Some Economic Terms (Part 2) - Daily Current Affair Article

1. FRICTIONAL UNEMPLOYMENT

  • Frictional unemployment is when workers are jobless and looking for work in a healthy economy. It doesn't matter if they leave voluntarily or are fired. Others may be returning to the labor force. It's differentiated from other types of unemployment because it's part of normal labor turnover.
  • Frictional unemployment is the result of employment transitions within an economy.
  • Frictional unemployment naturally occurs, even in a growing, stable economy.
  • Workers voluntarily leaving their jobs and new workers entering the workforce both add to frictional unemployment.

2. GILTS

  • Government bonds in the U.K., India, and several other Commonwealth countries are known as gilts. Gilts are the equivalent of U.S. Treasury securities in their respective countries. The term gilt is often used informally to describe any bond that has a very low risk of default and a correspondingly low rate of return. They are called gilts because the original certificates issued by the British government had gilded edges.
  • Gilts are government bonds, so they are particularly sensitive to interest rate changes. They also provide diversification benefits because of their low or negative correlation with stock markets. Gilts often respond strongly to political events, such as Brexit.
  • Gilts may be conventional gilts issued in nominal terms or index-linked gilts, which are indexed to inflation. Governments issue conventional gilts in the national currency, and they do not make adjustments for inflation. Index-linked gilts make payments for inflation, so they are quite similar to U.S. Treasury Inflation-Protected Securities (TIPS). There are also gilt strips that separate the interest payments from the gilts, creating separate securities.

Conventional Gilts

  • Conventional gilts are nominal bonds that promise to pay a fixed coupon rate at set time intervals, such as every six months. They represent the majority of government debt. When a conventional gilt matures, its holder receives the last coupon and the principal.
  • When first issued, the coupon rate of a conventional gilt typically approximates the market interest rate. Conventional gilts have prescribed maturities, which are often five, ten, or 30 years from the date of issuance. The U.K. also issued some undated gilts, which pay interest forever without ever reaching maturity and repaying the principal.

Index-Linked Gilts

  • Index-linked gilts represent bonds with borrowing rates and principal payments linked to changes in the inflation rate. The U.K. became the first country to issue inflation-indexed bonds in 1981. Index-linked gilts are a much more recent phenomenon in India, where they were first issued in 2013.
  • Index-linked gilts in the U.K. make coupon payments every six months, coupled with one principal payment upon maturity. Coupon rates are adjusted to reflect changes in the U.K. retail price index, which measures inflation. A higher inflation rate results in a higher coupon payment on index-linked gilts. For gilts issued after September 2005, coupon rates are adjusted based on the inflation rate published three months ago. Securities issued before September 2005 use an eight-month lag.

3. HUMAN CAPITAL

  • Human capital is the economic value of the abilities and qualities of labor that influence productivity, such as education. Investing in these qualities produces greater economic output.
  • The investments are called human capital because workers aren't separate from these assets. In a corporation, it is called talent management and is under the human resources department.
  • Human capital recognizes the intangible assets and qualities that improve worker performance and benefit the economy. These qualities cannot be separated from the people who receive or possess them.
  • In the 1950s and early 1960s, Nobel Prize winners and University of Chicago economists Gary Becker and Theodore Schultz created the theory of human capital. Becker realized the investment in workers was no different than investing in capital equipment, which is another factor of production. Both are assets that yield income and other outputs.
  • Becker differentiated between general and specific human capital.
  • Specific human capital: training or education that benefits only one company
  • General human capital: training or qualities that benefit the individual at any company.

4. INFLATION TARGETING

  • Inflation targeting is a central banking policy that revolves around adjusting monetary policy to achieve a specified annual rate of inflation. The principle of inflation targeting is based on the belief that long-term economic growth is best achieved by maintaining price stability, and price stability is achieved by controlling inflation
  • Inflation targeting is a central bank strategy of specifying an inflation rate as a goal and adjusting monetary policy to achieve that rate.
  • Inflation targeting primarily focuses on maintaining price stability, but is also believed by its proponents to support economic growth and stability.
  • Inflation targeting can be contrasted to other possible policy goals of central banking, including the targeting of exchange rates, unemployment, or national income.

5. LAFFER CURVE

  • The Laffer Curve is a theory that describes the tradeoff between tax cuts and tax revenues.
  • Tax cuts have an arithmetic effect on government revenue and spending. They have an economic effect on long-term revenue and economic growth. The total impact depends on the tax rate before the cut, among other considerations.
  • The Laffer Curve is an economic theory that describes the potential impacts of tax cuts on government spending, revenue, and long-term growth.
  • Economist Arthur Laffer developed it in 1974.
  • The Laffer Curve describes the relationship between tax rates and total tax revenue, with an optimal tax rate that maximizes total government tax revenue.
  • If taxes are too high along the Laffer Curve, then they will discourage the taxed activities, such as work and investment, enough to actually reduce total tax revenue. In this case, cutting tax rates will both stimulate economic incentives and increase tax revenue.
  • The Laffer Curve was used as a basis for tax cuts in the 1980's with apparent success but criticized on practical grounds on the basis of its simplistic assumptions, and on economic grounds that increasing government revenue might not always be optimal.

6. LIBOR

  • Definition: LIBOR, the acronym for London Interbank Offer Rate, is the global reference rate for unsecured short-term borrowing in the interbank market. It acts as a benchmark for short-term interest rates. It is used for pricing of interest rate swaps, currency rate swaps as well as mortgages. It is an indicator of the health of the financial system and provides an idea of the trajectory of impending policy rates of central banks.
  • Description: LIBOR is administered by the Intercontinental Exchange or ICE. It is computed for five currencies with seven different maturities ranging from overnight to a year. The five currencies for which LIBOR is computed are Swiss franc, euro, pound sterling, Japanese yen and US dollar. ICE benchmark administration consists of 11 to 18 banks that contribute for each currency.
  • The rates received from the banks are arranged in descending order and the top and bottom quartiles are excluded to remove outliers. The arithmetic mean of the remaining data is then computed to get the LIBOR rate. The process is repeated for each of the 5 currencies and 7 maturities, thereby producing 35 reference rates. 3 month LIBOR is the most commonly used reference rate.

7. MARGINAL PRICE

  • Marginal price is how much extra a consumer should pay for getting one extra unit.
  • It usually declines as a consumer decides to consume more of a single good.
  • It's a small, but measurable, change in a consumer's advantage if they use an additional unit of a good or service.

8. MERGERS AND ACQUISITIONS

  • Mergers and acquisitions (M&A) is a general term that describes the consolidation of companies or assets through various types of financial transactions, including mergers, acquisitions, consolidations, tender offers, purchase of assets, and management acquisitions.
  • The terms mergers and acquisitions are often used interchangeably, but they differ in meaning.
  • In an acquisition, one company purchases another outright.
  • A merger is the combination of two firms, which subsequently form a new legal entity under the banner of one corporate name.
  • A company can be objectively valued by studying comparable companies in an industry and using metrics.

9. MISERY INDEX

  • The misery index is meant to measure the degree of economic distress felt by everyday people, due to the risk of (or actual) joblessness combined with an increasing cost of living. The misery index is calculated by adding the unemployment rate to the inflation rate.
  • Since unemployment and inflation are both considered detrimental to one's economic well-being, their combined value is useful as an indicator of overall economic health. The original misery index was popularized in the 1970s with the development of stagflation, or simultaneously high inflation and unemployment.
  • The first misery index was created by Arthur Okun and was equal to the sum of inflation and unemployment rate figures to provide a snapshot of the U.S. economy.
  • The higher the index, the greater the misery felt by average citizens.
  • It has broadened in recent times to include other economic indicators, such as bank lending rates.
  • The misery index is considered a convenient but imprecise metric. There are several circumstances where it may not be accurately representative of economic distress.
  • In recent times, variations of the original misery index have become popular as a means to gauge the overall health of a national economy.

10. BROAD AND NARROW MONEY

  • Broad money is the most flexible method for measuring an economy's money supply, accounting for cash and other assets easily converted into currency.
  • The formula for calculating money supply varies from country to country, so the term broad money is always defined to avoid misinterpretation.
  • Central banks tend to keep tabs on broad money growth to help forecast inflation.
  • Narrow money is a category of money supply that includes all physical money such as coins and currency, demand deposits, and other liquid assets held by the central bank.
  • In the United States, narrow money is classified as M1 (M0 + demand accounts). In the United Kingdom, the narrowest measure of money is notes and coins in circulation.
  • Also known as M0, narrow money refers to physical money, such as coins and currency, demand deposits, and other liquid assets, that are easily accessible to central banks.
  • Narrow money is a subset of broad money that includes long-term deposits and other deposit-based accounts.

Sources

  • The Economic Times
  • The Balance
  • The Economics Help
  • The Indian Express
General Studies Paper 3
  • Economy