Youth unemployment is a problem of increasing concern - over a million youths (between the ages of 16 and 24) are now unemployed in the UK; the youth unemployment rate is 22%, well above the overall unemployment rate of 8.6%. The trajectory is up.

The willingness of employers to hire labour is, of course, determined in large measure by its cost. Youth wages have risen by less than adult wages over the last 15 years, so it is not immediately obvious that this is the source of the problem. The elasticity of the real youth wage with respect to the youth unemployment rate is negative (as we would expect) at around -0.1, indicating that a change in the youth unemployment rate from (say) 10 to 11 per cent would bring about a 10 per cent fall in youth wages. That should help to make young people more attractive to employers. Meanwhile, the elasticity of youth wages with respect to the adult wage is high (at a little over 0.8).

Weakening the link between youth wages and adult wages - making youth wages more responsive to conditions in the labour market specifically for young people - might, over the longer term, help alleviate the difficulties that many young people experience in finding work. Of more immediate concern, many firms lack the confidence to invest in new projects that would expand employment, and, where they do wish to invest, they still often lack the access to finance.

Some more evidence on what makes schools effective comes from Will Dobbie and Roland Fryer. They find that a mix of policies - including setting clear and high expectations, obtaining regular feedback on teachers, making data-based decisions on pedagogical issues - explain a substantial part of the differences in performance across schools. In light of the work that I reported in a recent blog entry, it is clear that there is a very durable impact associated with high quality schooling. The policies suggested by Dobbie and Fryer are therefore worthy of serious consideration.

Recent work by Raj Chetty, John Friedman and Jonah Rockoff suggests that teacher quality has a very considerable impact on students' outcomes - not just in terms of test scores but also in terms of lifetime earnings. These findings have obvious policy implications, but the fact remains that we still know remarkably little about how to create a good teacher. Dan Goldhaber and Emily Anthony provide some evidence that suggests that the characteristics of high quality teachers can be identified - but it is not clear that all of these characteristics can be delivered through training programmes. Based on what we do know, however, Rick Hanushek and Steven Rivkin suggest that an appropriate response is to tighten up on the subject-specific qualifications that are required of teachers, and simultaneously to firm up on human resource management - in particular tightening promotion and retention criteria. In light of the new evidence on the returns to high quality teaching, the societal benefits of such an approach are likely to be substantial.



Goldhaber, D., & Anthony, E. (2007). Can Teacher Quality Be Effectively Assessed? National Board Certification as a Signal of Effective Teaching Review of Economics and Statistics, 89 (1), 134-150 DOI: 10.1162/rest.89.1.134

Recent research by David Deming, Claudia Goldin and Larry Katz should provide a reality check for those keen on promoting the development of for-profit higher education in the UK. Using data from the US - where for-profits are now a significant player - the authors find that graduates of such institutions are more prone to unemployment and have lower earnings than those from more traditional universities. Moreover - and surely of immediate concern to government - graduates from the for-profit sector face much more severe problems of debt and their default rates on student loans are particularly high.

This evidence is particularly interesting in the context of yesterday's speech by David Willetts, Minister of State for Universities and Science, in which the goal of 'inviting proposals for a new type of university with a focus on science and technology ... (with) ... no additional government funding' was announced. There is, surely, a role to be played by the private sector in higher education. The case in favour of for-profits is not so clear.

Evidence to support my blog post of 16 December comes from the chief economist of the International Monetary Fund, Olivier Blanchard - 'substantial fiscal consolidation is needed, and debt levels must decrease. But it should be, in the words of Angela Merkel, a marathon rather than a sprint'. This is because IMF research suggests that 'it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds'.

Daniel Gros provides a clear economic analysis of an issue that has been prominent in recent debates. The question is whether austerity measures can, by reducing growth, serve to worsen government budget deficits. Gros finds that this is indeed possible in the short run, but not in the long run.

The long run finding is not surprising - to find otherwise would imply that (simply by reversing austerity measures) we could get 'money for nothing'. It is the short run finding that is both interesting and important - because it places importance on the pace with which austerity measures are applied. Few (if any) serious commentators would argue with the need to narrow the budget deficit. The choices are about how best to achieve this.

President Sarkozy and Chancellor Merkel are engaged in discussions about how to ensure fiscal discipline in the Eurozone. Amidst much rhetoric about fiscal union, there are differences about how this should be achieved. Merkel favours strict control of member states' budgets by the European institutions, with heavy penalties for members that violate limits. Sarkozy is reluctant to cede sovreignty. Both leaders are in glass houses; the early violations by their countries of the budget deficit limits of the 1997 Stability and Growth Pact set the scene for more widespread transgressions.

The leaders must tread a tough line - going too far too fast threatens democracy, but not going far enough threatens to prolong the crisis. A key part of the solution should surely involve automatic imposition of disciplinary measures. Conditional bonds continue to look as though they offer an attractive (albeit maybe only partial) solution.

It's good to see some sense of sanity returning in one place at least - the spread between French and German rates on 10 year bonds has tumbled back down to more sensible levels.

Meanwhile, the corresponding spread for Italy is proving to be somewhat more stubborn, though it has fallen by more than 0.75% points since 9 November.

Concerted action by several central banks, aimed at increasing liquidity by making it cheaper to borrow dollars, has been well received by the markets - possibly less for itself than because it hints at a growing awareness that the European Central Bank will indeed need to intervene through quantitative easing.

The OECD's latest forecasts (p.236) suggest that the UK is now slipping back into recession, with negative quarter-on-quarter growth in the fourth quarter of this year and the first quarter of 2012. This is in line with my own forecasts, though the OECD predicts a somewhat earlier recovery - with second quarter output rising, and (very) modest growth (but growth nevertheless) of 0.5% in 2012, taking the year as a whole.

The OECD also expects (p.222) the output gap - the gap between actual and potential output - to rise during 2012; this is a predictable consequence of recession. In the wake of the severe fall in output during the Great Recession, their estimates of the magnitude of this gap still look to be on the low side.

The forecasts for unemployment, unsurprisingly given renewed recession and very feeble recovery, are for continued increases over the next two years.

Details of the government's credit easing scheme have started to emerge in advance of this week's Autumn Statement. The government will introduce three schemes aimed at increasing the flow of credit to firms. These include underwriting bank loans, putting government money into an investment fund run jointly with the private sector, and enabling companies to issue bonds directly to the market. Together, these schemes should provide a significant flow of funds to businesses just at a time when conditions in the financial sector appear once again to be tightening. The package is very much to be welcomed.

Meanwhile, the Office for Budgetary Responsibility looks set to reduce its growth forecasts. This is no surprise - as I have stated elsewhere on this blog, a reasonable forecast for the coming months is for renewed recession. The credit easing package will not prevent this - the buffeting that demand is taking from the downturn in our major trading partners is too severe to be fully mitigated by any plausible dometic policy - but it will, to some extent, help.

John Muellbauer reminds us of Wim Boonstra's proposal for conditional Eurobonds - these would allow indebted economies to borrow on the financial markets at a rate of interest which - if conditions on their success in tackling their indebtedness are met - is contracted to fall over time. Boonstra first proposed such an instrument in 1991 - long before the introduction of the Euro. It's a clever idea.

Whether conditional bonds alone provide a solution to the current crisis is moot, however. The high interest rate premia (over and above German rates) that attach to Italian bonds - the spread is still around 5 percentage points. The corresponding measure for Spain is almost as high. The measures for Greece and Portugal are in silly territory. One might argue that the European Central Bank (ECB) needs to inflate some of the debt away in order to make conditions right for the introduction of conditional bonds. But if, by putting such bonds in place, we could guarantee that such an inflation would be a one-shot event, convincing the (still inflation-shy) German government that this is what the ECB must do might become a more feasible proposition.

Wim Boonstra (1991). The EMU and national autonomy on budget issues: an alternative to the Delors and free market approaches Finance and the international economy: the AMEX Bank Review prize essays, 4

The Nationwide's consumer confidence index took another tumble in October. The index has now fallen to a level below the previous worst ever scores (observed in January 2009 and February 2011). The economic environment is turbulent and the gloom is justified. Much of the policy response has now to come from abroad, with the EU still struggling to establish a coherent approach to the debt problem. But we must also look to the Chancellor's Autumn Statement at the end of this month to provide a boost to demand.

The latest forecasts from my neural network model, based on industrial production data for the UK, continue to indicate a serious slowdown in activity in the current quarter. The model expects the contraction to gather pace until the end of next summer, and growth to resume only in mid-2013.

I first reported the dip expected for the last quarter of 2011 on this blog as long ago as June 2010.

The divergence between the 3 month London Interbank Offered Rate (LIBOR) and the interest rate set by the Bank of England's Monetary Policy Committee was often, during the immediate aftermath of the 2008 credit crunch, cited as evidence that the banking system was not working as it should. In normal times, LIBOR is close to - typically a tenth or two-tenths of a percentage point above - the Bank of England's rate. Following the cut in the Bank's rate to 0.5%, the gap between the two rates fell back to near normal magnitudes. But it has been rising throughout this year. In January, it stood at 0.76% - some 0.26 percentage points above the Bank of England's rate. Today it has risen to 1%, and the rate at which it is increasing has been growing over recent months. The illness afflicting the banking sector may have gone into remission for a while - but the sickness is back.

One bank's reluctance to lend to another reflects a lack of confidence by the former bank in the latter - and across the system it suggests that bankers are becoming increasingly cautious. This has an adverse effect on the real economy as businesses and households find it harder to gain access to loans. At a time when growth is faltering, a second petrification of the financial sector represents really bad news.

And, as an article in last Tuesday's Wall Street Journal argues, the gap between base rates and LIBOR is now probably understating the extent to which financing has become difficult.

The UK economy grew by 0.5% in the third quarter of this year. This is faster than had been expected by many observers - myself included. It has to be regarded as welcome news.

But the outlook for the current quarter and the immediate future remains challenging. World demand remains muted, and the fiscal policy stance within the UK does little to promote growth. On the monetary side, interest rates remain low and the quantitative easing programme has restarted - these policies have moderated the adverse impact of other things, but it is not clear that they alone will be sufficient to underpin continued growth over the coming months.

The Chancellor of the Exchequer will make his autumn statement on 29 November. This may need to offer some fiscal easing if the relatively good outcome of the third quarter is to be sustained.

There is, understandbly, much talk at present about fiscal union. Tony Thirlwall's work reminds us that turning a country into a region cannot magic away fundamental problems.

Thirlwall, A. (1980). Regional problems are “balance-of-payments” problems Regional Studies, 14 (5), 419-425 DOI: 10.1080/09595238000185371

After a difficult few days, the European partners reached agreement last night on how to proceed in tackling the issue of sovreign debt. The main features of the deal are:

a 50% write-down for Greek debt held by private banks
additional finance for the Greek bailout package
the European Financial Stability Fund (EFSF) is to be extended
the EFSF will operate so that 'risk insurance would be offered to private investors as an option when buying bonds in the primary market' - in other words as an insurance
strengthening of the Stability and Growth Pact
changes in governance

The wording of the document is interesting. The 50% haircut is described as an invitation to 'Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notional Greek debt held by private investors'. The additional financing for the bailout fund is intended to come partly from parties (such as the International Monetary Fund) which have not been party to these negotiations. The first question that needs to be asked about this agreement - the prerequisite for going past first base - therefore, is: will key parties that are being asked to fund this agreement agree to do so?

The proposals surrounding the EFSF are central to the agreement. As BBC broadcaster Evan Davis has tweeted: 'Don't you go to jail for selling insurance when you have no means of paying out?' One might add that premia rise with risk, and when the risk is high the premia could lie outside the reach of even the expanded EFSF. An alternative to leveraging the EFSF in this way would have been to free up the European Central Bank (ECB) as proposed by Charles Wyplosz and Paul de Grauwe. While some observers may be wary of the inflationary implications of quantitative easing by the ECB, inflation is simply not a threat at present. The ECB alone has the capacity to provide all of the funding that the EFSF could conceivably require. The agreement comes up short in this area.

The strengthening of the Stability and Growth Pact - intended to provide fiscal discipline - is a step towards fiscal union, but is likewise timid. After all, the Pact in its original form has failed rather spectacularly. The new agreement issues an 'invitation to national parliaments to take into account recommendations adopted at the EU level on the conduct of economic and budgetary policies'. The EU Commission and Council 'will be enabled to examine national draft budgets and adopt an opinion on them'. The language is a fudge, and past form suggests that it will be treated as a fudge. Likewise, the agreement states that 'national budgets should be based on independent growth forecasts' - and so they should.

The governance of the Euro area also receives much attention in the agreement. There will be regular summit meetings of the 17 member states that have adopted the Euro, these being chaired by a President of the Euro summit. Clearly this forms an inner core of 17 of the 27 EU members, the remaining 10 states being in a periphery. The future political evolution of a two-tier EU will be interesting.

Hyunyoung Choi and Hal Varian have argued that data from google can be used to monitor certain economic trends. The more people are using the popular search engine to find web resources about certain key words, the more activity there is likely to be in areas of the economy connected with those words. Choi and Varian use retail sales, car sales, house sales and travel as examples.

Using a similar method for the economy as a whole presents some interesting results. A google trends analysis of 'recession', confining the search to the UK, yields the time series shown in the graph below. This clearly indicates that searches rose in the run-up to the 2008 recession. There is some sign that it is rising again now - though the series is not clear on this, and data from the next few months could see the series go either way. (It is, perhaps, surprising that 'recession' is not trending more strongly given current fears about the state of the economy. Maybe people found out what they needed to know during the last recession, or maybe they are searching for other, related, terms now.)



Language is important. During the 2008 recession, 'credit crunch' trended (see the first graph below), but 'debt crisis' (the second graph) did not. Now the reverse is the case. The terms in which the popular media describe events presumably influence the terms for which people search.

In a previous blog post, I noted Casey Mulligan's analysis of the origins of the 2008 recession in the US. More recent data - both for the US and the UK - appears in the two diagrams below.

The lines represent the marginal productivity schedules, calculated using Mulligan's method, as observed in 2007. In the US, it appears that the shake-out of labour has not been associated with a fall in productivity. Indeed between 2007 and 2009 there was little change in the position of the marginal productivity schedule. Mulligan interprets this as indicating that the fall in employment over this period was due either to supply side shifts or labour market distortions, rather than to changes in demand. An alternative interpretation is that the impact of the recession fell disproportionately on low productivity workers. In the UK, by way of contrast, the observation for 2009 lies way below the marginal productivity schedule in 2007 and 2008. This may reflect a shake-out of high productivity workers, but it is arguably more likely to reflect the severe drop in demand suffered by the UK economy at this time. In both countries there appears to have been an upward shift in 2010-11 as their economies (temporarily perhaps) recovered.

While the marginal productivity schedule is, by now, higher in the US than it was before the recession, in the UK the schedule still lies well below the pre-recession position. In this country, at least, demand deficiency has been a key factor throughout the last few years - and it remains a problem.

Quantitative easing - where the central bank buys assets from the rest of the banking sector in a move that is designed to increase the liquidity of the banks, essentially releasing more money into the economy - works. This is the conclusion of work reported in the Bank of England's latest Quarterly Bulletin, suggesting that the quantitative easing of 2009 - which amounted to £200 billion of asset purchases - served to raise GDP in the UK by between 1.5 and 2 per cent. (This work also suggests, unsurprisingly, that it raised inflation by 0.75-1.5 per cent.)

The Bank of England has now announced a new wave of quantitative easing, amounting to a further £75 billion. This is in response to the alarming signs of slowdown in the economy. The announcement is welcome. It is also likely that the Treasury will start to purchase private sector assets as a means of improving the flow of funds, especially to small firms. Since this would represent an investment, it can be done outside the government's self-imposed fiscal limits. This too is welcome - if the free market in financial services is shackled, then such measures would appear to be necessary. The government may not be good at picking winners, but neither is a rapidly re-ossifying financial sector.

Could this expansion prove to be inflationary? There are very few signs that it could. The economy is still a long long way from capacity, and the effect on headline inflation of last year's VAT rise will soon vanish from the figures. Inflation should be the thing of least concern to policy makers at this time.