ii) Legislation to reduce the length of a working week is a policy based on the principle of sharing the current level of work throughout the working population. In order for this policy to work the current wage rate must increase to compensate for the fall in hours. If the wage rate does not increase then the weekly wage for workers will fall, this may result in a rise of voluntary unemployed people, these are the workers who are looking for a job but will turn down work at the going wage rate. The legislation aims for firms to employ more workers and if the wage rate goes up then it is appealing to both the unemployed and the currently employed as they will have to work less hours for the same utility. This is shown in the diagram below:
However, if the wage rate is not raised or not raised to a sufficient level then people will have less disposable income, thus spending will decrease. If there is a fall in spending then aggregate demand will also fall causing a spiral effect where by firms produce less so employ less workers, lowering aggregate demand further.
iii) A cut in unemployment benefits may be an efficient method of reducing unemployment. Unemployment benefits can be seen as an advantage of being unemployed or at least a reason to not hurry into employment. Benefits offer reassurance to those out of work as they are guaranteed an income that will sustain a way of life to a certain extent; this is only if the benefits are slightly below the wage rate and so people will take benefits instead of contributing to the economy. This may mean that people would stay unemployed for an extended period of time resulting in them losing skills and becoming harder to employ. With a cut in unemployment benefits there would be an expected fall in people opting to receive benefits, as their standard of living will be much lower than if they were to work, making the opportunity cost of staying unemployed a much larger income and having a job a lot a lot more appealing.
Although it can be argued that unemployment benefits contribute to aggregate demand as it gives the involuntary unemployed more income to circulate round the economy, also it is a form of government spending. So if government spending in terms of benefits was reduced then aggregate demand would fall resulting in the firms demanding less labour.
All three of these policies offer the potential to reduce unemployment, although some appear more viable than others. The legislation to reduce the working week presents many possible problems in its application; it would be difficult to calculate the change in wage rate to coincide with loss of hours, too little and workers will leave but too high and it will strain the economy. By analysing the polices it appears that either an increase in government expenditure on goods and services or a cut in unemployment benefits would reduce unemployment most effectively either through fiscal expansion or benefit control.
2.
Toxic debt is a term that has only recently entered economic vocabulary. It is a term given to a certain class of assets that was once considered high value by the banks but is now worth considerably less or is even worthless.
Originally the term was used in the USA in accordance to loans lent out to ‘sub prime’ customers to buy homes. A ‘sub prime’ customer is one that may not be able to re-pay the loan, if this were to happen the bank could then repossess the house and sell it to cover the loan. The banks were encouraged to do this by the increasingly good property market, so a house that was bought by the customer with the loan was of greater value by the time the bank, if necessary, repossessed it to clear the loan. As the property market boomed this type of lending became a very successful business model and so the banks started bundling up these loans into collateralised debt obligations (CDO’s) and then sold to other banks priced on the risk level of the customers within the CDO; the higher the risk, the higher the price. These CDO’s were sold to banks all over the world, including those in the UK. CDO’s were appealing to other banks because it meant that they did not have to have large portfolios on their balance sheets as many loans and customers were all bundled up into single entities. The loans would then be repaid and if the customer defaulted the property was sold on the market at greater price than the original loan. With the property market continually rising the demand for CDO’s soared, but seeing as so many of these loans were leant out to ‘sub prime’ customers the number of customers defaulting grew also. This resulted in a saturation of houses on the property market bringing values right down. The fall in value of property meant that CDO’s also lost their value and in some case became completely worthless leaving the banks at a serious loss on investment. Thus being a ‘Toxic debt’ as the once highly valued CDO’s were now worth considerably less or nothing at all. The term toxic debt does not only apply to the property market though, it is also applicable with general loans to firms and individuals that fall under the same loss of value criteria.
Toxic debt is a real problem as banks rely on the underlying value of their assets to cover the costs of their obligations if the customer defaults, so if the asset has no value the bank has to right the loan off as a bad debt. The bank would expect to right off some of the loan as bad debt, but only a small percentage, around 2% to 4% but with the crash in value of the CDO’s the banks may have to right off 75% or more making a severe loss. For example the hardest hit UK bank was the Royal Bank of Scotland who had to right off £5.9billion in debt last year and raise £12billion from shareholders. The effect this has on the real economy is that the banks cannot then afford to lend to firms or individuals that have the capacity to pay it back, which results in the economy stalling. The inability to loan to businesses means that there is a stunt in investment and the economy stops growing, and without the interest on loans coming in the banks are not producing enough revenue to help pay off shareholders and cover bad debts. Toxic debt can therefore cause a complete lapse in confidence in the banks as they struggle to stay out of bankruptcy and still help lend out sufficient capital for the economy to continue growing.