Economic Jargon

a rise in either property prices or the stock market as opposed to CPI inflation. Inflation in the latter sense is regarded as bad, whereas asset price inflation is ignored by most economists and policy makers, and enjoyed by those who hold assets. This is a major problem when it comes to putting the UK economy on a sustainable footing.

Average wages or salaries per person. How do we arrive at “the average?”. There is a key difference between “average or mean” earnings and median earnings. Mean income is the figure derived by taking total wages and dividing by the number of wage earners. Median income reflects the income that lies midpoint between the highest and lowest income. It is closer to what the majority of wage earners actually receive. It could be argued median income is a more realistic measure because with the huge and rising levels of inequality in the UK, the mean wage is skewed upwards by the vast incomes of those at the top of the scale.

(or commercial bills) - A bit like a post-dated cheque, and used in international trade. The drawer has to pay the drawee a sum of money at certain date in the future.

Any open economy (one that trades with others), buys and sells goods and services with the rest of the world (ROW). The tally for this is called the Current Account. The UK, since 1983 has every year bought more from abroad than it sells- imports have exceeded imports. This is called a balance of trade deficit. How can a country buy more goods and services than it sells? The deficit is paid for by a corresponding surplus on what is called the **Capital and Financial **accounts. The precise makeup of these accounts has been redefined over the years but they are, as the name states, capital and financial flows going to and coming in from abroad. The overall balance of payments, the sum of the current account and the capital/financial account combined, has to balance - they add up/sum to zero. The current account is subdivided into goods and services, often referred to as **visibles and invisibles **respectively. The UK usually has a surplus on invisibles, but this is smaller than the deficit on visibles- hence the UK’s Current Account Deficit.

See Government Bonds and Gilts.

See Balance of Payments.

A buffer stock scheme is a system for stabilising prices by buying surplus goods when supply is high, storing them so as to keep a stock of them, and then selling goods from the acquired stock when supply is low. Offloading stocks onto the market during supply shortages stops prices from rising too much. Buying stocks when prices are low due to oversupply, helps stop prices from going too low. They are most often used in agriculture, where weather, fixed short-term supply and inelastic demand can cause sharp price swings. Buffer stock schemes can protect farmers’ incomes, encourage investment, support rural communities, prevent shortages and reduce food-price inflation for consumers. They are also needed for energy markets, and arguably oil and gas buffer stocks are inadequate.

Cons: they can be costly, encourage overproduction and inefficiency, require storage and administration, and may be hard to manage in global markets.

Historical examples include Joseph’s grain stores in Genesis, China’s ever-normal granary, the gold buffer stock under the gold standard, the EU Common Agricultural Policy, Australia’s wool floor price scheme and cocoa-stock schemes in Ghana and Ivory Coast. Under the gold standard, central banks held gold reserves as a buffer stock to defend the currency’s fixed value: gold could flow out when confidence or trade balances weakened, and reserves could be rebuilt when conditions improved. The examples show that buffer stocks can stabilise prices and incomes, but often fail when governments end up permanently buying unwanted surpluses rather than responding to genuine shortages.

The Job Guarantee concept espoused in The Money Sham is that of a buffer stock of employed labour. Here it works differently because the price paid for labour is ultimately what determines prices in an economy.

A buffer stock of employed labour:

1. Expands and contracts automatically – cheap to administer
2. Less leading sector inflation
3. Less bidding up of labour costs during expansionary phase of business cycle
4. Not the usual buffer stock problems

Expanding on the problems with commodity buffer stocks:

1. Perverse incentives for producers (wool growers): When the government buys wool to maintain a price floor, producers overproduce because they have a guaranteed buyer. This increases supply, forcing the government to purchase even more wool, making the scheme fiscally unsustainable. Producers may also hoard stock or delay sales if they expect the government to intervene at a higher price. Over time, this distorts market signals, leading to inefficiencies and waste.

2. Perverse incentives for consumers (wool buyers and the textile industry): If the government sells wool at a lower price in downturns, buyers may delay purchases, expecting future price drops. This reduces private demand, making the government the dominant buyer and further destabilising the market. Large buyers (e.g. textile producers) might strategically manipulate demand to force the government into more price intervention.

3. Why the Job Guarantee avoids these issues: A Job Guarantee buffer stock doesn’t suffer from these perverse incentives because labour is not a commodity in the same way as wool: people don’t “hoard” work or delay employment decisions based on expected price changes. The JG wage is fixed and doesn’t fluctuate based on speculation or market forces. There’s no overproduction problem: unlike commodities, extra workers in the JG programme do not create a destabilising surplus. The JG absorbs excess labour in downturns and releases it in booms, making it counter-cyclical rather than reinforcing price distortions.

Conclusion: commodity buffer stocks fail because they create feedback loops where producers and consumers manipulate market conditions for their own gain. In contrast, the Job Guarantee operates as a stabilising force, ensuring full employment without these perverse incentives.

See Current Account Deficit.

The percentage of productive capacity within an industry which is being used; when an economy is not running near full capacity it has an output gap. Empirical studies in the USA and UK have shown, contrary to the assumptions of many economists, that even when the economy is not in recession and there is apparently no output gap, industry usually operates at only 70% to 85% of capacity. This is one factor that supports the export led growth potential espoused in this book.

This is possibly the most confusing word in economics because it’s used to refer to many different things. What do all these things have in common? They tend to provide some form of future income, but it’s better to be specific to context.

1. Physical Capital. When you start studying economics, you’ll be told capital is a factor of production: things are produced using two factors, Capital and Labour.

In this assertion economists are using capital to mean machines, factories, infrastructure. We can call this physical capital.

2. Money Capital. When talking about firms and markets economists will talk about capital meaning the money value of company stocks shares, and corporate bonds. As companies raise money by issuing bonds, they are borrowing money, so these corporate bonds may be referred to as debt capital.
3. Human Capital. When economists talk about workers or businessmen having skills and improving these skills by training, they refer to this as Human Capital. So, an economy with low levels of education, skills and training, may be said to be poor in terms of human capital.
4. Balance Sheet Capital. If you are studying accounting, you will see that a firm’s balance sheet consists of two columns: what it has, its assets on the left-hand side, and what it owes, its liabilities, on the right-hand side. To make matters confusing on the right-hand side, at the bottom, you have a figure that is equal to the Assets less the liabilities: this is referred to as the firm’s capital. This applies to banks as well as firms. Banks are meant to ensure that they have some capital in hand, so that if their assets suddenly fall, they have capital to bridge the gap. If the capital isn’t enough, when added to their assets, to equal their liabilities, then the bank is insolvent and cannot trade. Really then the capital is an asset rather than a liability in the sense that it’s something the bank has. On the other hand, the capital may be owned by shareholders who may want to sell their shares. Iin this sense, it is a liability, in the layperson’s understanding of the term, because the bank cannot be sure the shareholders won’t try and sell.
5. Capital Flows. Capital flows, refer to currency changing ownership but sound like currency moving from one country to another. To see what’s going on we need to distinguish between three things. First, where the money exists, usually on digital entries on a computer hard drive. Secondly, the issuer of the currency, which is the central bank usually located in the country that issues the currency. Thirdly the nationality of the owner of the currency.

When capital “flows” it is the ownership that changes, or flows, rather than the location of any hard drives changing. To recap: the capital flows are sums of money changing ownership. They are flowing from a domestic owner to a foreign owner, rather than literally flowing from one place to another. If a UK company exports something, the foreign buyer, if they don’t already have pounds, will convert their own currency to pounds to pay the UK company for the good being exported. In this example the UK company has received pounds that were previously owned by a foreigner. When a foreigner exports goods to the UK, the UK importer may have to convert pounds to a foreign currency to pay for the import. If the UK importer pays in pounds and the foreign exporter accepts payment in pounds then the ownership of the pounds will be transferred to the foreign exporter. The pounds will not have flowed anywhere, as pounds are kept in sterling bank accounts at the bank of England. But the ownership of the pounds has “flowed”, or more accurately *transferred *to the foreigner. The foreigner, by keeping the proceeds of their sale in pounds, is lending these pounds to the bank. If the foreigner decides they don’t want to keep the pounds, they may exchange them for another currency. If lots of foreigners who own UK pounds decided to sell them, the price of the pounds on the international exchange markets would fall. This is called a depreciation of the currency. This might be described as a capital outflow. If loads of foreigners start converting other currencies into pounds the value of sterling would increase, and it might be referred to as a capital inflow. But these pounds would be owned by foreigners, so pounds have not flowed into the accounts of any UK account holders. In this sense, there has been no capital inflow.

It gets slightly confusing because there may be a situation when both the UK firms and foreign firms have saved their money in a non-UK currency, say US dollars. If UK exporters find they are not exporting so much, and UK importers find they are importing more and more, there would not be any changes in the value of sterling. There would be no run on the pound. What would happen, is that UK firms would own fewer and fewer dollars as their exports declined and imports increased, and foreign firm would own more and more dolars. UK firms would be the poorer, and foreign firms would be richer, but the changes would not involve any “flows” of pounds into dollars.

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Collateralised Debt Obligation - Structured asset-backed security: developed for the corporate debt markets, prior to the GFC (Global Financial Crisis of 2007-2008) CDOs had evolved to encompass mortgages. A security is a financial product designed to give the buyer an income. If it is asset backed this implies it is based on some real asset. For example, when the security is a mortgage, it is backed by the value of the property that has been purchased with the mortgage. If the person who has taken out the mortgage cannot meet their repayments, then the property can be sold. This system breaks down if lots of people default on their mortgages resulting in lots of houses being put on the market when no one is able to buy. The value of the collateral, the property, may then fall below the money lent. When different mortgages were bundled together and sold on to a third party, they were called collateralised debt obligations; again, the collateral is the property on which the original mortgage was granted.

This is the State Theory of Money, written by George Friedrich Knapp, in which he adopted the term which derives from the Latin charta which means a token or ticket. Chartalism says that money is a creature of law, not a commodity.

Alfred Mitchell-Innes held a similar view saying that the state issues debt in the form of its money and that it imposes a tax which citizens have to pay; when they pay the tax the government debt is “redeemed”. Innes said this was the law of coinage. Again, money derives from state law not from people swapping commodities. He wrote this in 1914 in The Credit Theory of Money, published in the Banking Law Journal**. **

The theory was reinforced in 1947, when Abba Lerner wrote his famous Money as a creature of the state.

A theory of international trade that originated with David Ricardo in the early 19th Century. It is used today to extol the virtues of globalisation. A country will specialise through international trade in those products which it produces **relatively **most efficiently. It may produce these products less efficiently (in absolute terms) than its trading partner, but trade will produce a win-win situation for both countries if the less efficient economy just produces what it is least poor (inefficient) at producing, while the efficient economy just produces what it is best at producing. So, the world benefits when countries specialise in what it they are least bad at producing.

The theory has been challenged: - it is corporations and consumers that trade with one another, not countries per se. In addition, the theory assumes a supply-constrained economy - is this realistic? In Ricardo’s day, when the UK wanted cheap raw materials and cheap food for its workers, it was used to argue against import tariffs on food and to promote free trade. However, there is a danger in moving from an assumption that some land is innately more fertile than other land, to assuming that countries always have an innate advantage in some sector. Such natural advantages are not immutable; they are often man-made rather than natural. For example, a country with less fertile land, if it has better fertiliser and better agricultural machinery than another, might end up with a comparative advantage in food production. So over time comparative advantage can shift.

created by banks, and given to borrowers. If money borrowed is someone else’s savings, it is not new money. But when banks make loans, they are not usually lending existing money but creating new money. This creates new demand in the economy. If banks are creating more new loans than are being repaid then the money supply will be increasing. If money being repaid exceeds the new money being created, the money supply will be decreasing. After the GFC both corporations and households cut back on their borrowing. This caused a drop in demand and recession

When Prime Minister David Cameron told everyone to pay back their credit card debt, he was effectively encouraging behaviour that would deepen the recession. Someone must have explained this to him, because he later “modified” his exhortation**. See Credit Squeeze below.**

We can think of credit as money created by a bank loan. In the Money Sham the term is used to refer to the difference between the quantity of money created by new loans and the quantity destroyed as loans are repaid. To aid understanding, the Money Sham in places uses the term net credit, instead of just credit. Steve Keen refers to this annual change of credit (which is private sector debt, not state sector debt) as Credit. For example, if total new loans within a year are £2m and total loan repayments are £1.75m, then credit is £2.5 million. This is “new money” added to the economy. If total new loans are £2m but repayments are £2.25m, credit is negative – money has been withdrawn from the economy. This withdrawal may cause an economy to contract, and when it is significant, economists refer to it as “a credit crunch”. The rate of change of net credit is a key factor in whether and economy grows or contracts.

occurs when a central bank decides to buy riskier assets. For example, if mortgages which might look like they are not going to be repaid are bought by a central bank, the risky mortgages will sit as assets on the central bank’s balance sheet and the seller of the mortgages will have got cash. This will have put more money into the economy and helped to stop asset prices from falling.

Banks don’t feel confident enough to issue new loans and credit, suspecting borrowers may not be able to repay. This may dramatically slow down economic growth.

When exchange rates are fixed, a fall in the currency is called a devaluation. When exchange rates are not fixed, they are said to float. Sterling is floating, so if it goes down in value this is called depreciation.

A government that issues its own currency cannot involuntarily run out of it. The real constraints on public spending are inflation and real resources, never funding.

A country imports more goods and services than it exports. Since the early 1980s the UK has had a CAD. It exports more services than it imports but this surplus is outweighed by a larger deficit in goods.

A group of states that have agreed to charge the same import duties on goods and services from outside the union, while usually allowing free trade (no export/import duties) between themselves. The EU is such a Union. For example, every country has to impose the same tariff on agricultural goods from outside the EU. There are no tariffs within the EU so it is a Tariff Free Zone

The total accumulated amount of money owed by an individual, company or other organisation to banks or other lenders is their debt. The money owed by government, is the public debt. Every year a government spends money and has money given back to it in taxes collected. If in any year a government spends more than it destroys through taxation, it is said to have run a ** deficit**. The government deficit is a figure for the year in question. The government debt is the accumulation of past deficits. Post GFC the government has thought it important to reduce the government debt. It has gone on increasing; what has reduced is the annual government deficit. So, what has happened is that the debt has been increasing but not so rapidly as before when the annual government deficits were not decreasing.

Debt is worrying if there are signs that it cannot be repaid; the interest rate determines the cost of repaying any given amount of debt. The income of the borrower determines whether they can afford this. For a country, debt is often measured as a percentage of GDP. If a country has the level of private debt to GDP constantly rising, a tipping point may be reached when the private sector can no longer service its loan repayment costs. Such private sector debt can be regarded as a burden. As regards government debt, the key factor is whether it issues its own currency or uses a currency it does not issue. If it issues its own currency, and has not borrowed in a foreign currency, the debt is not a burden. It is just the non-government sectors’ savings. If the government does not issue its own currency, or has borrowed in a foreign currency, or in some commodity such as gold, the debt has different consequences. Here the metric is whether the economy is growing faster or slower than the debt is growing. Debt repayments in this context may be said to be ‘sucking money out of the economy’: they are a “burden”.

See also National Debt for a full explanation

Can occur when the collateral that was used to secure a loan (or another form of debt) falls in value. For example, the value of a house, used to secure a mortgage, goes down. Irving Fisher is the famous economist who, having gambled that asset prices would continue rising before the 1929 Wall Street crash, lost a fortune and set about understanding what had happened. He published his debt-deflation theory of depressions, in 1933.

High levels of debt which become difficult to service can lead to falling asset prices. As people find they can no longer meet their interest payments they sell off the assets to repay their debt. As more people sell, the value of assets falls and their value no longer covers the money borrowed; for mortgage holders this creates “negative equity”. For businesses and even whole countries that have borrowed in a foreign currency, it means having to sell off more and more assets to pay creditors. Asset prices fall but the money owed - the nominal value of debt - remains the same. Therefore, the Debt to GDP ratio increases. Private sector firms try to reduce pay. This reduces demand, which causes firms to lay off workers. This creates a vicious down spiral; falling wages, while the debt - which is fixed at its original price (its nominal price) remains the same. In real terms it increases.

Creditors and financial institutions, which lent the money, do not want the amount owed to be written off in the way that shareholders have the value of their equity “written off” as their shares plunge when a company fails. Some heterodox economists argue that debts that cannot be paid won’t be paid. The solution, they argue, is for debt to be written down or written off. This is the way to escape the debt trap (more below).

This refers to the downward spiral referred to above. In this situation as borrowing has fallen back, investors and consumers cut back their spending. This leads to loss of jobs and vicious circle of falling wages, falling demand and falling asset prices sets in. The costs of goods and services may start to fall- negative inflation. With incomes and prices falling and unemployment increasing, overall production can fall. GDP starts to fall but the debt is still measured at its original price, so the debt burden increases. After the GFC corporations and households reduced their borrowing and so spent less. This can start a downward spiral. If the government had not allowed its own borrowing to increase, the downturn would have been even more severe. To halt the downward spiral the UK government also used QE (quantitative easing) to prop up asset prices. This however has its own negative consequences; see QE.

When a government, business, or household spends more in a given period of time than it generates in income, it has a deficit. A deficit must be financed with new borrowing, or by running down previous savings.

See Debt and Deficit above.

A decline in the overall average level of prices.

When the level of output and employment is limited by the amount of overall demand for its products. See also Effective Demand

the loss of value, due to wear and tear over time of plant and machinery (and at a national level the whole infrastructure- transport system and school/hospital buildings). A company or country must invest continuously just to offset depreciation, otherwise its capital stock will erode away. Long before Brexit, the UK’s net investment per person was close to zero. If for example, total (gross) investment is 14% of GDP but depreciation is 11% of GDP that means there is only 3% net investment. If the population is expanding, this can mean virtually no real increase in investment per head (depending on the rate of population growth).

A bad recession! High unemployment, of over 10%; growth doesn’t return.

The extra amount of additional dollar receipts required by a country to pay for goods imported from the USA or from other countries that wanted payment in US$. After World War 2 the supply of US dollars wasn’t enough to meet the demand for them from overseas buyers.

(see also Marshall-Lerner Condition for restatement of this key concept) Elasticity refers to the extent to which the volume of sales of a good or service will alter due to a change in price or a change in the income of purchasers. If a good is a must-have good, and no substitutes exist for it, and especially if it is addictive like tobacco, then it is price inelastic. In other words, people will go on buying it even if the price increases quite a bit. More specifically, Price elasticity of exports is defined as the ratio between the increase in value of export sales to the change in prices at which they are offered. Thus, if a fall in price of 1% produces an increase in sales volumes of 2%, the elasticity would be 2. (Vice versa for imports).

The condition which has to be fulfilled to make a devaluation produce a better ex-post trade balance than the one ex-ante is called the Marshall Lerner condition and it is that the sum of the elasticities for exports and imports (ignoring any negative signs) is more than unity.

Company assets “owned” by shareholders. A company’s equity is equal to its value less its debt owed to bankers, bondholders, and other lenders. Importantly, equity can quickly go up and down in value; the other source of finance for a company, debt, owed to banks, and bond holders, is stable. A company’s equity = its value less its debt.

When economists build models of the economy, they may refer to endogenous or exogenous variables or factors. If something is endogenous its value is determined within the model; if it is exogenous its value is regarded as being outside the model: it is “a given fact”, not determined within the model. An important controversy is whether Money itself is created endogenously or whether it is exogenous: see Money.

see neoclassical economics above

The nominal exchange rate is what you see when changing currency to go on holiday abroad. The real exchange rate is the price of on country’s goods and services in terms of another- it is the nominal exchange rate times average prices. The real effective exchange rate takes the real exchange rate and gives it a weighting across all the currencies a country trades with, according to the proportion of trade done in each currency. A nominal exchange rate change does not take account of any variations in inflation between the devaluing country and world currencies, whereas changes in the real exchange rate do.

The debate - For the UK over the last thirty years, official figures show that the nominal sterling exchange rate and the real effective exchange rate move closely together. So, if the nominal exchange rate moves down, our exports become cheaper; if it moves up, our exports become more expensive. For some countries including the UK, changes in inflation do not offset or wipe out changes in the nominal rate. Neoliberal economists ignore or deny this. For other economies, such as small emerging economies that have a less diversified economy, devaluation can cause serious inflationary problems.

Benefits and costs to an economic activity that do not show up in the accounts of the given activity; for example, a farmer may make a profit selling corn, but might not have had to pay for the loss of income caused when the fertiliser used leaches into rivers and kills fish. The effect on the fish or environment generally would be a negative externality. One person’s gain may have a bad effect on others not involved. Similarly, one person’s gain or one company’s gain, may have a multiplier effect on others- a positive externality. If a company trains its workforce in new methods, output may increase, the new methods might involve less pollution; the trained workers may impart their knowledge to others and thus “knowledge transfer” may find its way into other parts of the economy. This will create new production and the new wage earners will new demand by spending, and a virtuous circle may develop. See Multiplier Effect

Keynesians like this concept – what’s true for the individual in a group is no good for the group as a whole. If you are in a cinema and you can’t see the screen because your view is blocked by a tall person sitting directly in front of you, you would be able to see the screen if you stood up. However, you would then block the view of anyone sitting behind you. But provided nobody in front of you stood up and you didn’t mind being anti-social to those behind you, you would personally gain by standing up. But if everybody in front of you stood up because they too had their view impaired by those in front of them, then nobody would be able to see the screen any better. The moral is that if one or just a few individuals do something they may benefit but if everybody follows suit, nobody gains. Keynesians can argue that while it may make sense for one person to reduce their debt if they are in financial trouble, if everyone reduces their debt, no one will gain (a flawed recommendation based on this Fallacy of Composition). This is because one person’s spending is another’s income: if we all stop spending, no one will have any income. Hence when governments stop spending to reduce the ratio of debt to GDP, or when governments tell consumers to stop spending because they are running up debt, the result could be a total shut down of the economy if *everyone *did this (the Paradox of Thrift). Austerity, as a way of reducing to debt to GDP may therefore be a flawed recommendation.

Monetary purchasing power, typically created by a bank or other financial institution, which allows a company, household, or government to spend on major purchases (often on capital assets or other major purchases).

The trend under neoliberalism through which real production in the economy is accompanied by an increasing degree of financial activity and intermediation (including various forms of lending, financial assets, and securitization). One way to measure financialisation is by the ratio of total financial assets to real capital assets in an economy.

when a bank gives you a mortgage in exchange for the upfront money you receive, you are obliged to make future repayments. These repayments when interest is included, will add up to more than the money you received. They therefore provide a future income for the bank. In financial terms we say that the bank has a claim on the borrower. Financial securities are claims such as these being traded (bought and sold) in financial markets. For example, instead of the bank that gave you the mortgage keeping the mortgage with it (on its books) it may get an immediate income by selling the mortgage to someone else who pays the bank a big sum up front in exchange for the mortgage. The buyer than has a future income stream. Mortgages are the type of financial claim that most people know about; almost as familiar to the layperson are stakes in the ownership of a firm, which are called stocks or shares.

Stocks or shares give the holders a claim on the firm: they may get dividends or they may find the value of the share goes up, which is called capital growth or capital appreciation. However, with mortgage debt and debt in general the borrower is legally obliged to repay it, whereas with stocks and shares there is no guarantee that the shareholder will make money: if the firm does badly the share value may fall and dividends may be small or non-existent. But people buy these claims hoping for dividends and or for capital appreciation. These days it is more often the latter. There are also claims based on other agreements which like mortgages, promise to repay money over a period of time.

More complicated are derivatives, which are bets on the future value of other financial securities or on the future value of commodities (such as wheat, copper etc). You can bet that the price will go up in the future, so you gain if it does but lose if it doesn’t. Or you can bet it will down, when you gain if it goes down in value but lose if it doesn’t. Betting that something will fall in value is called shorting it; betting that it will rise in value, is called going long, but there is no set time limit for these bets, which can vary in duration.

The use of government spending and taxation to influence the economy.

An investment by a company based in one country, in an actual operating business, including real physical capital assets (like buildings, machinery and equipment), located in another country.

This is when banks are required to hold back a proportion (fraction) of assets; they can lend more than they hold but only up to a certain multiple. This means they lend money they have not actually got, but are restricted by the reserve ratio. In reality it is now accepted by the Bank of England and emphasised by Post-Keynesian economists, that banks lend as much as they can and find the reserves afterwards; they know that if the central bank refused to create the reserves the whole system would collapse. The Central Bank, afraid of this scenario, will always provide the reserves. Some economists still deny this.

An agreement between two or more countries to trade without export and import tariffs on each-others’ goods and services. Countries often put other obstacles in the way to protect their home producers- these may be specific rules and regulations that they know their competitor will find it tricky to meet. These are called “non-tariff” barriers”.

When everyone who wants a job can get one. There will always be a number of people out of work between jobs. Time taken job searching and having difficulty matching up people to vacancies is called frictional unemployment. Structural Unemployment is when the jobs on offer require skills that workers do not have: this is sometimes called the skills mismatch. The solution is meant to be better training and better ways to match job offers with job seekers. Finally, there is Cyclical Unemployment. When the economy slows or contracts job vacancies are fewer while the number of job seekers remains the same. Nearly all economists accept that market economies have booms and slumps or peaks and troughs and that during the downturns there won’t be enough jobs. They disagree about the causes of these so-called business cycles and they disagree about how to deal with job shortages. Since 1979 the UK has made several revisions to the way it calculates the employment/unemployment figures. If the pre 1979 method were used today, the unemployment figure would be much higher.

In his 1943 article “Functional Finance and the Federal Debt”, Abba P. Lerner argued that government fiscal policy should be judged by how it functions in terms of its economic effects, not by whether the budget is balanced.

A currency-issuing government should use spending, taxation, borrowing and money creation to achieve public purposes such as** full employment, price stability and economic stability.** If unemployment is too high, it should spend more or tax less; if inflation is too high, it should spend less or tax more. The budget balance itself is not the goal.

See Global Financial Crisis.

as per 2008-2009 - Things came to head when banks stopped lending to one another because nobody knew for sure who could be trusted. Sub-prime mortgages had been sold on from one agent to another so when mortgage payers began to default and property prices started to fall these financial agents didn’t know what anything was really worth. Many would argue that the global financial crisis was the inevitable result of a long period of financial deregulation that began under Thatcher and Reagan but continued under Bill Clinton. The current author has argued that incorrect exchange rates played a key role: with the west’s exchange rates overvalued there was increasing unemployment and/or lack of wage demand in the economy. Central Bankers countered by setting extremely low interest rates to offset this lack of demand. This did not kick start investment as hoped, but instead facilitated the build-up of unsustainable private debt which necessitated the build-up of public debt.

UK government bond; the government issues these to people who want a reliable form of saving. Mainstream economics tell us it issues them to borrow money. More realistically it offers them to take demand out of the economy. The famous example in the UK is War Time Bonds in WW2. The government was spending a lot of money into the economy to support arms production and the wages of the armed forces. The war caused a drop in production of peace time goods and fewer imports. The extra spending was therefore inflationary. The bonds took spending power out of the economy, reducing inflation. How did the government encourage the population to invest in these bonds? It offered a decent interest rate and appealed to their patriotic self-interest. It told them their money would be used for building the weapons needed to defeat the enemy. In reality the government had already spent the money into existence and the bonds were a way of keeping a lid on inflation.

A statistical measure of inequality. A Gini score of 0 implies perfect equality (everyone has the same income). A Gini score of 1 implies perfect inequality (in which one person has all of the income). Gini scores for the UK and for the vast majority of countries have increased since the end of the Keynesian era (circa 1972).

The process of more economic activity taking place across national borders. Forms of globalisation include international trade (exports and imports), foreign direct investment, international financial flows, and international migration. In terms of goods, this took off after the Vietnam War with the use of containers to transport goods back to the west; with the advent of the internet corporations now find it easier to communicate and organise across great distances.

Government Bonds

Only the government can create money. Those purchasing bonds are not counterfeiters: they have to buy bonds with money that has already been created.

From 1945 until 1998 the UK was not subjected to bond market hysteria and fear of bond vigilantes. The government had a system that worked for over fifty years. It was called** The Tap System**

The Core Policy: Demand-Driven Supply

Under the UK’s Tap System, the government issued bonds based on how much the public wanted to buy, not how much the state needed to sell.

• The Bank of England would look at the economy and dictate a set interest rate (yield) and price for a bond.
• They would open the tap.
• If investors wanted to buy, the supply was essentially unlimited until the Bank decided to change the rate or close the tap.

2. How the Policy Handled the National Debt

Because the government wasn't forcing a fixed number of bonds onto the market via auctions, it needed a safety valve for days when nobody wanted to buy.

• The Bank of England acted as a cushion: If the government needed to withdraw money from the economy, but investors weren't biting at the chosen tap price, the Bank of England bought the bonds themselves or used central overdrafts to balance the books.
• Controlling inflation: If the money supply was deemed to be growing faster than productive capacity, the Bank would intentionally make long-term bonds highly attractive. This "mopped up" excess cash from banks and everyday citizens, locking it away so it couldn’t cause inflation.

3. Why the Policy Was Used (The 1940s Context)

The system was formalised in 1940 to fund World War II. The government needed to borrow astronomical sums of money without letting interest rates skyrocket. By manually holding the "tap" price steady, they ensured borrowing remained cheap.

4. The Neoliberal Ascendancy: Why the Policy Was Abandoned (The 1990s Shift)

Following the OPEC prices hikes, the free market economists, first calling themselves monetarists, regained control of the economic narrative. Global finance asserted its own vested interests. They said the system lacked transparency: they said the Bank of England was acting as both the player and the referee, setting interest rates while simultaneously selling and buying its own debt. Which is what a government must do if it is not to hand power to the finance sector.

*In 1998 the “Full Funding Rule” *was introduced when the UK created the Debt Management Office (DMO) and the government forced itself to issue bonds to cover the deficit in full. Today, the government decides exactly how much debt it must sell to cover its budget deficit, and competitive auctions let the free market dictate the price. This causes instability and allows speculators to make gains and losses without adding to the production of real wealth.

**The current system is described below: **

Government debt is issued in Treasury Bills (T Bills) or Gilts.

The chart below shows the features of this debt:

** Government bonds are money in bank accounts that pay interest when they mature and which, unlike money in “ordinary” accounts, can be traded:** Governments issue promises on pieces of paper (or on entries on hard drives). For T Bills they sell the pieces of paper for less than their redemption value at maturity. For Gilts they promise to repay the face/par value at a specific time (the maturity date) and to pay interest (the yield or coupon rate). The government allows people to buy and sell these pieces of paper. It allows them to become financial assets, whose price can go up and down.

Prior to the maturity date, the purchaser of the promise receives a fixed rate of interest, based on the official price of the promise. (The interest is usually paid twice a year and to confuse us further it’s called the coupon.). The official price (called the par price) may not be the purchase price but is the price the purchaser will receive back when the bond “matures” at the end of the fixed period of time.

**Government bonds thus are tradable interest-bearing tax credits, which are held in an account at the central bank. The money used to purchase them is created by prior government spending. **

In the UK such promises by the government to repay in up to three months are called Treasury Gilts; promises to repay longer than this are called Government Bonds. Both gilts and bonds are also called Government securities. Many economists incorrectly believe that the government has to issue these bonds in order to get the money it needs for its spending plans. Hence bonds and gilts are referred to as “government borrowing”. This is roughly the difference between what the government spends into the economy and what it takes back out of the economy through taxes. In reality the government alone can create its own money, so it is borrowing from itself. This is why it’s a misnomer to call government “borrowing” government borrowing, even though in accounting terminology it is correct to do so.

The value of all the goods and services produced for money in an economy, measured in market prices. The “measured in market prices” is significant. GDP may exclude services we all value, such as giving birth or cleaning the kitchen hob - anything that is unpaid. Secondly, as manufacturing becomes more efficient, it produces more output with the same or less input. This rise in productivity is what raises living standards, but paradoxically, rising productivity causes prices per unit of output to fall. This, all things equal, tends to reduce the value of manufacturing when compared to other sectors of the economy where increases in productivity are harder to achieve. This in turn leads many to underestimate the importance of manufacturing to a country’s overall standard of living.

GDP is calculated by adding up the gross value-added at each stage of production.

GDP divided by the population of a country or region. Changes in real GDP per capita over time are often interpreted as a measure of changes in the average standard of living of a country, although this is misleading (because it doesn’t account for differences in the distribution of income across factors of production and individuals, and it doesn’t consider the value of unpaid labour). or the segment of ‘GDP devoted to investment/saving rather than consumption, if living standards are being measured.

See Value Added.

Gross National Income - Not all the income that the UK enjoys is generated in the UK; some income will come into the economy from abroad; this may be profits from UK companies based abroad for example. Such income streams are added to GDP to give the Gross National Income. In recent years transfers from abroad which throughout UK history have been positive have turned negative. In other words, more money is being sent abroad than is coming in. This is contributing to our balance of payments problem. See BOP - Balance of Payments

The value added in a particular stage of production equals the value of total output, less the value of intermediate products (including capital equipment, raw materials, and other supplies). Value added is ascribed to the various factors of production (including the wages paid to workers, the profit paid to a company’s owners, and interest paid to lenders). Value added in the total economy equals its gross domestic product (GDP)

Economists like to divide us into two main groups: **Firms or Corporations **that make stuff or provide services, and **Households. **Households offer labour supply to the labour market, earn income (from employment and other sources), make consumer purchases, and care for each other through unpaid labour within the home.

Another group is the Capitalists, who own the firms.

As individuals we can be part of a corporation or firm by working for it and we are part of the Consumer group when we shop. If we own a firm, we are part of the Capitalist group.

Can you see a missing group? There should be a fourth group, the Bankers, as banks are the only non-government owned part of the economy that can legally create new money.

The nub of this idea is that the present is path dependent, and events may persist long after their original cause has departed the scene.

The term hysteresis was coined by Sir James Alfred Ewing, a Scottish physicist and engineer (1855-1935). He used it to refer to systems, organisms, and fields that have memory. To put it another way, the consequences of some economic events are experienced with a time lag or delay. Iron, for example, still retains some magnetization after it has been exposed to and removed from a magnetic field. Hysteresis is derived from the Greek word meaning a coming short or a deficiency.

Hysteresis in economics is the idea that something can happen that causes a second thing to happen; then the original cause, the first thing that happened, stops happening, but the second thing continues. It applies especially to unemployment and international trade. Say an overvalued exchange rate or a lack of demand caused by over taxation causes industries to go bankrupt and results in mass unemployment. ( the situation in the UK after 1979). Then later demand increases because the exchange rate depreciates or taxes are reduced. There is increased demand but the unemployed are not rehired because employers don’t want to hire people who have been out of work. Or perhaps the new jobs on offer require new skills that the unemployed have not been given training for. The unemployment persists; it can apply to international trade when the factors that make a country uncompetitive have been relieved, but the other countries that were trading successfully have moved on in leaps and bounds, gaining expertise as they learn by doing and increasing their investment in new technology courtesy of the profits they were making. The country that became unsuccessful may continue to be unsuccessful. Hysteresis has a lot to answer for.

See Incremental Capital Output Ratio.

This can be confusing as it’s a bit counter intuitive- a higher ICOR is bad, and lower one is better- the ICOR measures the amount of extra output you get from each extra unit of capital you use. So, the less capital you need to produce one extra unit of output the more efficient your capital is. Technically the definition is usually phrased the other way round: how much must the capital stock increase by to get a 1 unit increase in output. The Social Rate of Return on Capital is the reciprocal. See SRRC below For the SRRC therefore the higher the rate the better.

Government policies to help the domestic development of particular desirable or productive industries, in order to boost productivity, create higher-paid jobs, and enhance international trade performance. Tools of industrial policy can include measures to stimulate investment in targeted industries; trade policies (such as tariffs, export incentives, or limits on imports); and technology policies. Britain’s Achilles Heel argues that a competitive exchange rate is an absolutely integral requirement of industrial policy, without which none of the strategies mentioned will work.

Inflation refers to rising prices, but there are different ways of measuring price rises. One way is to refer to the Term Structure of Prices.

The idea here is that buyers can buy stuff now for delivery at some time in the future. If you buy now and get delivery immediately or very quickly then you pay “today’s” price. But you may pay now for something that will be delivered much later, maybe months or years in the future. The future cost of something being delivered in the future will depend upon the costs the supplier has to bear between now and when the good or service is delivered. These costs will include the cost of storing it and any interest that has to be paid between now and when it is delivered. The future cost therefore has to take into account interest rates. Take a commodity, such as wheat and assume that interest rates are zero, as they have been in Japan for a long time. Then the price of buying wheat in Japan, all things equal, will not rise as the interest costs that have to be borne are zero. This measurement of future prices is referred to as the term structure of prices; the word term refers to the time period between now and the future. If the interest rates in an economy are 5%, then each year these interest charges will have to be incorporated into the future price. In which case the term structure of prices will rise by 5% per year, all things equal.

One academic definition of inflation is “an ongoing annual increase in prices”. Data shows that when interest rates are low the ongoing annual increases in prices are low; when they are high, the ongoing annual increases are higher. While supply side improvements or problems will lower or raise prices, and demand side fluctuations will likewise affect prices, the underlying price trend will be determined by interest rates. The data shows this to be true. In Japan the term structure of prices has been flat while it has had low interest rates.

It follows that low interest rates mean lower inflation, all else equal, and higher interest rates mean higher inflation, all else equal. This reality is the opposite of mainstream economic theology which holds that the way to get prices down is to increase interest rates! Slightly bananas!

Normally, when commentators and politicians talk about inflation, they don’t talk about the way interest rates affect ongoing changes in prices. Instead, they just compare the price of a bunch of goods now, with the price of a bunch of goods in the past. They quote the year-on-year change in price. Different bunches of goods contain different goods. The idea is to make up a bunch or shopping basket that the average guy or average household is likely to have. Of course, a wealthy household’s shopping basket will be very different from a very poor person’s shopping basket. Poor people pay a much higher portion of their take home income on accommodation and utilities than wealthy people. So, when the CPI is based on an “average shopping basket” it may show a much lower increase than a poorer household’s shopping basket.

In the post pandemic cost of living crisis utilities, accommodation and food, which form a major part of a poorer household’s shopping basket, have gone up more than many of the goods in a wealthy household’s shopping basket.

When thinking about inflation you have to be aware of all this before deciding whether a government is doing a good job in protecting your own interests.

Here are three common price indexes used in the UK:

**CPI - **Consumer Price Index - this does not include the cost of housing or Council Tax- it is a geometric mean - it is meant to reflect changes in what people are actually buying better than the RPI. It is usually lower than the RPI.

**ONS GDP deflator - **this also takes into account improvements in efficiency in the public sector. It’s tricky to calculate these, hence controversy.

**RPI - Retail Price Index - **this includes the cost of housing, such as mortgage interest and council tax, and is an arithmetic mean - it adds up the price of all the items and then divides by the number of items; it is invariably higher than the CPI.

bank created money, as opposed to government created money (Outside Money)

This was a model of the economy by John Hicks that purported to explain what Keynes was on about.

IS stands for investment savings and LM stands for Liquidity Preference Money Supply. The Investment Savings Line represents the market for goods: I is the interest rate and the idea is that as interest rates fall, investment increases because it’s cheaper to borrow money and this makes more projects profitable. The LM curve represents the money market: as businesses expand they need to attract more money from savers, and for savers to be encouraged to save instead of spend, interest rates must go up. The **LM **curve slopes up to the right, the IS curve slopes down to the left, and where they cross is the mythical equilibrium point. Keynes in fact realised that when times are uncertain people will hold cash instead of investing it, because they won’t trust parting with their cash to invest: it is their “liquidity preference “ that decides how much they wish to keep in liquid funds, (liquid funds are ones that can be quickly and with certainty converted into cash). While this was an insight that the neoclassical economists did not share, it’s not clear whether Keynes realised that investment does not necessarily come from savings. Banks create the money for firms to invest when they grant them loans. We now have enough historical data to note that periods of high investment do not correlate with periods of high investment, so the IS LM curve of Hicks is wrong not just as an interpretation of Keynes but it is also empirically unsound. The extent to which Keynes himself failed to fully understand that loans create deposits and therefore liquidity is less clear.

**An investment bank is different from a high street commercial bank. It is an intermediary, that carries out a variety of financial services. It arranges for investors to pool their unspent income (their savings) and invest in firms; this process does not create new money extending loans on the basis of the borrowers promise to repay; an investment bank collects existing deposits and invests these when a firm wants to raise capital by issuing securities, such as shares, the investment bank provides the expertise to assess the firm’s project and to organise the structure and price of shares offered and attract potential investors.

There can be a conflict of interest between the advice given by their advisory divisions, for which they get paid fees, and the profit and loss of their own trading divisions which depend on their market performance; the two divisions are therefore meant to be kept separate.

Clients include corporations, governments hedge funds, pension funds and other financial institutions

They connect people with capital to firms that require money.

An investment bank is usually involved when a startup company prepares for its launch of an initial public offering (IPO) and when a corporation merges with a competitor. It also has a role as a broker or financial adviser for large institutional clients such as pension funds.1

Global investment banks include JPMorgan Chase, Goldman Sachs, Morgan Stanley, Citigroup,Bank of America, Credit Suisse, and Deutsche Bank. (Source: Investopedia)

Investment banks can also extend loans and act in the way commercial banks do.

Services carried include

Financial Advisors

As a financial advisor to large institutional investors, an investment bank may provide strategic advice on a variety of financial matters.

They accomplish this mission by combining a thorough understanding of their clients' objectives, industry, and global markets with the strategic vision necessary to spot and evaluate short- and long-term opportunities and challenges.

Mergers and Acquisitions

Facilitating mergers and acquisitions is a key element of an investment bank's work.

The investment bank estimates the value of a potential acquisition and helps negotiate a fair price for it. It also assists in structuring and facilitating the acquisition to make the deal go as smoothly as possible.

Research

Investment banks have research divisions that review companies and write reports about their prospects, often with buy, hold, or sell ratings. This research may not generate revenue directly but it assists its traders and sales department.

The research division also provides investment advice to outside clients who can complete a trade through the trading desk of the bank, which would generate revenue for the bank.

Research maintains an investment bank's institutional knowledge on credit research, fixed income research, macroeconomic research, and quantitative analysis, all of which are used internally and externally to advise clients.

There are now millions of working age people in the UK who are out of work or underemployed. While fiscal policy will ensure the economy operates near full employment, the government offers a paid job to those who are between jobs or who are laid off during downturns. The jobs are funded by the central government, but locally designed and run. This pool of employed labour replaces the deliberate policy of a pool of unemployed labour. It acts as an automatic stabiliser and a price anchor. It is cheaper than the current cost of £125000 for each young person out of education and employment! It improves mental health, social well-being, and prevents a race to the bottom in wages. It will permanently increase the share of the national cake going to those who work rather than to those who live off the ownership of existing wealth.

see** Elasticity** and Marshall-Lerner Condition. Linearity means that a relationship can be represented by a straight line. Economics often start by assuming that one variable changes in a steady, proportional way when another variable changes. They may assume linearity in their models, ignoring that relationships are often non-linear, or that they can be linear for a time, until a tipping is reached.

This states that for a currency devaluation/depreciation to reduce a current account deficit, the sum of the price elasticities of demand for exports and imports must sum to greater than unity. Unity means 1. Elasticity refers to the degree to which the sale/purchase of a given good or service responds to a change in price or a change in the income of potential buyers.

If UK export goods have high income elasticity of demand, that means that if income in countries we export to goes up, then a lot more of our exports will be sold. If UK export goods have high price elasticity of demand, this means that if their price goes down, the cheaper price will result in a lot more sales. For imports the same applies but in reverse- if imports have high price elasticity, then if they go up in price, we will import a lot less

.

The issue, in terms of reducing a current account deficit therefore, is whether for exports a fall in price which results in less money received for each unit sold, is more than compensated for by the increase in volume. For the current account deficit to reduce the gap between imports and exports has to get smaller and this can be by exports increasing in value more than imports, or by imports reducing in value more than exports. Or by a combination that reduces the deficit. If the sum of the elasticity of exports and imports is greater than 1 (one/unity), this will happen.

Opponents of devaluation say export and import price elasticities are low, but their income elasticities are high. They believe that when UK incomes rise, we buy too many imports - they are price inelastic- rather like addictive products such as cigarettes, when the price rises, we still go on buying them. Opponents of this book claim our exports are also price inelastic but income elastic- when their price falls, we don’t sell much more of them; exports only increase when incomes rise in those countries that buy them. This has led economists such as Thirlwall to argue the UK could not solve its trade deficit problem through devaluation - it must restructure its economy through supply side measures to make our exports more desirable. This book regards price elasticity of demand as non-linear and context specific.

Elasticity is non-linear.

This means that the response of export sales to a diminution in price is not constant- for example if the cost of producing and selling a food-blender for export were to fall by 20% from its current level, there might be no increase in export volumes if food blenders are available from other countries at a cost 23% below the cost the UK would produce them at. So, a 20% fall in price would show a price elasticity of precisely zero. But if the price fell by 26% this would make food blenders cheaper than those currently selling round the world. With this extra 6% price drop export volumes might increase. Elasticity would now “kick in”. Economists who like to draw graphs showing changes would have to draw a line that would be straight and showing no change in sales as prices fell, until the price fell by more than 23%, at which point the line would bend- the rate of change would not be constant- the line would not be straight- it would be non-linear.

A pre-capitalist economic theory and practice- you got rich by exporting far more to other countries than you imported from other countries; the idea was to have an ongoing trade surplus; you made up the difference by accumulating gold. The more gold you had the better. Free traders pointed out that one person’s surplus is another’s deficit; eventually deficit countries would not be able to find the resources to go on importing from the surplus countries. This is topical today when countries such as Germany, Switzerland and China keep persistent trade surpluses. They are sometimes accused of having neo-mercantilist policies. This author is concerned about these imbalances and how they can be rectified.

we should restrict the money supply to control inflation - see under A - Economics – schools of. **Monetarism **- Monetarism is arguably the rebirth and development in the late 1970s of an old establishment preference for focusing on money and prices rather than on production. Its most famous advocate is Milton Friedman (see Monetary Targeting). Inflation is held to be a purely “monetary” phenomenon, which means it’s caused by too much money being issued into the economy and that we can always stop it by making sure the government reduces the money supply. It puts money supply as the cause of inflation, rather than turning things around and assuming that rising prices are the cause of the increase in the money supply. More broadly, monetarism believes that inflation is a major danger to economic performance, and should be controlled through disciplined policies; modern “quasi-monetarists” agree with this view, but now use high interest rates (rather than monetary targeting) to indirectly regulate the money supply.

Monetary policy is the use by government and government agencies (especially the central bank) of interest rate adjustments and other levers (such as various banking regulations) to influence the flow of new credit into the economy, and hence the rate of economic growth and job-creation. A “tight” monetary policy tries to reduce the growth of new credit (through higher interest rates); a “loose” monetary policy tries to stimulate more credit creation and hence growth.

A policy, as per Friedman above - which tries to directly limit the growth in the total supply of money in the economy. It was the main policy tool used by strict monetarists. This policy approach failed in the 1980s, when it became clear that the supply of money could not be directly controlled by a central authority.

Broadly speaking, money is anything that can be used as a means of payment (for example, to settle a debt). It includes actual currency (that means notes and coins of the currency), bank deposits, credit cards and lines of credit, and various modern electronic means of payment. See M0 M1 M2 M3

Economists divide money into different “types”.

M0- Central Bank Money - High Powered Money, monetary base, or narrow money. This money is the notes and coins produced by central banks or by the Mint, which they own and control. Where is it? It’s in our pockets, piggy banks, safes, suitcases or under our beds or up chimneys; some is waiting for us in cash machines and banks and the rest is in the central bank, which supplies it to banks when they need more.

M1 consists of the Notes and coins of M0, plus money in sterling current accounts. This money is the money in our current accounts and exists on a ledger in banks’ computer drives. It can be converted on demand into M0, namely, cash and notes. M1, accounts today in the UK for only circa 3% of money!

M2 consists of M1 plus money in sterling deposit accounts of up to three months’ notice or up to two years’ fixed maturity, These M2 deposit accounts cannot be immediately be returned to a current account and therefore cannot be *immediately *converted into cash and coins.

M3 consists of M2 plus repurchase agreements, money market fund units, and debt securities up to two years - this is to be consistent with M3 as measured by the Eurozone.

M4 M3 plus deposits at UK building societies

M1 M2, M3 and M4 together, are referred to as broad money:

Commercial banks create new money whenever they create a new loan- having decided the borrower is credit worthy, they type the value of the loan into their own account and into the borrower’s account. Assume the loan is for £1000. The bank records a £1000 asset, because the borrower now owes the bank £1000 (plus interest); it also records it as a £1000 liability, as it must pay this to the borrower who now has £1000 in their account; on the bank’s balance sheet the borrowers account is a liability for the bank. Of course, in the borrower's account it will show up as a deposit. The bank has added £1000 of credit money out of nowhere because it chose to do so. If the borrower keeps this in a current account M1 has increased by £1000. When the conservative government under Chancellor Geoffrey Howe tried to reduce the money supply by putting up interest rates, he found he could not do so and later abandoned the policy. Banks may choose to create more money, even if interest rates go up, or may choose not to create more money when interest rates go down. The money creation depends on the confidence of borrowers and lenders to agree to the deal, and interest rates are not the sole factor that influences this decision.

Looking only at the nominal value of money and not its real value - for example if your wage increases by 5% you are happy if you fail to notice prices are up by 6%. You are deluded because your **real **wage has gone down. You are suffering from Money Illusion.

An initial stimulus to spending (in the form of new business, consumer, or government purchases) usually results in a larger final increase in total spending, production, and employment in the economy. This magnifying effect is called the multiplier. The strength of the multiplier depends on many factors, including the type of initial spending, the importance of imports in spending, and the amount of unused capacity that initially exists in the economy. The multiplier effect was made famous by Keynes, who showed that an initial increase in government spending would have a knock-on effect as it is spent not just once but many times. Keynes noted that wage earners have a marginal propensity to consume which is higher than a firm’s marginal propensity to consume and may be higher than a firm’s marginal propensity to invest. The wage earner spends and consumes from wages earned. The firm (or “capitalist”) spends from profits. At any given time, if the wage earner earns one extra pound in income, they will spend a certain proportion of that pound and save the rest. The higher proportion they spend (i.e., the higher their marginal propensity to consume) the greater the knock-on effect throughout the economy. If instead of spending most or at least some of the extra pound they were to save all of it, then the multiplier effect would not exist. Thus, if consumers have a high marginal propensity to save, the economy can slow right down. After the GFC when UK consumers started to pay down debt, the multiplier effectively collapsed, helping to create the recession. There are therefore times when too much saving can damage the economy.

See Non-Accelerating Inflation Rate of Unemployment and also Natural Rate of Unemployment below.

The accumulated debt “owed” by the government – it consists of all the money spent into existence by the government that has not been redeemed through taxes. It is the accumulated net financial assets of the private sector. However, in mainstream economics it is only referred to as debt when it has been converted into gilts or bonds. Bank deposits and central bank reserves are not called debt, even though they are a government IOU (hence debt) that has been swapped for a piece of paper called a gilt or bond that can be traded. It can be owned by the government, by the people within the country and by overseas holders, such as overseas banks, overseas governments and overseas companies. In accounting terms, the holders of debt are defined as “lenders”.

This so-called national debt is usually presented as if it were a burden owed by “the nation” to some outside creditor. This is misleading. In accounting terms, government debt is a liability of the state, but it is also an asset of whoever holds it. The government’s liability is the non-government sector’s financial asset.

The national debt is best understood as the accumulated stock of sterling-denominated financial assets left in the non-government sector as a consequence of past government deficits and related monetary operations. When the UK government spends more into the economy than it removes in taxes, the non-government sector receives a net financial asset. Over time, those accumulated net injections appear, in conventional accounting, as public debt.

Government spending, taxation, reserve creation, cash issuance, and gilt sales are different operations. But the core accounting point remains: the state’s deficit is the non-government sector’s surplus, and the accumulated government debt is the accumulated record of those past net injections.

Gross Debt, Net Debt and Public Sector Borrowing

Several different terms are often confused:-

**Public Sector Net Borrowing, or PSNB, **is the annual deficit. It measures how much the public sector has borrowed in a particular year because its spending exceeded its receipts. In ordinary political language, this is usually called “the deficit”.

**Public Sector Net Debt, or PSND, **is the accumulated stock of public sector debt, after deducting liquid financial assets. This is the UK’s most commonly quoted headline debt measure.

**Gross debt is broader. **It counts the public sector’s liabilities without deducting financial assets. International comparisons, such as IMF or Maastricht-style figures, often use gross general government debt rather than the UK’s headline PSND measure. This is one reason different sources give different debt-to-GDP ratios for the UK.

Public sector net worth is broader again. It attempts to compare the public sector’s total assets, including some non-financial assets, with its total liabilities. This is not the same as public sector net debt. Roads, schools, hospitals, land, military assets and public buildings are real assets, but many are not readily saleable and should not be treated as if they were money in a bank account available to pay off gilts.

To clarify:

PSNB is the annual deficit. PSND is the accumulated headline stock of public debt after deducting liquid financial assets. Gross debt is a broader measure of liabilities before those deductions. Public sector net worth compares public sector assets and liabilities more comprehensively, including non-financial assets.

Who Owns the Debt?

UK government debt is mostly made up of sterling liabilities, especially gilts and Treasury bills. These are held by a mixture of domestic and overseas investors, including pension funds, insurance companies, banks, households, companies, overseas institutions, and the Bank of England’s Asset Purchase Facility.

The exact ownership shares change over time. This is especially true because the Bank of England bought large quantities of gilts under quantitative easing and has since begun reducing those holdings.

Under quantitative easing, the Bank of England bought gilts, largely from private financial institutions. The sellers’ banks received new central-bank reserves, and the sellers themselves received bank deposits. QE therefore changed the composition of private-sector balance sheets: fewer gilts, more deposits, and more reserves in the banking system. It did not make the UK “better funded”.

Nor did it provide the government with money it could not otherwise create. It was an asset swap carried out through the central bank.

Where gilts are held by UK residents, the interest paid on them is also income to UK residents. Where gilts are held overseas, the interest flows abroad. But in either case, the gilts are overwhelmingly denominated in sterling. That distinction matters more than whether the holder is domestic or foreign.

Foreign-Held Debt and External Debt

It is also important not to confuse foreign-held government debt with external debt.

**Foreign-held government debt **means UK government liabilities, such as gilts, held by overseas investors.

**External debt is much broader. **It includes public and private liabilities owed by UK residents to non-residents, including debts of banks, financial firms, companies and government. Because the UK has a large international financial sector, its gross external debt can look very large. But this does not mean the UK government is in the same position as a country that has borrowed heavily in a foreign currency.

The real vulnerability is not debt in the abstract. The key question is:

Is the debt denominated in a currency the issuer can create, or in a currency it does not issue and must therefore obtain from elsewhere?

The UK government issues debt mainly in sterling, its own floating currency. It is therefore not financially constrained in the same way as a household, business, local authority, eurozone member state, or emerging-market state that has borrowed heavily in dollars or euros.

That does not mean there are no constraints. The real constraints are inflation, productive capacity, imports, the exchange rate, distributional conflict, and ecological limits. But the UK government cannot involuntarily run out of sterling in the way a household can run out of money or Turkey can run short of dollars.

Why Currency Denomination Matters

A two-country comparison makes the point clearer.

A country is more vulnerable when its liabilities are denominated in foreign currency, because it cannot issue the currency required to service those debts. If a government, banking system, or corporate sector owes large amounts in dollars, euros or another foreign currency, it must obtain that currency through exports, borrowing, asset sales, or foreign-exchange reserves. If confidence falls, the exchange rate falls, and the foreign-currency debt burden can rise sharply in domestic-currency terms.

That is the classic danger for countries with large foreign-currency debts.

The UK is in a different position. Overseas investors may hold sterling assets, including UK government gilts, but those assets are denominated in sterling. The UK state is the monopoly issuer of sterling. It therefore faces a different type of risk: not solvency in its own currency, but inflation, exchange-rate pressure, import costs, and the availability of real resources.

This is why the phrase “the national debt has to be paid back” is misleading. A currency-issuing government does not need to “pay back” its debt in the household sense. Maturing gilts are paid by crediting bank accounts. The question is not whether the UK can find the sterling. It can. The real question is what level and composition of government spending, taxation, private credit, imports, investment and resource use is consistent with price stability, full employment and ecological sustainability.

Concise Summary

The national debt is not a household-style burden passed on to future generations. It is the accumulated stock of sterling-denominated government liabilities, which are also financial assets held by the non-government sector. The annual deficit is measured by PSNB. The accumulated headline stock is measured by PSND. Gross debt is a broader measure of liabilities. Public sector net worth takes account of a wider set of assets and liabilities. Foreign-held gilts should not be confused with gross external debt. The crucial issue is not whether the holder is foreign, but whether the debt is denominated in a currency the issuer controls.

For the UK, the central constraint is not the availability of sterling. It is the availability of real resources, productive capacity, imports, labour, energy, infrastructure and ecological space. That is the ontologically correct starting point: money is a creature of the state, but real wealth consists of the resources, skills, institutions and productive capacities that money can mobilise.

To reassure those afraid of government here is a rough balance sheet comparison between state liabilities and state-owned assets.

Using the latest ONS balance-sheet table (2026):

Let's do a two-country comparison, showing how a country is vulnerable when its national debt consists of more foreign denominated assets than foreigners own of its domestically denominated assets. In the example below, Turkey is vulnerable, because it cannot issue foreign currency.

For the UK, more people outside the UK own GBP assets, than UK people hold foreign assets.

For Turkey, more Turkish people hold foreign denominated assets than foreign people own Turkish lira assets. Turkey’s external debt is 60% of its GDP. The UK's external debt is 337% of its GDP. But it is Turkey that is vulnerable.

According to neoclassical economics, the wage rate is determined by a process of labour-market clearing (in which workers and employers compete with each other, ensuring that labour supply equals labour demand). Why, then, do we often observe unemployment? Neoclassical theorists argue that observed unemployment reflects frictional, structural, or disguised effects that are consistent with labour market clearing. In other words, this “natural” level of unemployment is, in fact, full employment. It is fruitless, in this view, to try to reduce unemployment below this natural level - misguided attempts to do so only create inflation. Unions, minimum wages, and other “market-inhibiting” measures will tend to increase the natural rate of unemployment. The monetarists developed this into the NAIRU- if governments try to increase employment above the natural rate, then inflation will result. There is therefore a natural rate of unemployment which does not result in inflation. This is the NAIRU.

See Economics above.

Nominal gross domestic product measures the total value of all the goods and services produced and traded for money in the formal economy, evaluated at their current money prices. Nominal GDP can grow from one period to the next because of an increase in actual (real) output, and/or because of an increase in average prices (that is, as a result of inflation).

This theory is a variant of the neoclassical Natural Rate of Unemployment (see above). As in original natural rate theory, NAIRU advocates believe that unemployment cannot be reduced below a certain level without sparking a continuous acceleration in inflation. Unlike the original natural rate theory, however, the NAIRU doctrine does not strictly define this position as “full employment.” The policy prescriptions of the natural rate and NAIRU theories are practically identical (namely, don’t try to reduce unemployment through demand-side measures, but instead attack unions and minimum wages to allow labour markets to function more “efficiently”). Neoclassical economists tend to blame unemployment on labour market rigidities (unions, minimum wages, employment protection law, unemployment benefit) as opposed to deficient effective demand.

See Elasticity and price elasticity.

Some products cannot be transported over long distances, or otherwise sold to consumers from far-off locations. These products (including some goods and most services) are hence considered non-tradeable - they must be consumed near to where they are produced. Non-tradeable products include most construction, some manufacturing (such as highly perishable or extremely bulky products), most private services, and nearly all public services.

See Inflation.

To hit their desired interest rate, central banks buy and sell government bonds (Treasuries or Gilts) on the secondary markets; the primary market consists of the central bank and the commercial banks that have been specifically chosen to purchase new government bonds; the secondary market consists of the government, via the central bank and Treasury, buying and selling government bonds from and to non-bank institutions.

When a central bank buys government bonds from non-banks it increases the money supply because the seller of the bond gets a deposit in its bank account which sits on the liability side of the bank’s account, matched by government reserves on the asset side of its account. If the central bank sells a bond to a non-bank institution, the recipient loses deposits, and gains a bond. Bonds of short duration are considered part of the M3 broad money supply definition but not part of the narrower M2 definition. Whether we regard selling bonds to the non-bank sector as reducing the money supply depends on how we have defined money supply. Bonds have been swapped with bank deposits. The latter are regarded as part of the money supply, whereas the bonds are not.

In the mid-1990s, Joseph Overton of the Mackinac Center for Public Policy in Michigan argued that politicians are usually not the originators of ideas, but followers of what public opinion will tolerate. Their policy choices are therefore confined by the prevailing conventional wisdom, the “window” of what is politically possible. Over time, if the consensus changes, that window moves, opening up new possibilities and closing off others. Activists, writers, intellectuals and think tanks therefore try to shift the Overton Window by making once-radical ideas seem acceptable, and eventually mainstream.

Money created by government when it spends.

see also** Fallacy of Composition **- An individual household, business, or government may attempt to save money by reducing their current expenditures. However, those attempts to save, once amalgamated at the level of the overall economy, may reduce aggregate spending levels and hence output and employment, thus undermining overall growth or even causing a recession. If this occurs, the revenue of households, businesses and governments will decline, and overall saving may end up no higher (and potentially be even lower) than before the effort to boost savings began. Because of this paradox, it is not usually possible to improve economic performance by boosting savings.

The proportion of working-age individuals who decide to “participate” in the labour force, by either being employed or actively seeking work. The precise definition of what constitutes “actively seeking work” varies from one country to another, and over time. Comparisons are therefore tricky. For example, governments can underestimate the rate of unemployment by ignoring those who are not actively seeking work because they are demoralised and know from personal experience that the chances of getting work are remote. Alternatively, there are those who have not got the money to travel to job interviews.

An abstract assumption, central to neoclassical economics, in which companies are so small that none can influence total output or price levels in an industry, none can make its products different from those of competing firms (= products are homogenous), and none can anticipate or interact with the actions of its competitors.

The textbook definitions formalise these ideas by citing five criteria that must be met for perfect competition to exist: 1) Firms sell an identical/homogenous product (as above). 2) Firms are price takers, so they cannot influence the price of the product.3) Firms have a fairly small market share (how large a firm’s market share has to be before it has a degree of control over prices is tricky to assess and the subject of debate). 4) Buyers have perfect/complete information about the product being sold and the prices charged by each firm. 5) New firms can enter the market and existing ones can exit the market (for example if a huge amount of capital is required to enter a market, existing firms will have a degree of monopoly power; indeed, they may even sell products below cost for a while when new entrants try to move in to their market). Textbooks often cite a vegetable market as an example of a perfectly competitive market: buyers can see all the prices and the quality of the products and all sellers therefore have to sell at the same price. However, critics argue that perfect competition is rare in real life: - it is a theoretical assumption developed to support the internal logical integrity of neoclassical economic theories.

A tangible tool, building, machine, or other productive asset which is used to produce other goods or services.

See Economics.

Most economic statements about poverty are not absolute but relative - they are derived from a ratio: for example, the percentage of households that have less than 60% of average household income.

The purchasing power of a currency refers to how much currency is needed to purchase a given unit of a good, or a common basket of goods and services. Purchasing power is determined by the relative cost of living and inflation rates in different countries. One Euro will buy more in China than it will in Germany, because the cost of living is cheaper in China. When we compare the GDP of different countries by converting the value of GDPs measured in different currencies into a common currency, it can exaggerate the difference in the real standard of living between countries. If we convert GDP per head in Chinese yuan into Euros, China will look very poor.

To get a better comparison, we can try and compare how many actual goods and services can be purchased in China with its average GDP per head, and do the same in Germany. The difference in the standard of living will now be less. Purchasing power parity means equalising the purchasing power of two currencies by taking into account these cost-of-living differences.

Asserts that with free markets, the price of goods in different countries, measured in a common currency (i.e.) converted into one currency, should be the same. If prices are different, it means the countries concerned do not have Equilibrium Exchange Rates. Economists have tried to find evidence that in the very long run there is a trend to Purchasing Power Parity. The evidence is weak and or contested. In reality, exchange rates do not usually move towards equilibrium as defined above, and costs and standards of living can vary enormously for sustained periods of time in countries that are indeed trading with one another.

Quantitative easing is usually presented as a way for the central bank to stimulate the economy by buying assets, especially government bonds, in order to lower yields and borrowing costs. In practice, the central bank buys bonds in the secondary market and pays by crediting reserve accounts at the central bank.

The conventional story is that this gives commercial banks more money, which they can then lend to businesses and households. But this is wrong. Central bank reserves are used by banks to settle payments with each other. They cannot be lent directly to firms or consumers, and they cannot be spent by households on goods, services or houses.

QE is best understood as an asset swap. If the central bank buys bonds from commercial banks, the banks give up interest-bearing gilts and receive central bank reserves. If it buys bonds from non-banks, such as pension funds, insurance companies, investment funds, companies or individuals, those sellers give up gilts and receive bank deposits, while their banks receive additional reserves at the central bank. In either case, QE changes the composition of private-sector balance sheets rather than injecting new spending into the economy in the way that fiscal policy does.

The hope was that, having exchanged bonds for lower-yielding money-like assets, banks and investors would seek higher returns elsewhere. But banks do not lend because they have more reserves. They lend when they can find creditworthy borrowers and profitable lending opportunities, subject to capital requirements and risk. After the global financial crisis, businesses were cautious, banks were cautious, and increased reserves did not translate into a surge of lending to the real economy.

Instead, QE worked mainly through financial markets. By buying government bonds, the central bank pushed up bond prices and pushed down yields. Investors then shifted into other assets, including equities and property. This helped raise the price of existing financial and property assets, benefiting those who already owned them. Critics therefore argue that QE did more to inflate asset prices than to support productive investment, wages or ordinary household spending.

This is why QE did not produce the consumer-price inflation that many of its critics predicted. It increased reserves and helped raise the prices of financial and property assets, but it did not directly increase wages, pensions, benefits or public spending on goods and services. Without a matching rise in household incomes, business investment or bank lending to the real economy, there was no direct mechanism by which QE alone would cause a general rise in consumer prices. QE was therefore much more effective at inflating asset prices than at generating CPI inflation.

In short, QE swaps one asset for another. It lowers yields and supports asset prices, but it does not give banks money they can simply lend out, does not work like government spending into the real economy, and does not directly cause CPI inflation.

The value of total gross domestic product (that is, all the goods and services produced for money in the economy) adjusted for the effects of inflation.

The interest rate on a loan, adjusted for the rate of inflation. The real interest rate represents the real burden of an interest payment. Real interest rates must be positive for the lender to attain any real income from the loan.

The value of wages, adjusted for the level of consumer prices. If the nominal value of wages is growing faster than consumer prices, then real wages are growing, and hence the real consumption possibilities offered to workers are improving.

Imprecisely used, usually a sharp slowdown in growth or actual contraction in the economy for two quarters or more. See Depression

When real GDP begins to grow again, following a recession.

What Is a Repurchase Agreement?

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations.

For the party selling the security and agreeing to repurchase it in the future, it is a repo; for the party on the other end of the transaction, buying the security and agreeing to sell in the future, it is a reverse repurchase agreement.

Summary:-

• A repurchase agreement, or "repo," is a short-term agreement to sell securities in order to buy them back at a slightly higher price.
• The one selling the repo is effectively borrowing and the other party is lending, since the lender is credited the implicit interest in the difference in prices from initiation to repurchase.
• Repos and reverse repos are thus used for short-term borrowing and lending, often with a tenor of overnight to 48 hours.
• The implicit interest rate on these agreements is known as the repo rate, a proxy for the overnight risk-free rate.

Business profits which are not distributed to shareholders (through dividends or other pay outs), but instead are retained within the company in order to finance future investment or other expenditures. In times of recession most investment is done from retained earnings rather than from new borrowing.

A measure of business profitability equal to net after-tax income divided by the average level of shareholders’ equity in the business.

See Inflation.

Across three sectors, government, private domestic, and foreign, the surpluses and deficits sum to zero. Government deficits create exactly equivalent net surpluses for the other two sectors combined.

Sterilisation refers to a central-bank action designed to offset the domestic monetary effects of international trade or capital flows.

For example, suppose a country’s currency is rising because foreign investors want to buy its assets, or because exports are bringing in large amounts of foreign currency. To prevent the domestic currency appreciating, the central bank may intervene in the foreign-exchange market by buying foreign currency. It pays for that foreign currency by creating domestic currency, usually by crediting the reserve accounts of domestic banks. This increases the supply of domestic currency relative to foreign currency and helps hold down its exchange rate. (China has pursued this policy to support its exporters).

The reverse can also happen. If a currency is falling and the authorities want to support it, the central bank may sell foreign currency reserves and buy domestic currency. This removes domestic currency from the foreign-exchange market and helps support its exchange rate. But it also drains domestic reserves and liquidity from the banking system.

Sterilisation is the process of offsetting these domestic monetary effects. If the central bank’s foreign-exchange intervention has added too much domestic liquidity, it can drain that liquidity by selling government bonds, issuing central-bank bills, taking term deposits from banks, increasing reserve requirements, or using other operations that absorb reserves. If the intervention has drained too much liquidity, it can add liquidity back through bond purchases, lending operations, or other reserve-adding operations.

In simple terms, foreign-exchange intervention aims to influence the exchange rate. Sterilisation aims to prevent that intervention from automatically expanding or contracting domestic liquidity and credit conditions.

Swap Lines and Eurodollars

Fed swap lines

When the US Federal Reserve enters into a swap line with a non-US central bank, it swaps US dollars for that central bank’s currency, for example, euros, at the prevailing market exchange rate. The non-US central bank sends euros to the Fed and receives dollars in return. Both parties agree to reverse the transaction at the same exchange rate on an agreed future date. The non-US central bank also pays the Fed a fee or interest charge for the use of the facility.

Because the exchange rate for the reversal is agreed in advance, the Fed does not normally bear exchange-rate risk. Provided the counterparty central bank honours the agreement, the Fed receives back the dollars it supplied and earns income from the transaction.

Dollars and Dollar Funding

In 2018, non-US banks and offshore financial centres provided approximately $12.8 trillion of US dollar funding. This raises an important question: where did these dollars originally come from?

If a resident in Germany deposits dollars in a German bank, this is described as local dollar funding. But the question remains: how did the German resident obtain the dollars in the first place?

A US resident could also deposit dollars in a German bank. That would be described as cross-border dollar funding. But here too the question arises: where did the US resident obtain the dollars before placing them in the German bank?

It is also worth clarifying what is meant by booking dollar funding. Does “booking” dollar funding mean the same thing as making a dollar loan, or does it refer to where the transaction is recorded on the bank’s balance sheet? Is the “booking location” the location of the bank branch or entity that receives the deposit, grants the loan, or records the transaction?

Cross-border flows can become fickle in a crisis, as the events of 2008 demonstrated. That is why central banks need policy tools to backstop dollar liquidity during periods of stress. Central bank swap lines are one such tool.

Central Bank Swap Lines

Swap lines are agreements between central banks to exchange their currencies with one another. They ensure that one central bank can obtain a supply of another central bank’s currency when needed. For example, the ECB can obtain US dollars from the Federal Reserve and then lend those dollars to banks in the euro area.

A currency swap line therefore allows a central bank to obtain foreign currency liquidity from the central bank that issues that currency. This is usually done so that the receiving central bank can provide foreign currency liquidity to domestic commercial banks.

For example, the swap line between the ECB and the US Federal Reserve enables the ECB and the national central banks of the euro area, the Eurosystem, to receive US dollars from the Fed in exchange for an equivalent amount of euros provided to the Fed. Such agreements have been part of the central banking toolkit for decades.

Why Swap Lines Are Needed

Swap lines were originally used to help central banks fund market interventions. More recently, however, they have become important tools for preserving financial stability and preventing financial-market stress from spilling over into the real economy.

Since 2007, ECB swap agreements have mainly been used to provide foreign currency liquidity to domestic banks. When funding markets in a particular currency deteriorate, banks outside that currency area may struggle to fund assets denominated in that currency. For example, euro area banks may hold dollar-denominated assets but have no direct access to the Federal Reserve, which issues dollars.

If the ECB has a swap line with the Fed, it can obtain dollars from the Fed and then lend those dollars to euro area banks. This allows the ECB to provide dollar liquidity without drawing down its foreign exchange reserves.

During the financial crisis following the collapse of Lehman Brothers in September 2008, dollar funding markets dried up because of extreme risk aversion. Euro area banks found it difficult to obtain dollars to fund their dollar-denominated assets. To prevent forced asset sales, sharp price movements and disruptions to credit, the ECB and the Federal Reserve used a currency swap line so that the Eurosystem could provide dollars to banks located in the euro area.

Which Central Banks Have Swap Agreements with the ECB?

In 2011, the ECB, the Bank of England, the Bank of Canada, the Bank of Japan, the Federal Reserve and the Swiss National Bank established a network of swap lines. These arrangements allow the participating central banks to obtain currency from one another.

In the aftermath of the financial crisis, the ECB also created arrangements to provide euros to the central banks of Denmark and Sweden. It also made temporary arrangements to provide euros to the central banks of Hungary, Poland and Latvia before Latvia joined the euro area in 2014.

In 2013, the ECB established a currency swap agreement with China, reflecting China’s growing systemic importance and the rapid growth of trade and investment between China and the euro area. For the Eurosystem, the agreement acts as a liquidity backstop, reassuring euro area banks that Chinese renminbi will remain available if market conditions deteriorate.

Since then, the ECB has established additional temporary swap lines with several central banks around the world, while some earlier lines have expired.

How Swap Lines Work in Practice

Under normal conditions, a euro area bank that needs US dollars can obtain them in the market, for example to make a dollar loan to a client. But if dollar funding costs become too high, or if the market is disrupted, the bank can turn to its national central bank.

In this case, the ECB can obtain dollars through its swap agreement with the Federal Reserve. Since the global financial crisis, the ECB has conducted regular dollar-providing operations, allowing euro area banks to borrow dollars at a predefined interest rate.

In return, the banks must provide the ECB with high-quality collateral. The value of this collateral is marked to market and then reduced by an agreed deduction, known as a “haircut”. Many of these currency agreements act mainly as safety nets and have never been activated. The ECB also tests its monetary policy instruments regularly to ensure that they can be deployed safely and quickly if needed.

Central Bank Liquidity Lines

Central bank liquidity lines are established instruments in the central banking policy toolkit. They are designed to ease tensions in international funding markets. They are framework agreements that allow central banks to obtain currencies issued by other central banks in exchange for collateral, on predefined terms.

There are two main types of central bank liquidity line:

1. Swap agreements, in which one central bank obtains another central bank’s currency in exchange for its own currency as collateral.
2. Repurchase agreements, or repo lines, in which the borrowing central bank obtains foreign currency for a specified period in exchange for financial assets used as collateral.

Swap and repo lines have been used increasingly by the ECB and other major central banks since the global financial crisis of 2008–09. The ECB is part of a standing swap-line network with the Bank of Canada, the Bank of Japan, the Swiss National Bank, the Bank of England and the Federal Reserve.

During the COVID-19 crisis, the ECB reactivated existing swap lines and established new ones. It also created new bilateral repo lines with several non-euro area central banks.

Currency Swap Agreements

Currency swap agreements between central banks are contractual arrangements in which the borrowing central bank obtains another central bank’s currency in exchange for its own currency, which serves as collateral. Both central banks agree to reverse the transaction at a specified future date. The borrowing central bank repays the borrowed currency plus a contractually agreed interest charge.

The ECB can provide euros against foreign currencies accepted as collateral. Under reciprocal swap lines, the ECB can also receive foreign currency, such as US dollars, by providing euros as collateral.

Many ECB swap agreements are reciprocal. This means the ECB can either provide euros to another central bank while receiving foreign currency as collateral, or receive foreign currency from another central bank while providing euros as collateral. Which direction is used depends on the circumstances.

Some ECB swap agreements, however, only allow the ECB to provide euros to another central bank in exchange for that central bank’s currency as collateral.

Repurchase Agreements

Repurchase agreements are contractual arrangements in which the borrowing central bank obtains foreign currency for a specified period and at an agreed interest rate. In return, it provides financial assets denominated in that same currency as collateral.

Under ECB repo agreements, the ECB provides euros to a non-euro area central bank and receives euro-denominated financial assets as collateral.

The Eurosystem’s swap and repo lines are used both as monetary policy instruments and as stabilising tools during periods of stress in global financial markets.

When the ECB provides euros to non-euro area central banks, these liquidity lines address possible euro liquidity shortages outside the euro area. This helps prevent financial stress abroad from spilling back into euro area financial markets and disrupting the transmission of ECB monetary policy.

When the ECB receives foreign currency from another central bank, for example, US dollars from the Federal Reserve, and provides euros as collateral, the liquidity lines help maintain the supply of foreign-currency loans to banks. This can prevent forced deleveraging, extreme asset-price movements and interruptions in the flow of credit.

The ECB Framework and EUREP

The ECB has a main framework for assessing requests for swap and repo lines from non-euro area central banks. The ECB Governing Council considers such requests case by case.

Some ECB swap agreements are standing agreements with no fixed end date, although either party can terminate them. Others have a predefined end date but can be extended by mutual agreement.

In June 2020, the ECB established the Eurosystem repo facility for central banks, known as EUREP. EUREP was designed to broaden access to Eurosystem liquidity arrangements beyond the existing swap and repo lines.

Euro-providing swap and repo lines operate as backstop facilities. They are intended to address possible euro liquidity needs outside the euro area during periods of market dysfunction. By doing so, they help prevent problems outside the euro area from affecting euro area financial markets and the transmission of ECB monetary policy.

EUREP was initially introduced as a temporary and precautionary facility during the coronavirus shock. It was later used in response to the uncertainty caused by Russia’s invasion of Ukraine and the risk of regional spillovers affecting euro area financial markets.

A tariff is a tax imposed on the purchase of imports. It is usually imposed in order to stimulate more domestic production of the product in question (instead of meeting domestic demand through imports). The firm importing the goods has to pay the tariff to the domestic government.

See Tariff and Customs Union.

Debt imposed on population by their Government.

Capital Gains Tax - tax on an asset that goes up in value, paid if you sell it, applied to company dividends too.

Direct Taxes - tax deducted from your income (Payroll taxes, National Insurance in the UK).

Excise Duties - special extra purchase taxes - on tobacco, petrol, products whose consumption you want to reduce.

Indirect Taxes - taxes on goods and services (Purchase Tax, Value Added Tax (VAT)).

Inheritance Tax - tax on your estate when you die.

The ratio of the average price of a country’s exports, to the average price of its imports, is its terms of trade. In theory, an improvement in a country’s terms of trade raises its real income (since through trade it can “convert” a given amount of its own output into a larger number of consumable products) - although in practice it depends on how those terms of trade gains are distributed. When the real exchange rate appreciates, a country’s terms of trade improve. Modern Money theory argues that the better the terms of trade the better off you are: you get more imports for a given amount of exports. However, if currency appreciation means that your exports become uncompetitively priced, this apparent improvement *may *in fact damage the economy by hitting export production and hitting firms' ability to remain profitable. It can result in firms closing down. The firms concerned will be those producing tradable goods, rather than firms selling only to the domestic market. Service firms, such as hairdressers and restaurants, sell to the domestic market and therefore aren’t directly affected. They tend to have less opportunity for increased productivity than manufacturing firms; over long periods of time increases in growth come from manufacturing technology and energy. When these exporting industries are made uncompetitive because of currency appreciation, economic growth falls. Consumers and firms find they are buying more and more imported goods. This is fine for as long as the country concerned can export its currency to pay for its imports. The ultimate question is what enables a country to export its currency. Or looked at from the perspective of the country sending over the exports, why do exporting countries want to accumulate the currency of the country they are importing to.

A product (a good or service) is tradeable if its purchaser can buy it far away from the place where it is produced. Most goods (other than perishable or extremely perishable products) are tradeable, and some services (such as tourism and specialized financial, business, and educational services) are also tradeable. The prices of non-tradeables react less to currency changes than tradeables.

Governments redistribute a share of tax revenues back to groups of individuals in the form of various social programs (such as welfare benefits, unemployment insurance, public pensions, or child benefits). These transfer payments supplement the market income of the households which receive them. In the UK** fiscal transfer** occurs when taxes collected in wealthy areas are transferred to poorer parts of the economy. In the Eurozone, there is no Federal Government with sufficient tax to distribute to the poor areas of Europe. This is a major problem, because without their own currencies the poor countries cannot devalue to make themselves more competitive so they need fiscal transfer which is not forthcoming.

How much an employer pays for the labour required to produce each unit of a good or service. Unit labour cost can be calculated by dividing a worker’s hourly (or annual) labour cost, by the amount (in physical units or value terms) that they produce during that hour (or year). It is thus the ratio of labour costs to productivity. Companies try to reduce their unit labour cost, either by increasing productivity (the denominator) or by reducing labour costs (the numerator). With regard to the exchange rate hypothesis advanced in this book, it is vital to appreciate that it is not unit labour costs across the whole economy that determine export competitiveness but the unit labour costs in the goods that an economy exports or might wish to export. The unit labour costs of these goods do not necessarily move in tandem with unit labour costs in general.

See Sterilised Intervention.