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Issue 6/25 March 2009

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Today’s Issue Includes:

1) Collapse in Global Trade by Nigel Tree

This week the World Trade Organisation (WTO) forecast that the collapse in global demand will drive global exports down by roughly 9% in volume terms this year. This would be the biggest contraction since the Second World War. The situation will be more severe in developed countries with exports falling by 10% and a more moderate fall of 2%-3% in developing countries.

During the whole of 2008 world trade grew by 2% in volume terms, although growth tapered off in the second half of the year and was well down on the 6% volume increase recorded in 2007.

The WTO also noted that world economic growth measured by GDP slowed sharply last year. It fell to 1.7% from 3.5% in 2007, and is likely to fall by between 1% and 2% in 2009. This is the first decline in total world production since the 1930s. It was also the slowest growth rate since 2001 and well below the 10 year average rate of 2.9%. Developed economies were hit hardest last year and only recorded a growth rate of 0.8% compared to 2.5% in 2007. By contrast, developing countries saw an increase in growth of 5.6%, which was down from the 7.5% recorded in 2007, but was still equal to their average rate in the current decade.

The recent picture can be seen in Figure 1 below.

Figure 1: Growth in the volume of world merchandise trade and GDP, 1998-2008
Annual Percentage Change


Source: World Trade Organisation

One of the main reasons why trade performance worsened in the second half of 2008 was the volatility in the prices of primary commodities. This was particularly evident with oil prices which rose by 144% between January 2007 and July 2008 but then fell by 63% in the last half of 2008. Some recent trends can be seen in Figure 2 below.

Figure 2: Prices of selected primary products, January 1998- January 2009
Index, January 2002 = 100


Source: IMF International Financial Statistics

Why did trade contract so much last year?

The WTO gave four main reasons why the decline in trade growth is larger than in previous recessions.

  • The recent fall in demand has been a global one and more widespread than in previous downturns, with all regions of the world slowing at the same time.

  • The increasing development of global supply chains mean that goods now go through many countries as components are added to the production process. This increases the magnitude of trade flows and will have a more pronounced downward effect in current recessions.

  • The credit crisis has resulted in a shortage of trade finance.

  • The signs of rising protectionism, with countries favouring their own products and industries over imported goods, will also serve to reduce trade growth further.


Prospects for 2009

The WTO’s forecasters see a fall in global trade of 9% in 2009. But how accurate is this figure? There have been some remarkable falls in exports over recent months, with China experiencing a fall of 26% in February compared to the previous year, and countries such as Germany and Japan which are very export-oriented, also suffering large declines.

The WTO points out that although their forecast of a decline in trade is already large, there are still “substantial downside risks” to their projection. They are primarily concerned about the prospect of further adverse developments in financial markets and also the possibility of increased protectionism. Added to this they note that recovery could also be slower if household consumption does not return to trend soon.

Over the past thirty years trade has become increasingly important on a global basis, with trade growth often exceeding growth in output. Now, as demand falls we can expect trade to fall even faster. Pascal Lamy, Director-General of the WTO warned that: “Governments must avoid making this bad situation worse by reverting to protectionist measures which in reality protect no nation and threaten the loss of more jobs.” He also said that trade can be a “potent tool in lifting the world from these economic doldrums” and called upon the G20 leaders meeting next week to pledge resistance to any further protectionist measures.

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2) Where is monetary policy going? Nigel Tree gives a summary of a recent talk by David Blanchflower of the Bank of England’s, Monetary Policy Committee.

Yesterday, David Blanchflower, who is a member of the Monetary Policy Committee, gave a very interesting talk on “The Future of Monetary Policy” at Cardiff University. I will attempt here to bring out some of his key points.

He argues that while we cannot expect to abolish economic cycles, the recent credit crisis has just been too costly and that reform is required. “The ‘one-tool one-target’ approach to monetary policy of using Bank Rate to target CPI inflation has been inadequate. Inflation targeting alone will not suffice.” He goes on to say that new tools are required to regulate the financial sector and prevent such crises in the future. However, this is hampered by the fact that current macroeconomic research has little to say about bank lending, financial instability and house and asset price bubbles. He believes that policy makers are now starting from scratch.

20poundnotes_400If inflation targeting alone is not sufficient what other measures are there? He looks at so-called “macro-prudential tools” which would be involved in placing restrictions on bank lending. However, he notes that it is very unlikely that banks will take undue risks in their lending for the foreseeable future. The current problem, in fact, is that banks are currently risk averse, and time needs to be taken in deciding what measures to take. If a new macro-prudential instrument linked the level of reserves held by banks to say, GDP growth in the economy, this would restrict bank lending in the good times so that banks had excess reserves during a downturn.

However, there is a potential cause of conflict here. Trying to control the supply of credit through such policies could conflict with attempts to control the price of credit through interest rate changes. He envisages a potential situation where “Central bankers might have one foot on the accelerator, whilst simultaneously applying the hand brake.”

He does note that in ‘normal times’ there may be little difference in the transmission mechanism between controls on the price and quantity of bank lending, and poses the question as to whether central banks should “lean against the wind” when asset prices appear to rise unsustainably. Based on this he makes the suggestion that house prices should be included in the MPC target, and that it might even be possible to change the target back to the RPIX measure, which includes housing costs.

He concludes these thoughts by suggesting that central banks do need to have additional tools such as macro-prudential instruments and that there needs to be a more subtle and less target driven approach to monetary policy. Secondly, central banks will need to consider house and asset prices in combination with consumer price inflation in order to judge whether current levels are sustainable. Thirdly, central bankers need to recognize that monetary policy cannot affect growth in the medium term. He says that “stable growth in lending and money supply, however hard they are to measure, are our ultimate goal.”

To read the whole of his talk click here:

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