international community, this will help achieve the goal of vaccinating at least 40 per cent of the population in every country by the end of 2021, and at least 60 per cent by the first half of 2022. 

Second, every effort should be made to ensure SDRs are used for the benefit of member countries and the global economy. The decision on how best to utilise them rests with member countries of the IMF. They can hold them as part of their official reserves, or use them by converting them into US dollars, euros or other reserve currencies. 

But while this is a sovereign decision, it must be prudent and well-informed. The fund will work with its members to help ensure accountability and transparency. 

We are providing a framework for assessing the macroeconomic implications of the new allocation, its statistical treatment and governance, and how it might affect debt sustainability. The fund will provide regular updates on all SDR transactions, plus a follow-up report on their use in two years’ time. 

Third, with increasingly divergent economic fortunes due to the pandemic, we need to go further to ensure more SDRs go to those who need them most. That is why the IMF is encouraging voluntary channelling of SDRs from countries with strong external positions to the poorest and most vulnerable nations. 

By magnifying the impact of the new allocation, redirecting SDRs could help those most in need, while reducing the risk of social and economic instability that could affect us all. 

The good news is that we can build on progress achieved so far. Over the past 16 months, some better off member countries have pledged to lend a total of $24bn, including $15bn from existing SDRs, to the IMF’s Poverty Reduction and Growth Trust, which provides concessional loans to low-income countries. We hope to see further support to the PRGT from the new SDRs. 

The IMF is also engaging with its members on a possible new Resilience and Sustainability Trust that could use SDRs to help poor and vulnerable countries with structural transformation, including climate-related challenges. Another possibility could be channelling SDRs to support lending by multilateral development banks. 

Of course, SDRs are not a silver bullet. They must be part of a broader programme of collective action by countries and international institutions. Since the pandemic began, the IMF has played its part, providing about $117bn in new IMF financing to 85 countries — and debt service relief to 29 low-income nations. The fund also joined forces with the World Bank, World Health Organization and World Trade Organization to promote the urgent task of vaccinating the world. 

The poet Robert Frost wrote of the “road not taken”. We now have a unique opportunity to take the right road as the world strives for a more resilient future. We at the IMF pledge to do our best to ensure that this historic SDR allocation, used wisely, plays its part in promoting a strong and sustainable global recovery.

A-level grades to be adjusted downwards

Many students will have at least one adjusted grade to ensure this year’s results are in line with previous years writes Sally Weale in The Guardian 

 

Ofqual said results are still likely to be slightly higher than last year, up 2% at A-level. Photograph: Matthew Horwood/Getty Images


Teacher-assessed A-level grades, submitted by schools in England because exams have been cancelled, will have to be adjusted down by 10 percentage points, though results will still be up on last year.

The exams regulator Ofqual said a substantial number of students would receive at least one adjusted grade – usually downwards – as a result of a standardisation process, designed to ensure this year’s results are in line with those of previous years.

Ofqual said schools and colleges had submitted grades that were higher than would normally be expected, but it was not surprising because teachers had not been given an opportunity to develop a common approach to grading in advance and “naturally want to do their best for their students”.

The regulator also sought to reassure students and their teachers that despite the downward adjustments, results are still likely to be slightly higher than last year, up 1% across all grades at GCSE and 2% at A-level.

The government was forced to cancel all summer exams this year as a result of the Covid-19 pandemic, which closed schools to all but the children of key workers and vulnerable pupils. As a consequence, grades awarded this year will be based on a combination of teacher assessment, class ranking and the past performance of pupils and their schools.

Ofqual revealed that predicted grades submitted by schools and colleges were around 12 percentage points higher than last year’s results at A-level, and 9 percentage points higher at GCSE, with peaks at key grades such as 4 at GCSE which is a pass, and B at A-level which can be required for university entrance.

“Improvement on such a scale in a single year has never occurred and to allow it would significantly undermine the value of these grades for students,” the regulator said.

Ofqual also sought to allay fears that certain groups of pupils, including black, Asian and minority ethnic (BAME) students, as well as those with special educational needs and disabilities (Send) could be disadvantaged by calculated grades. Ofqual said their analysis had found no evidence of widening of gaps in attainment.

Nansi Ellis, assistant general secretary of the National Education Union, said: “It is very good news that results from this year’s extraordinary exams process are broadly comparable to previous years’ results, and that the majority of students will not be disadvantaged by this year’s process.

“A majority of teacher-calculated grades were unchanged by the Ofqual process, showing that centre assessed grades have been as robust as exam grading. This is a credit to the hard work and professionalism of teachers, who have a sound understanding of their pupils’ attainment.”